Recovery of Executive Compensation Expenses in Utility Rate Cases

The recent economic downturn has brought greater scrutiny to executive pay across the country, including within the utility sector. For this reason, it is more important than ever to have a fair and prudent compensation system in place and to carefully monitor pay practices, ensuring that executive pay remains competitive yet reasonable given current economic conditions. Julia E. Sullivan is a partner in the Washington, DC, office of Akin Gump Strauss Hauer & Feld LP. She Julia E. Sullivan and Jennifer Good represents gas and electric utilities in regulatory proceedings. She received her law degree from American University’s Washington College of I. Introduction undermine confidence in the Law in 1988. utility’s public service ethic, The recent economic downturn driving negative outcomes in Jennifer Good is a human resources has brought greater scrutiny to utility rate cases and lowering consultant in Annapolis, Maryland. executive pay across the country, customer satisfaction. Such She received her Master’s Degree in Public Administration from Texas including within the utility sector. perceptions also can cause A&M University in 1985. She is an For this reason, it is more resentment among employees active member of the Society for important than ever to have a fair who may be facing pay freezes, Human Resources Managers, and prudent compensation benefit reductions, and even American Society for Training and system in place and to carefully severances as load growth in many Development, and International monitor pay practices, ensuring jurisdictions remains anemic. Society for Performance Improvement. that executive pay remains his article offers practical competitive yet reasonable given T advice to help utilities current economic conditions. structure and present their Perceptions that executives may executive compensation be over-compensated can programs in a manner that will

April 2011, Vol. 24, Issue 3 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 59 strengthen the case for full rate here are key structural Each of these factors recovery. T differences between contributes to the unique compensation practices for challenges of designing executive executives and compensation compensation practices that can II. Elements of Executive practices for other employees: survive regulatory scrutiny. Compensation First, executives are paid more than other employees, and the Utilities must maintain a pay differentials can be III. Regulatory Issues competitive total compensation significant. Relating to Executive package in order to attract and Second, a larger percentage of Compensation retain executive talent. Not being executive compensation is able to provide a compensation variable from year to year. For a Regulators and utility critics opportunity equivalent to other typical utility employee, variable have offered various reasons for firms competing for the same disallowances of executive executive talent would challenge compensation costs. These any utility’s ability to meet Short-term include: ratepayer’s expectations for incentives are A. Executives serve reliability and customer service. often shareholders, not customers. As the Connecticut Department of B. Executive compensation Public Utility Control stated formula-driven costs are just too high. succinctly in Southern Connecticut and have C. Expert testimony offered Gas Co., 198 P.U.R.4th 233 (Ct. specific in support of executive DPU 2000), ‘‘competent performance compensation levels is not management is beneficial to persuasive. ratepayers.’’ criteria attached. D. Variable pay should not be xecutive compensation in included in rates. E the utility industry is E. Supplemental Executive typically comprised of four basic pay is generally 0 percent to 10 Retirement Plan (SERP) costs components: base salary, short- percent of total cash should not be included in rates. term incentive pay (STIP), long- compensation. For utility This article addresses these term incentive pay (LTIP), and executives, variable pay can arguments in turn below. benefits such as pension and represent as much as 40 percent to health care. Base salary, STIP and 50 percent of total cash A. Executives serve LTIP make up total cash compensation. This means that, shareholders, not customers compensation with incentive for executives, total cash compensation typically making compensation can vary Officers of a corporation have up a large portion of the total significantly (up or down) fiduciary duties of care and compensation program for from year to year based on loyalty to shareholders. Because executives. Short-term incentives performance. officers do not have the same are often formula-driven and Third, executives often receive fiduciary duties to customers, have specific performance criteria a portion of their compensation some argue that executive attached. Long-term incentives in the form or stock or stock compensation costs should be can vary for individual executives options. Calculating ‘‘test excluded from rates, at least in and may be in the form of cash, period’’ costs of such programs part. For example, the stock options, or a combination of can be complicated and Washington Utilities and the two. confusing. Transportation Commission

60 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 The Electricity Journal stated: ‘‘We recognize that the under extraordinary economic inclined to allow rate recovery of activities of the executive officers circumstances present a serious a minimal level of executive of regulated companies such as issue.’’2 Incentive compensation compensation expense.6 The PSE confer some benefit on the programs that are perceived as Connecticut Public Utilities ratepayers, but the officers’ granting ‘‘bonuses’’ during a Commission stated tersely in a fiduciary responsibilities run to period of economic hardship are recent case: ‘‘the expectation of the shareholders, not the particularly vulnerable.3 The ratepayers that they receive ratepayers. This is a fact that we Maryland Public Utilities appropriate service at a must keep in mind in considering Commission recently remarked reasonable cost in these difficult what part of executive that ‘‘members of the public are economic times appears to far compensation is appropriate for frustrated by the magnitude of overshadow the potential recovery in rates.’’1 CEG’s (and other corporations’) shareholder and executive ny notion that utility executive compensation.’’4 expectations of increasing A executives are insensitive personal wealth in today’s to customers’ interests, or ‘‘out of world.’’7 touch’’ with the economic realities With customers A transparent and objective consumers face, must be struggling to pay their process for setting executive absolutely avoided and dispelled bills, utilities must compensation levels strengthens by the utility in rate case the case for rate recovery. proceedings. Quality of service present compelling Executive compensation levels must be maintained and total cost