Cost-Cutting Airlines Grapple
With Issue of Executive Pay
By JOANN S. LUBLIN
Staff Reporter of THE WALL STREET JOURNAL
January 25, 2005; Page B1
A harsh downdraft grips the U.S. airline industry, with five carriers stuck in bankruptcy court and others amassing extensive red ink.
Whipsawed by sky-high fuel prices, lower fares and a glut of seats, nine of the 10 biggest carriers by traffic are expected to report fourth-quarter losses. Five did so last week.
Distressed airlines typically pin their survival hopes on huge savings from worker concessions. But slashing rank-and-file paychecks creates a management conundrum. Union members want senior executives to share their financial pain.
Indeed, the prior heads of Delta Air Lines and AMR Corp. got forced out partly due to union ire over executive sacrifices perceived as inadequate. Yet further curbs on the compensation of the airlines' top brass could push even more of them out of the executive suite.
"It's a real tough dilemma," says Kim Cameron, a University of Michigan management professor. While profitability and stock prices usually rise when leaders share their subordinates' pay pain, pressure to pinch executive pay harder could weaken carriers' chances for recovery by increasing the tempo of management turnover.
"If you pay below market, you get what you pay for," says a former vice president of a troubled major carrier who joined a start-up airline earlier this month. "You will be left with the 'B' team."
As it now stands, virtually no upper-management wallet at sick airlines remains untouched, but the extent of slimmed compensation varies by carrier. Delta's chief executive officer, Gerald Grinstein, skipped his $500,000 annual salary for six months last year. And since he became head of the Atlanta airline in January 2004 (after having been a Delta board member), Mr. Grinstein has taken no other remuneration.
Gerard Arpey, AMR's chairman and CEO, makes less than he did as chief operating officer there. He has turned down two promotion raises since the Fort Worth, Texas, parent of American Airlines sliced his salary 14.4% in April 2003. AMR had threatened a bankruptcy filing that year to wring $1.8 billion in pay and benefit cuts from all employees.
Mr. Arpey spurned stock-option awards during 2003, the year he advanced to chief executive. On the other hand, he did receive 172,000 options last July, priced at about $8.88 a share. Mr. Arpey holds 910,230 exercisable and unexercisable options, most of which currently lack value. But like the chiefs of many sick carriers, he could fatten his bank account through option exercises once AMR's depressed stock price recovers. In 4 p.m. New York Stock Exchange composite trading yesterday, AMR shares traded at $7.83, down 51 cents.
US Airways Group Inc. has weathered labor tension over the issue of executive-pay sacrifices. Bruce Lakefield, a retired investment banker, accepted a relatively modest pay package when the board member took command of the struggling carrier last April. His $425,000 salary was 30% less than his predecessor earned and skimpier than many rivals'. Having shunned severance and retirement benefits, he also is refusing to collect an annual bonus until the Arlington, Va., concern returns to profitability.
Nevertheless, last fall, after US Airways filed for bankruptcy-court protection for the second time in two years -- and asked the court to impose a 23% temporary pay cut on its union workers -- Mr. Lakefield upset rank-and-file staffers when he didn't lower his own salary. (The court-approved 21% reduction expires Feb. 15.)
Last month, several unionized employees confronted Mr. Lakefield outside the courthouse, recalls Joe Tiberi, a Machinists union spokesman. "They were being asked to make sacrifices, and he wasn't even making a token sacrifice," Mr. Tiberi says. "It's not really leading by example." On Friday, a majority of the union's 8,800 mechanics, ramp workers and other ground employees approved a five-year labor contract that will save the airline $353 million a year. The concessions include pay cuts, reductions in vacation and holiday pay and a big loss of jobs to outsourcing.
Mr. Lakefield "took his pay cut when he came in," says Christopher Chiames, a US Airways senior vice president. "Over the past 2½ years, senior management has cut 27.5% of our pay. We have waived pay raises [and] reduced some pension contributions." The rest of Mr. Lakefield's top management team trimmed their salaries between 7.5% and 10% in October.
