March 18, 2002

Enron Unit Chiefs' Compensation Raises Fresh Questions

   Of DOW JONES NEWSWIRES

(This article was originally published Friday.)

LOS ANGELES -- Enron Corp. (ENRNQ) rewarded many of its key executives with unusual compensation packages that included lavish equity stakes in business units and bonuses worth tens of millions of dollars, even as the units they ran piled up losses.

The packages, outlined in filings with the Securities and Exchange Commission, shed new light on how Enron's former executives may have profited at the company's expense.

Many corporations use both equity stakes and bonuses to encourage strong performance by their executives. But analysts said those handed out by Enron were unusually large and weren't sufficiently tied to long-term performance.

Compensation experts said that in some cases the packages potentially put the executives in direct conflict with shareholders. And one equity analyst said he might not have recommended Enron stock to clients had he known the details of the packages.

"This really drives home the way executives treated a public corporation like their own cash cow," said Elizabeth Warren, a Harvard University law professor and expert on business ethics. "They looked for any excuse to pay themselves."

A number of Wall Street analysts agreed with Warren that the lavishness of the packages was unheard of, even among the country's largest corporations. A key component was equity stakes in Enron business units.

More than 100 senior executives who worked for Enron between 1988 and 2000 held equity in business units and were able at certain times to convert that equity into common stock or receive outright cash payments, Enron President Jeff McMahon said through a spokesman. There's no easy way to determine how much the company paid out before the practice was halted in 2000, the spokesman said, but some of the payments were huge.

     Not Just Skilling

As previously reported by Dow Jones Newswires, Jeffrey K. Skilling, then Enron's president, held a 5% stake in Enron's retail energy unit, Enron Energy Services. Enron called Skilling's stake "phantom equity," reflecting that it was conceptual, designed to track the unit's performance, as EES had no stock of its own.

Skilling converted his stake into $100 million in Enron common stock in 1998 after he helped persuade the California Public Employees' Retirement System and the Ontario Teachers' Pension Plan to invest $130 million in the unit.

Skilling attorney Bruce Hiler confirmed that chain of events, but said Skilling only ever collected on a third of the $100 million, because he "didn't need all that money."

Enron revealed Skilling's stake in a March 1997 proxy filing with the Securities and Exchange Commission. The same filing shows Lou Pai, the former president of EES, owned a 15% phantom equity stake in EES. Over a period of four years, Pai converted that stake to Enron common stock, accounting for the bulk of the $268 million in shares he sold before leaving the company in June 2001, the Enron spokesman said.

Reached at home in early March, Pai said he couldn't comment because he, along with other present and former Enron officers and board members, is the target of dozens of suits by shareholders, pension funds and former employees that charge Enron insiders profited from share sales even as they hid the company's deteriorating condition from outsiders.

In a similar compensation arrangement, Robert Kelly, chairman and chief executive of Enron Renewable Energy Corp., received a 20% stake in his unit and was a minority owner, McMahon, Enron's former treasurer, said through the spokesman. But Kelly's stake wasn't listed in any of Enron's proxy filings, McMahon said. Kelly converted his stake into Enron shares that he sold for more than $20 million before leaving the company in 1999, McMahon said.

Kelly couldn't be reached for comment.

John Olson, an analyst with Sanders Morris & Harris in Houston who has covered Enron for nearly 10 years, said he would have been skeptical of recommending Enron stock if he had known that Enron executives held equity stakes of more than 5% in the company's subsidiaries.

"If I'm hyping something and not telling people I have 20% in it, that's a real disclosure issue," Olson said. "It's not a level playing field. That's too much."

John Core, an assistant professor of accounting at the University of Pennsylvania's Wharton School and a researcher on executive compensation, said the stakes diminished the value of shareholders' investments.

"It's a potential problem if you give away 15% equity in a project, then shareholders only retain 85%," Core said. "Presumably if shareholders had been aware, they would have rejected the magnitude of the payments."

Compensating executives with stock options may help align their interests with shareholders', but equity stakes in subsidiaries might not have the same effect, said Bruce Markell, a law professor at the University of Nevada at Las Vegas. Executives with stakes in subsidiaries, for example, may have an incentive to inflate their units' performance.

"The point is that when you have someone who is a fiduciary to parent company stockholders and also a fiduciary to the subsidiary, unless the interests of the two are completely aligned, and they never are, there will always be some conflict," Markell said.

     Performance Links Termed Weak

Besides distributing the equity stakes, Enron paid some huge bonuses - unusual even by the standards of large corporations.

Rebecca Mark, former chief executive of Enron International, received a bonus of $54 million for her work in securing the financing for the $2.9 billion Dabhol power project in India. The bonus was paid in 14 installments of $3.9 million each between 1996 and 1999.

Joe Sutton, president and chief operating officer of Enron International, received a $42 million bonus for his work on the project, paid in 14 increments of $3 million over the same period. An Enron spokesman confirmed the details of the payments to Mark and Sutton, which the company disclosed in a May 1998 proxy filing.

"If you look at Forbes' survey of executive pay, very few CEOs got $50 million cash," Core said.

An attorney for Mark said her client worked very hard at Enron and deserved "every penny she made." Sutton couldn't be reached for comment. Both left Enron in 2000.

Enron's compensation structure, according to various SEC filings, was designed to create "long-term shareholder value." A member of Enron's board of directors who had a hand in approving the packages said the goal was to create incentives similar to those given to merchant bankers. The flaw, however, was that the compensation wasn't sufficiently tied to long-term performance.

"They were compensated by receiving a piece of the action, but the most attractive part for them was that they received their bonus up front when the deal was signed," the board member said. "It made no difference whether or not the deal ultimately delivered revenue to Enron."

Indeed, many of the units turned out to be losers for Enron and its shareholders.

Enron Energy Services, created in 1997, lost about $300 million before turning profitable in 1999, Enron said. Former employees have said the $274 million in profit recorded since was an illusion created by aggressive accounting.

The Dabhol power plant has been mired in conflict since 1995, and a payment dispute forced Enron to shut down the plant last June.

Annual reports don't break out the performance of Enron's renewable-energy unit, but the former board member said it lost about $160 million, a figure an Enron spokesman didn't dispute.

Eventually, Enron decided to end the practice of awarding executives stakes in their units and paying out huge bonuses. In an ironic twist, Skilling attorney Hiler claims it was his client who in 2000 called a halt to the "extreme" packages that enriched Enron's senior executives because "it could be interpreted as a conflict of interest."

-By Jason Leopold, Dow Jones Newswires; 323-658-3874; jason.leopold@dowjones.com

-By Jessica Berthold, Dow Jones Newswires

Updated March 18, 2002 8:56 a.m. EDT