evidence to justify rate are set by a utility’s board of of service must be managed. recovery of high directors. The extent to which Evidence of the executive team’s executive compensation executives may be able to recent, specific achievements and influence the board and/or its the associated benefits to costs. executive compensation customers should be presented. consultant can be a subject to Utility executives should great interest in rate case maintain direct, one-on-one Similarly, the Washington litigation. If the utility’s interaction with customers – Utilities and Transportation executives have significant through consumer sessions, Commission recently stated: power, through the appointment community outreach, public of directors, the appointment of education, and other venues. In recent years we have witnessed the executive compensation increasing attention to, and criti- Without evidence of a strong cism of excessive levels of execu- consultant, or the ability to offer public service focus and tive compensation and bloated other consulting engagements to commitment, executive severance packages. This criticism the consultant, then the level of compensation costs in any has come in part from prominent executive pay may be more amount may be vulnerable. members of the business commu- difficult to defend. The board of nity who have served on corporate boards.5 directors should set executive B. Executive compensation compensation levels based upon costs are just too high With customers struggling to pay market research, experience their bills, utilities must present levels, and individual The Kansas State Corporation compelling evidence to justify contribution, and market research Commission recently stated that rate recovery of high executive should be provided by experts ‘‘requests by utilities for high compensation costs in utility rate who have no ties to the individual levels of executive compensation cases. In the current economic executives and do no other when utility customers suffer environment, regulators may be business for the utility.

April 2011, Vol. 24, Issue 3 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 61 C. Expert testimony offered in in the peer group can be its salaries, especially officers’ support of executive subjective, and compensation and executives’ salaries, were not compensation levels is not consultant conflicts of interest truly comparable....[T]he persuasive have been alleged. In December comparisonstudyislessthan 2007, the Congressional totally credible and has skewed Most utilities hire a Oversight Committee’s Majority NSP’s calculations of the market compensation consultant to Staff issued a report that found, median.’’12 conduct an annual survey of the among other things, that further challenge is that compensation packages that other ‘‘compensation consultant A some compensation utilities offer. Utilities typically conflicts of interest are pervasive. consultants, while highly skilled will set a goal of offering In 2006 [], at least 113 of the in other respects, lack compensation at the low, mid, or fortune 250 companies received appreciation for the regulatory top tier as compared to other executive pay advice from environment in which public utilities. utilities must operate. In a recent ne criticism of this practice proceeding, the Nevada Public O is that it can appear A key part Utilities Commission circular. If most companies target of the engagement disregarded a detailed analysis a median or top tier, the utilities at of an executive of executive compensation the low end of the scale will prepared by a national respond to each new survey by compensation consulting firm because the firm increasing their own consultant should had refused to provide its compensation levels. This, in turn, be support proprietary regression analysis begets further increases in through the rate to the commission staff in compensation. Moreover, discovery.13 Some consultants executive compensation levels case process. lack experience testifying in may be strongly influenced by regulatory proceedings and fail regulatory decisions, which in to devote time and effort turn are influenced by prevailing consultants that were providing required to adequately prepare compensation levels. The other services to the company.... and present an executive California Public Utilities The fees earned by compensation compensation case. Commission stated that consultants for providing other When the board of directors regardless of the potential for services often far exceed those engages an executive circularity, ‘‘compensation levels earned for advising on executive compensation consultant, a key at competitive employers must be compensation.’’10 The part of the engagement should considered in order to promote Washington Utilities and include support through the rate the attraction, motivation and Transportation Commission case process, including providing retention of utility employees.’’8 stated, ‘‘we are wary of studies by an experienced expert witness if However, ‘‘[s]urveys of other consultants that potentially are needed. The compensation companies, while relevant, are not self-serving and may not provide consultant must have an objective the only measure in determining objective information that is basis for the selection of peer whether or not the utility’s useful to us.’’11 Similarly, the group companies and be able to requested compensation is just Minnesota Public Utilities explain differences in peer group and reasonable.’’9 Commission rejected comparison selections from year to year and Another criticism of studies presented by a regulated among different clients. To compensation studies is that the utility, stating: ‘‘the companies address the circularity issue, it selection of companies to include withwhichNSPchosetocompare may be helpful if the

62 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 The Electricity Journal compensation consultant can increase based on the previous expected from the individual provide benchmarking data from year’s performance guarantees executive. both regulated and unregulated that the employee retains that rate industries, where competition is regardless of future performance. c. Motivation and business presumed to discipline executive A large merit increase for a great goals compensation practices. All year becomes a permanent The motivational potential of analysis must be transparent and financial burden, effectively variable pay is stronger than that discoverable. increasing annual fixed costs. of other forms of compensation. With variable pay, the employee Variable pay creates a D. Variable pay shouldn’t be and company as a whole must re- performance culture rather than included in rates earn the reward every year. If an entitlement culture. Variable excellent performance is not pay that is tied to defined Variable or ‘‘incentive’’ pay sustained, variable pay can be objectives and standards provides has many advantages over other a scorecard with a sharp focus on forms of compensation, organizational