At Delta, union members are griping that Mr. Grinstein's fellow senior managers haven't matched his austerity -- even though every executive's paycheck shrank 10% Jan. 1. The pilots' union squawked when Delta gave about 1.9 million options to six other top officers last November. The grant came shortly after Delta narrowly avoided bankruptcy because the pilots agreed to a 32.5% pay cut and five-year wage freeze in exchange for up to a 15% stake and other concessions.
"Are we to infer that shared commitment means labor sacrifices so management can be rewarded with richer options packages?" asked John Malone, the union's leader, in a letter to Delta pilots. "The generals are dining while the troops are toiling."
At AMR, the prospect that the "generals" will bolt if their rations dwindle too much worries some investors and board members. "The market test is, 'Are they able to retain key management?' " says Ed Shapiro, a partner at Boston-based Par Capital Management, AMR's fourth-biggest shareholder. "If not, they're not paying them enough."
The AMR board's compensation committee said in the latest proxy statement that "retention challenges are increasing" because annual bonuses have been zero for three years, and nearly all options awarded to officers "have no in-the-money value."
Among those hurt by canceled bonuses, worthless options and the broad 2003 pay cuts was Jeffrey C. Campbell, then AMR's senior vice president and chief financial officer. He quit later that year "for a more lucrative opportunity outside the airline industry," despite a July raise and restricted-stock grant, the proxy reported.
Mr. Campbell became finance chief of McKesson Corp., a San Francisco health-care-services concern. Long term, this position "will be more remunerative in both financial and nonfinancial ways," he said in an interview.
AMR's management drain persists. "We're just not competitive on salaries within our own industry," one senior executive laments. Recent departures from his group included individuals offered nearly twice their AMR pay elsewhere.
At US Airways, "the management team ... is fleeing," concedes spokesman David Castelveter. He says 331 middle and senior managers quit last year, up from 202 in 2003.
Making matters worse, carriers may find that unions oppose their efforts to revive upper management's reduced remuneration when corporate fortunes rebound. Northwest Airlines, where pilots ratified a two-year contract last November that chops wages 15% and generates $265 million in annual concessions, says that managers and other noncontract employees will contribute $35 million in yearly salary and benefit reductions. A spokesman declines to comment further.
Northwest's top management agreed to a roughly 23% compensation cut -- plus a pay freeze and no new compensation or retirement plans for all of management until both sides craft the next accord, according to the pilots' union. "Our view is that it should be share and share alike," explains Northwest pilot Mark McClain, the union chairman there.
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Shared Pain?
A look at how compensation has changed for some senior executives in the airline industry.
CARRIER RECENT PAY MOVES BY TOP BRASS
UAL (in bankruptcy) Salaries of CEO and seven highest lieutenants fell 15% Jan. 1. CEO already has collected $3 million from bankruptcy-proof special trusts.
US Airways (in bankruptcy for second time since 2002) Senior officers except CEO cut their salaries 10% and took 25% reduction in pension-plan contributions last fall. All officers skipped raises in early 2004.
ATA Holdings (in bankruptcy) Upper management accepted 10% salary cuts last summer.
AMR (lost $761 million in 2004) CEO twice refused promotion raises after his pay was cut 14.4% in April 2003; he got 172,000 stock options and 135,000 performance units last July.
Delta (narrowly averted bankruptcy last November) CEO took no salary for half of 2004, but six other high-level officials received about 1.9 million options last November. CEO's reinstated $500,000 salary slid 10% Jan. 1 as did fellow executives' paychecks. Their pay fell 8% in early 2003 while officer bonuses for that year were later canceled.
Continental (lost $363 million in 2004) Newly promoted CEO waived his 2004 bonus payout. His salary, bonus and long-term awards will shrink 25% starting Feb. 28. Four other executives take 20% cuts that day.
a-Mesa Air Group (profitable) Senior managers lowered their salaries about 8% last fall to help US Airways emerge from bankruptcy.
Note: a - Mesa Air Group runs several regional airlines through code-sharing agreements with major carriers, including US Airways Group's US Airways Express.
Source: WSJ research
Write to Joann S. Lublin at joann.lublin@wsj.com