According to a Sept. 17, 2003 written statement from GE, the change was instituted "to attract, retain and motivate the best talent in the world, to reward outstanding performance and to align the long-term interests of our executives with those of our investors. We believe investors expect these goals to be among the board's top priorities."

Boards of directors and their compensation committees throughout corporate America will be reviewing the Immelt plan and considering whether to institute similar packages. They'll do so for those same two reasons -- satisfied investors and preferred accounting practices. Once companies decided to adopt Financial Accounting Standards Board Statement No. 123 (or FAS 123-accounting), they no longer faced the accounting disadvantage of mark-to-market accounting that exists under Accounting Principles Board Opinion No. 25 (APB 25).

Insight into Immelt's pay
Despite the timeliness of GE's announcement, the package had likely been in the works for some time. Making such a change can be challenging, and requires a sign-off on various fronts, including the CEO, corporate legal, the board of directors and the compensation committee. Over the past year, GE's compensation committee reviewed executive compensation policies and practices. They looked at the expensing of stock options, the impact of significant long-term stock ownership requirements and the institution of a one-year holding period for shares acquired upon the exercise of stock options.

When all was said and done (and signed-off on), stock options disappeared from the Immelt plan. (Other executives will retain stock options as part of their equity compensation. GE issues stock options annually in September.) Effective Sept. 12, 50 percent of Immelt's future equity compensation is based on cumulative total returns equal to or better than those of the S&P 500 over a five-year period. The remaining 50 percent of his equity pay is made up of "Performance Share Units" (PSUs), tying payout directly to the company's cash-generation performance.

Stock options versus PSUs
Employee retention figures significantly in granting stock options. The theory is that employees with options will remain with the company through the vesting period, which is often set at three years or longer. In striking stock options and adding PSUs, GE's board has signified that retention is no longer a CEO issue. The company declared, in a written statement, that Immelt needs no retention compensation, and that his equity compensation should be focused entirely on performance and alignment with investors. However, a PSU structured with no payout before the end of a performance period does provide a retention incentive.

PSU structure, in some aspects, is not unlike stock options -- with grant and vesting terms applicable to both types of equity compensation. But in other aspects, PSUs can be quite different if the value of time-vested stock options is not dependent upon corporate health. With stock option grants, a company could perform well, while the options are "underwater." A stock option is underwater when the exercise price for the company's stock exceeds the current market price. "Underwater" is not applicable to PSUs.

As some companies review "pay for performance" structures, they may consider performance options. With such options, there is no payoff to executives unless both performance is met and stock price increases. This links the executive to shareholder well-being.

According to GE, in September Immelt was granted 250,000 PSUs. That represents a present value of approximately $7.5 million -- provided performance criteria are met. The full value of the grant is at risk based upon GE stock and GE corporate performance. By comparison, in 2002 Immelt's annual equity grant was 1 million stock options, vesting in equal parts over five years, with an estimated present value of $8.4 million. (This information is available in GE's 2002 proxy statement.)

According to GE, Immelt's PSUs may vest at the end of five years; half of the PSUs will convert into shares of GE stock only if GE's cash flow from operating activities has grown an average of 10 percent or more per year over the period. The remaining PSUs will convert only if GE's total shareowner return meets or exceeds that of the S&P 500 over the period. If one or both performance criteria are not met, the associated PSUs will be cancelled. During the performance period, Immelt will receive quarterly cash payments on each PSU equal to GE's quarterly per-share dividend. In addition, he gets the dividend on 250,000 shares for five years, even if the shares are not earned. At $.80 dividend per share per year, that equates to about $1 million that was not added to the above-mentioned grant value.

Linking 50 percent of Immelt's equity compensation directly to cash generation performance of the company underscores what GE calls its "commitment to strong operating discipline, our triple-A ratings and the GE dividend." The remaining 50 percent of the equity compensation is based solely on successfully delivering GE's shareholders total returns equal to or better than the broader market.

"With the grant, more than 60 percent of Mr. Immelt's compensation is fully at risk and linked to performance measures that are directly aligned with long-term investor interests," cites a company statement on GE's Web page.

Mechanics of the plan
The mechanics of the plan are not difficult to work with. The challenge is in defining the benchmarks -- the comparators; determining how many PSUs at what value is the end result: how Immelt's compensation is actually reported on and executed. What is difficult is determining the potential range for his compensation. What benchmarks does the compensation committee use to determine how much (or how little) Immelt should be paid? Benchmarks include comparing pay to that of CEOs in similar companies, in companies that are similar in structure, size or asset base.

The beauty of Immelt's pay -- and why compensation committees will be discussing it -- is the inherent impact upon the compensation committee itself. The CEO's performance incentives are aligned with the company's fiscal health. And in an era where stories of sky-high CEO pay are putting intense public scrutiny on boards and compensation committees, this is one move that restates the committee's value to the board and the investors.

TOM WAMBERG is chairman and CEO of Clark Consulting, the largest publicly traded executive compensation firm.

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