priorities and particularly for executives. The motivational enables people to continuously Yet the rate case process potential of evaluate and improve results. By contains many traps for utilities variable pay reinforcing positive employee seeking rate recovery of costs performance, variable pay serves associated with variable pay. is stronger as a catalyst for improving This is a gauntlet well worth than that customer service and other running, but it must be done of other important business goals. very carefully. forms of Executives know exactly what is expected of them and know this 1. Variable pay has many compensation. performance will be rewarded. By advantages over other forms of including department level and compensation organization-wide goals within Variable pay has many reduced or eliminated. Escalation the incentive system, variable pay advantages over other forms of rates can be better managed over motivates executives to support compensation and these should time and can quickly be adapted each other and to work be clearly explained by the utility to changing market pressures. cooperatively toward common in rate case litigation. Variable objectives. pay programs make sense b. Recruitment and retention on every level and have Variable pay targets d. Communication economic advantages as well as compensation dollars in the right Variable pay is one of the helping with recruitment, way to the right people and strongest signals an organization retention, motivation, and ensures top performers that they can send to its executives about communication of important will be rewarded for their what is important. It provides business goals. performance. This type of alignment and motivates compensation package offers great commitment to the overall a. Economics opportunity and helps attract high business strategy. Key priorities One of the most significant performers who are confident of are identified, optimized, clearly advantages of variable pay is that their abilities. Retention of talent understood, and adequately the costs associated with a plan also is improved with variable pay funded. By continually measuring can be aligned with performance. programs in that there is a clear results, high quality feedback is With traditional systems, a merit communication of what is provided.

April 2011, Vol. 24, Issue 3 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 63 wide body of research organizations reveals that 2. The argument that variable A supports the view that variable pay spending has been pay is too uncertain to be variable pay works. One steadily growing over the included in rates researcher states, ‘‘theory and past decade.19 According to the A significant concern is research show that incentive pay 2009 survey, in 2009, actual that the costs of an incentive can substantially increase company spending on variable plan may be included in rates but individual and organizational pay as a percentage of payroll not earned or paid in the rate performance, and can represent a increased to 12.0 percent, up from effective period, either because powerful tool for establishing a 6.4 percent in 1994.20 The study the performance goals were not competitive advantage within an reports that companies are met or because the company industry.’’14 A study by the budgeting variable pay at 11.8 retains discretion to withhold International Society of payment based upon such Performance Improvement factors as the financial condition showed that incentive pay of the company. Some have programs increase performance argued that the uncertainty by an average of 22 percent.15 The surrounding incentive pay study showed that team justifies removal of the expense incentives can increase from rates. For example, in performance by as much as 44 rejecting rate recovery of costs percent.16 As stated by the Society associated with a utility’s of Human Resource incentive plan, the Minnesota Management: Public Utilities Commission stated: Research has demonstrated that some human resource programs Another of the plan’s serious and initiatives produce a signifi- percent for 2010.21 Ken Abosch, defects is that the Company retains cant impact on performance in the right not to make incentive leader of Hewitt’s North organizations (as measured by payments earned under the plan. factors such as quality, produc- American Broad-Based Management exercised this pre- tivity, speed, customer satisfaction Compensation Consulting rogative in 1992 and did not dis- and unwanted turnover). The two business, added: claim its ability to do so in the initiatives that consistently future. This is a clear case of showed statistically significant transferring risk from share- Over the past decade, we’ve seen positive results were linking pay to holders to ratepayers. If expenses companies steadily shift from a performance and using variable are unexpectedly high or revenues fixed pay model to one that pay. Research has established the unexpectedly low, shareholders emphasizes true performance- potential of variable pay to pro- can offset these losses with funds duce the desired business based awards, and we expect this 22 provided by ratepayers for the 17 trend will continue. results. incentive compensation program. This runs contrary to the test year Most organizations use variable iven the benefits and concept on which rates are based, pay as a significant element of G prevalence of variable pay and the Commission strongly their total rewards package. The programs, particularly for utility disapproves.23 2009-10 WorldatWork Salary executives, it is critical to Budget Survey reports that 80 understand the regulatory Executive compensation varies percent of responding challenges these programs face more, year over year, than that of organizations use short-term and to structure the programs in a non-executives. As noted above, incentive pay.18 A 2009 Hewitt manner that can address any variable pay typically comprises Associates study of 1,156 large potential concerns. amuchhigherpercentageof

64 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 The Electricity Journal totalcashcompensationfor included in rates, then the Public Utilities Commission executives than for non- shareholder receives a windfall. recently stated: executives. Moreover, while The shareholder is receiving rate variable pay for non-executives recovery of a non-existent The Commission continues to generally is tied to short-term expense. Thus, for example, in consider earnings per share thresholds an improper transfer (one-year) goals, variable support of its decision denying of risk, since ratepayers bear the pay for executives may rate recovery of incentive risks (the costs of incentive focus on longer-term compensation expenses, the compensation) and shareholders objectives. The Connecticut Florida Public Service reap the benefits (increased Department of Public Utility Commission noted that ‘‘if the earnings per share). The Commission also continues to Control recently noted, company does not meet its believe earnings per share thresh- ‘‘[b]ecause long-term incentive olds can jeopardize a utility’s payments incorporate longer commitment to providing safe, periods of performance reliable, economical service measurement, their variability over the long-term by over- emphasizing short-term perfor- is likely to be greater than mance. In most private business short-term payments; contexts, short-term thinking is therefore, they present an merely unfortunate. In the public even greater problem in utility context, it can create a 29 ratemaking than do short-term public crisis. 24 payments.’’ The Massachusetts tilities should be prepared Department of Public Utilities U to explain in rate case has allowed financial litigation significant year over performance as a ‘‘threshold year changes (positive or component’’ of variable pay, negative) in variable pay levels. If financial performance targets, the so long as the metrics used the differences are dramatic, incentive compensation to determine the amount of normalization of executive payments can be reduced while payout focus on customer compensation expense the shareholders retain the interests: through averaging may be revenues paid by ratepayers for appropriate. The normalized those incentive compensation Going forward, where companies values must be justified as programs.’’26 seek to include financial goals as a component of incentive compen- reasonable for inclusion in Second, if the executives do sation program design, the 25 rates. earn their variable pay, ‘‘[t]he Department would prefer to see the benefits of improved employee attainment of such goals as a 3. The argument that variable performance...accrue to threshold component with job pay plans primarily benefit investors in the form of higher performance standards designed to encourage good employee perfor- shareholders, not customers share prices and dividends.’’27 mance (e.g., safety, reliability, and/ Several arguments are Thus, there is an argument that or customer satisfaction goals) used commonly made in support of the costs of the incentive pay as the basis for determining indi- allocating a portion of costs of program should be paid by vidual incentive compensation. variable pay plans to shareholders, not customers. Companies that wish to maintain the achievement of financial shareholders. Metrics tied to earnings per share, metrics as a direct component of an First, if the executives do not if included in an incentive pay incentive compensation award earn their variable pay, but 100 plan, create particular must be prepared to demonstrate percent of the expected cost is vulnerability.28 The Minnesota direct ratepayer benefit from the

April 2011, Vol. 24, Issue 3 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 65 attainment of these goals or risk will be achieved cost effectively incentive compensation, give disallowance of the related incen- and whether the value of achiev- appropriate weight to tive compensation costs.30 ing these goals is worth the additional executive compensation responsiveness to customers and 38 ome jurisdictions require expense.36 other stakeholders. The West S specific quantification Virginia PSC ordered a utility to of the benefits of incentive When incentives represent a revise its incentive compensation compensation to customers – an significant percentage of total plan to add ‘‘a strong but 31 extremely difficult burden. compensation (as they typically balanced emphasis ... on Regulators also have required do for executives), the plan’s customer service and that the performance metrics be performance metrics may receive responsiveness, in relation to the 32 objective and measurable. The particular scrutiny. The other performance indicators.’’39 Kansas Corporation Commission The Minnesota Public Utilities recently excluded incentive Commission stated that compensation from rates, acceptable criteria in an incentive concluding that, ‘‘the relationship compensation plan would between KCPL and GPE’s short- include ‘‘quantifiable goals term executive compensation relating to safety, customer plans and benefits to KCPL satisfaction, productivity, cost ratepayers is simply too tenuous control, and individual employee 33 to include in cost of service.’’ If performance.’’40 The Illinois an incentive program provides Commerce Commission has benefits for both ratepayers and identified as acceptable goals shareholders, the costs may be ‘‘OSHA Recordable Injuries, 34 partially recoverable in rates. Energy Efficiency, Gas Leak Thus, for example, the California Response Objectives, and Gas Minnesota Public Utilities PSC has allowed recovery in rates Compliance.’’41 If financial Commission stated: of 50 percent of short-term performance objectives are used, 35 incentives. However, The fact that incentive compensa- every effort should be made to determining an appropriate tion is such a high percentage of clearly show how achieving these allocation can be challenging. overall compensation is a warning measures benefits the customers. The Connecticut Department of flag for the Commission - executives and officers will be extremely Public Utility Control recently focused on the achievement of the 4. The argument that variable stated: program goals. The Commission pay in the form of stock or must therefore scrutinize the stock options should not be As utilities become more choice of incentives very criti- included in rates competitive, the variability of cally.37 annual incentive payment There are at least three amounts is likely to increase. n order to strengthen the challenges in defending rate Because of this variability and I case for rate recovery, recovery of variable pay in the the difficulty of distinguishing performance objectives form of stock or stock options. goals that benefit ratepayers from underlying variable pay plans First, the degree of uncertainty those that benefit shareholders, it may be difficult to determine should be carefully crafted with is much greater than it is with the portion of incentive payments a strong customer focus in mind. variable pay plans that pay out as that represents reasonable costs The Federal Energy Regulatory a simple percentage of base pay. in a rate case. It is usually even Commission has encouraged, but The actual value that executives more difficult to determine not required, that management will receive will depend on whether the goals can and programs, including executive whether the requirements of the

66 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 The Electricity Journal long term incentive plan have Second, variable pay in the explained in the application been met and the value of the form of stock or stock options requesting rate recovery.44 utility’s stock at the time the does not require a cash outlay by Third, variable pay in the form shares vest. In denying rate the company either when the up- of stock or stock options may be recovery of stock-based front promises are made or when perceived as aligning executives’ compensation, the Federal the shares actually vest. While the personal financial interests with Energy Regulatory Commission stock is diluted by the issuance of those of shareholders (as opposed stated: treasury shares, no cash payment to the customers). The Federal occurs. This element of executive Power Commission stated nearly The Commission finds that the pay cost is therefore different half a century ago: ALJ’s decision to exclude from WNG’s cost-of-service the accrued from nearly every other element The function of regulatory amount of EICP stock awards was agencies is to exercise a positive reasonable. This cost component is influence on the welfare and too speculative to be used as a growth of this industry which is representative amount. This fundamental to the progress of our amount represents stock awards entire economy by controlling rates that were not vested in either the and profits and by focusing the base period or test period and, in attention of management on their fact, may never vest. Even if vest- public service responsibilities. The ing occurs, it might not occur until incentives under stock option after the rates in this proceeding plans, however, tend naturally to become effective. In addition, divert management from their some executives leave the com- responsibilities to the public and to pany before their stock awards focus their attention on maximizing have vested and the price of prices and earnings in order to push stocks is volatile in nature. stock quotations ever higher. Moreover, WNG fails to point to *** any record evidence to show that The goal here must rather be the costs related to the stock of revenue requirement in a rate effectiveness in the performance of award component of the EICP are case, which can be tied to a a public service and the measure of not speculative. A mere claim specific cash expense in the executive endeavor is and must that the stock award component accounting records of the remain not the judgment of the of its EICP ‘‘tends’’ to attract (and company. The Federal Energy stock market on present and future hold) qualified personnel to the profits but success in providing a benefit of its ratepayers without Regulatory Commission has service upon which our entire more is insufficient. Under these criticized stock option plans, economy is dependent, not at the circumstances, we agree with the stating that ‘‘there is no highest prices which can be ALJ that the costs are not known practical method of accounting obtained but at the lowest rates or measurable and are too spec- for stock options which will consistent with the health of the ulative.42 give a clear indication of their industry and its ability to care for or rate recovery purposes, cost to the company.’’43 At an the future needs of its customers. An overriding personal stake in relying on awards actually intuitive level, the dilution of F the stock market is doubtfully made in the test period (rather company stock may strike some compatible with the public than accruals), and normalizing utility critics as a shareholder service responsibilities of the these amounts to account for concern not appropriate for management of a public utility. significant year-over-year recognition in utility rates. The The electric power industry of today recognizes that it must variances, may be more link between the variable pay perform its work with a broad successful than requesting program, the Company’s regard for the interests of accrued amounts that have not financial position, and the consumers and the general vested. customer must be clearly public, as well as the interest of

April 2011, Vol. 24, Issue 3 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 67 stockholders and management. the general pension plans are Funding a supplemental Stock option plans do not lend subject to certain limitations retirement plan for the exclusive themselves to this balanced management attitude.45 under the Internal Revenue Code. benefit of executives at a rate In general, the Internal Revenue substantially higher than that n support of a recent decision Code allows for the computation afforded to non-executive I to deny recovery of the costs of of benefits on an annual salary up employees at the expense of stock-based compensation, the to $240,000. SERP plans provide ratepayers is of concern to the Arizona Corporation benefits in addition to the benefits Department and subject to review Commission recently stated: provided under the general in the Company’s next rate ‘‘ratepayers should not be pension plan of the company. In proceeding.’’48 Similarly, the required to fund the costs of a addition, some executives are Arizona Corporation program that is based on the Commission recently stated, company’s, or its parent ‘‘ratepayers should not be 46 company’s, stock price.’’ required to fund the retirement Similarly, the Michigan PSC benefits of a few select recently stated: ‘‘The Commission executives whose salaries exceed finds that Detroit Edison’s request current IRS limits.’’49 Utilities for projected 2009 stock option seeking to recover these types of expenses, performance shares expenses should support the expenses, restricted stock request with market research expenses, and executive deferred supporting the reasonableness of compensation gains expenses the program at the time the should be rejected. These benefits vested. expenses are used to encourage executives to promote the financial performance of Detroit covered by a richer benefit IV. Recommendations Edison, which mainly benefits the formula or have a greater portion company’s shareholders, not its of total compensation counted In building a case to support 47 ratepayers.’’ Aligning the than under the basic pension plan, rate recovery of executive performance goals with customer and therefore receive benefits that compensation expense, this objectives, such as cost control non-executives would not receive article offers the following and quality of service, can even if they earned the same recommendations for utilities: strengthen the case for rate compensation as the executives. Executive compensation recovery. egulators in some should be set by the board of jurisdictions question directors with the assistance of a F. The argument that R whether SERP expense is compensation expert who is Supplemental Executive necessary to recruit and retain highly qualified, whose analysis Retirement Plan costs should qualified executives. For example, is highly transparent, and who not be included in rates the Connecticut Department of has sufficient regulatory expertise Public Utility Control stated, ‘‘A to support the rate recovery Many utilities offer their specific current concern in process throughout case executives SERP plans, although industry regulation has been the preparation, discovery and public this practice is becoming less disregard by upper management hearings. prevalent. SERP plans for highly for the impact of generous Significant variances in compensated individuals are executive compensation packages year-over-year executive pay provided because benefits under on the rate paying public. should be explained.

68 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 The Electricity Journal Variable pay plans should 5. Pacificorp, 257 PUR4th 380 (Wash Joint Advocates themselves would Util. & Transp. Comm’n. 2007). hire’’). be strongly tied to customer objectives, such as reliability, 6. Southern California Edison Co., 2009 13. Nevada Power Co., 2009 WL WL 801553 (Ca. PUC Mar. 12, 2009) (‘‘in 1893687 (Nv. PUC June 24, 2009). safety, and customer satisfaction. light of the current economic situation 14. Dow Scott, INCENTIVE PAY:CREATING Specific, recent and the dire financial circumstances A COMPETITIVE ADVANTAGE (World-at- many Californians find themselves in, accomplishments of the Work Press, 2007). it is reasonable to limit the level of executive team, and the executive compensation ratepayers are 15. International Society of associated benefits to customers, responsible for provided such Performance Improvement, Incentives, should be highlighted. & reductions do not result in total Motivation and Workplace Performance: compensation levels falling below the Research and Best Practices (Spring amount required for Edison to attract 2002). Endnotes: and retain employee’’). 16. Id. 1. Puget Sound Energy Inc., 255 PUR4th 17. Robert Greene, Variable Pay: How 287 (Wash. Util. & Transp. Comm’n. to Manage it Effectively, at 4 (Society of 2007). Human Resource Management, April 2. Atmos Energy, 2010 WL 3200341 at 2003). ô91 (Ks. S.C.C. July 30, 2010). See also, 18. Kathryn Cohen and Alison e.g., Golden State Water Co., 2010 WL Aviaos, WorldatWork 36th Annual 4912438 (Cal. PUC Nov. 19, 2010) Salary Budget Survey 2009–2010 (‘‘The level of rate increases sought (WorldatWork Press). and executive compensation were particularly troublesome to the 19. Hewitt Associates, U.S. Workers speakers given the current economic Can Expect to See Slight Recovery in crisis and its personal impact on Salary Increases for 2010; Variable Pay many of Golden State’s customers. Remains Stable (August 11, 2009) One sentiment expressed over and (http://www.hewittassociates.com/ over again was that citizens of the intl/na/en-us/AboutHewitt/ state and nation are being forced to Newsroom/PressReleaseDetail.aspx? cid=7126). tighten their belts and Golden State 7. United Illuminating Co., 2009 WL should do so as well. The 1640725 (Ct. DPUC June 3, 2009). 20. Id. Commission is mindful of ratepayers’ concerns voiced at the 8. Pacific Gas & Elec. Co., 2004 WL 21. Id. 1376593 (Ca. PUC May 27, 2004). public participation hearings and our 22. Id. review of Golden State’s applications 9. Id. is undertaken within the broader 23. Northern States Power, 146 PUR4th context of the current economic 10. U.S. House of Representatives 1 (Mn. PUC 1993). But see Williams situation.’’); Gas, Inc., 280 PUR4th 505 Committee on Oversight and Natural Gas Co., 80 FERC ô 61,158 (Az. Corp. Comm’n. 2010) (‘‘current Government Reform, Majority Staff, (1997) (‘‘the objections to including the economic conditions should cause Executive Pay: Conflicts of Interest accrued cash awards are meritless utility companies to reconsider Among Compensation Consultants because the accrued cash awards are whether it is appropriate to seek (Dec. 2007) (prepared for Chairman in fact known and measurable and not recovery from captive ratepayers of Henry A. Waxman). speculative’’); West Virginia American Water Co., 231 PUR4th 423 (W.V. PSC incentive programs, such as 11. Pacificorp, 257 PUR4th 380 (Wash 2004) (‘‘Indeed, incentive providing stock options to Util. & Transp Comm’n 2007). management and employees.’’). compensation is a known and 12. Northern States Power, 146 measurable expense in this case. It was 3. Progress Energy Florida, 2010 WL PUR4th 1 (Mn. PUC 1993). But see contained in the test year and shall be 867088 (Fl. PSC Mar. 5, 2010) ISO New England,127FERCô 61,254 allowed for ratemaking purposes.’’). (‘‘Especially in light of today’s at 22 (2009) (‘‘We also find that 24. Richard Blumenthal, 2008 WL economic climate, we believe that Joint Advocates have not supported 5159064 (Ct. DPUC Dec. 3, 2008). PEF should pay the entire cost of their claim that Mercer Consulting incentive compensation, as its gave a biased report to ensure 25. E.g., Potomac Electric Power Co., 263 customers do not receive a significant being re-hired. Mercer Consulting’s PUR4th 1 (D.C. P.S.C. 2008) (‘‘The benefit from it.’’). motivations are no different from Commission rejects the Company’s 4. Baltimore Gas & Electric, 277 PUR4th any other independent paid proposal to average these costs over 365 (Md. PSC 2009). consultant’s, including any that the three years. The Company has failed

April 2011, Vol. 24, Issue 3 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 69 to demonstrate the variability performance based rates, where The Commission’s disallowance of associated with these costs and customers may benefit from ‘‘over- the costs of these programs is not explain why they should be averaged earnings,’’ regulators have shown meant to discourage incentive instead of adjusted out of the more flexibility regarding incentive compensation plans that are Company’s proposed test-year pay. E.g., New England Gas Co., 2004 appropriately designed to stimu- expenses.’’). WL 22677185 (RI PUC Aug. 23, 2004) late employee creativity, produc- (‘‘Because under the ESM ratepayers tivity, and loyalty. Disapproval of 26. Florida Power & Light, 2010 WL receive 50 percent to 75 percent of over the particular structure and terms 1005321 (Fla. PSC Mar. 17, 2010). earnings, and 50 percent of merger of these plans does not mean that 27. Consumers Energy Co., 246 PUR4th savings are shared with ratepayers, it the Commission should, or wishes 177, 199-200 (Mich. PSC 2005). appears fair and reasonable for 50 to, design utility compensation percent of the incentive compensation programs in the future. This dis- 28. See also, e.g., Michigan Cons. Gas related to achieving earnings, or allowance simply means that in Co., 282 PUR4th 1 (Mi. PSC 2010) (‘‘the $173,500 to be included in the ESM this particular case, where the plan Commission observes that Mich Con’s forms a very high percentage of proposed EICP remains 50% focused total compensation, and the pro- on cash flow and shareholder value gram incentives are questionable, and that many of Mich Con’s EICP the Commission will disallow all goals that benefit ratepayers are costs except the small percent tied already requirements imposed by the to direct ratepayer benefit. Commission’s Service Quality and Reliability Standards. Thus, Mich See also, e.g., Central Illinois Public Service Con’s incentive compensation plan Co., 2003 WL 23473070 (Ill. Comm. does not provide additional benefits to Comm’n. Oct. 22, 2003) (‘‘While there ratepayers commensurate with the also may be cases in which the Com- costs of the program.’’); Narragansett mission permitted a utility to recover Elec. Co., 281 PUR4th 161 (RIFSB 2010) incentive compensation costs for a (‘‘In this case, the Commission is not program that primarily conferred a persuaded that the $2.4 million cost clear benefit on the ratepayers, the associated with incentive Commission finds that the instant pro- compensation is wholly for the benefit ceeding is not such a case’’); New Eng- of ratepayers. The Commission land Gas Co., 271 PUR4th 1 (Ma. DPU believes Mr. Effron’s testimony that 2009) (‘‘the Department finds that the benefits tied directly to the Company’s calculation. However, in the future, Company has failed to demonstrate financial performance are not benefits the Commission will remain vigilant that the Annual Incentive Plan for directly benefiting ratepayers and to insure that an incentive does not SUG’s corporate employees and the finds the Division’s position to be become too large, too easy to achieve, Amended Bonus Plan for SUG’s pre- meritorious. Additionally, the or become based on factors that are a sident and senior executive vice presi- Commission cannot justify increasing detriment to ratepayers.’’). dent are reasonably designed to rates in order that NGrid attain higher encourage good employee performance profits and higher stock prices or 29. Northern States Power, 146 PUR4th and will result in benefits to NEGC’s shareholder value. The Commission 1 (Mn. PUC 1993). Similarly, in ratepayers’’). finds Mr. Dowd’s testimony Minnegasco, 170 PUR4th 193 (Mn. PUC unpersuasive in establishing any link 1996), the Commission stated: 30. Boston Gas Co., 2010 WL 4391332 between the Company’s attainment of (Mass. D.P.U. Nov. 2, 2010). financial goals and ratepayer The level and structure of 31. Detroit Edison Co., 270 PUR4th 134 benefits.’’); Progress Energy Florida, these particular plans are likely to (Mi. PSC Dec. 23, 2008); New York 2010 WL 867088 (Fl. PSC Mar. 5, 2010) lead officers to focus their energy State Elec & Gas Corp., 252 PUR4th (‘‘incentive compensation tied to on corporate balance sheets 165 (NY DPS 2006). [earnings per share] should not be rather than the judgments and passed on to ratepayers’’); Empire decisions which can directly 32. Empire District Elec. Co., 2008 WL District Elec. Co., 2008 WL 1795006 affect ratepayer service and 1795006 (Mo. PSC Mar. 26, 2008). (Mo. PSC Mar. 26, 2008) (‘‘We satisfaction. In situations in 33. Kansas City Power & Light, 2007 WL conclude that incentive compensation which short-term financial goals 4302461 (Mo. PSC Dec. 6, 2007). for meeting earnings goals, charitable may conflict with the long-term activities, activities unrelated to the policies necessary to achieve safe, 34. E.g., Gas, Inc., 280 PUR4th 505 provision of retail electric service, reliable, and reasonable service, (Az. Corp. Comm’n. 2010) (‘‘a 50/50 discretionary awards, and stock officers will be financially sharing of incentive compensation options should not be recoverable in rewarded by seeking the costsprovidesareasonablebalancing rates.’’). In jurisdictions with short-term financial goal. of the interests between ratepayers

70 1040-6190/$–see front matter # 2011 Elsevier Inc. All rights reserved., doi:/10.1016/j.tej.2011.03.004 The Electricity Journal and shareholders. The equal sharing By Indiana End Use Customers In long-term incentives in its TY of such costs recognizes that the Demand Response Programs Offered By forecast. As DRA and TURN note, program is comprised of elements The Midwest ISO And PJM these incentives have not been that relate to the parent company’s Interconnection, 2009 WL 605637 (Ind. included in rates in the past and are financial performance and cost URC Feb 25, 2009) (‘‘The Commission closely tied to stock performance of containment goals, matters that continues to encourage, but not the parent company, Edison primarily benefit shareholders, while require, each RTO and ISO to ensure International and, therefore, to non- atthesametimerecognizingthat that its management programs, utility activities’’). approximately 40 percent of the including executive compensation, 45. Black Hills Power & Light Co.,31 program’s incentive compensation is give appropriate weight to FPC 1605 (1964). based on meeting customer service responsiveness to customers and goals. This offers the opportunity for other stakeholders. If the RTO or ISO 46. Gas, Inc., 280 PUR4th 505 (Az. the Company’s customers to benefit board is well-informed about the Corp. Comm’n. 2010). from improved performance in that needs of customers and various 47. Detroit Edison Co., 270 PUR4th 134 area.’’); Southwest Gas Corp.,270 (Mi. PSC Dec. 23, 2008). PUR4th 465 (Az. Corp. Comm’n. Dec. 24, 2008) (same); Washington Gas Light, 48. Connecticut Water Co., 2009 WL 98 Md. PSC 508 (Md. PSC 2007) 246929 (Ct CPUC Jan. 28, 2009); see (allowing recovery of 50% of incentive also, e.g., Southwest Gas Co., 270 PUR4th compensation’’). 468 (Az. Corp. Comm’n 2008) (‘‘Without the SERP, the Company’s 35. Southern California Edison Co., 2009 officers still enjoy the same retirement WL 801553 (Ca. PUC Mar. 12, 2009). benefits available to any other 36. Richard Blumenthal, 2008 WL Southwest Gas employee and the 5159064 (Ct. DPUC Dec. 3, 2008). attempt to make these executives ‘whole’ in the sense of allowing a 37. Minnegasco, 170 PUR4th 193 (Mn. greater percentage of retirement PUC 1996). Compare Southern California benefits does not meet the test of Edison Co., 235 PUR4th 1 (Ca. PUC reasonableness. If the Company 2004) (‘‘If SCE had decided that the wishes to provide additional total cash compensation received by retirement benefits above the level executives should be in the form of permitted by IRS regulations base salary without any incentive applicable to all other employees it plan, there presumably would be no stakeholders, it will set criteria for may do so at the expense of its issue of ratepayer cost responsibility performance, appropriate goals and shareholders. However, it is not as long as total compensation for targets for the organization and its reasonable to place this additional executives is at market levels. In the management and institute measures burden on ratepayers.’’). absence of any evidence that the for achieving those targets. By executive incentive program itself 49. focusing our requirements on having a Gas, Inc., 280 PUR4th 505 (Az. produces outcomes that are contrary well-informed board, we decline to Corp. Comm’n. 2010). See also, e.g., to ratepayer interests, we will not intrude further into board Providence Gas v. Malachowski, 656 A.2d interfere with the utility’s discretion to prerogatives regarding management 949, 952 (R.I. 1995) (upholding PUC adjust the appropriate mix of base compensation.’’). decision finding SERP expense salary and incentives.’’). excessive and unnecessary). But see, 42. Williams Natural Gas Co., 77 38. Order No. 719, FERC Stats. & e.g., Washington Utilities & Transp. FERC ô 61,277 (1996) (footnotes Comm’n., 281 PUR4th 329 (Wash. Regs. ô31,281 at ô561; see also Wholesale omitted). Competition in Regions with Organized UTC 2010) (‘‘The ultimate issue is whether total compensation is Electric Markets, 128 FERC ô 61,059 at 43. Black Hills Power & Light Co., 55 reasonable and provides benefits to ô182 (2009). PUR3rd 65 (1964). ratepayers, not whether incentive 39. Monongahela Power Co., 257 44. See, e.g., Entergy Arkansas, Inc., 258 compensation is pay in stock or PUR4th 186 (WV PSC 2007). PUR4th 1 (Ark. PUC 2007) (‘‘EAI whether compensation, particularly for executives, is similar to that of 40. Minnegasco, 170 PUR4th 193 (Mn. offers no substantial evidence of other comparable companies. The PUC 1996). ratepayer benefit which would justify including these stock-driven Company’s SERP meets this test. 41. Central Illinois Light Co., 2010 WL incentives in rates’’). See also, e.g., Taken as part of the overall 1868345 (Ill. Comm. Comm’n. Apr. 29, Order at 134–35, Southern California compensation package, it is reasonable 2010). See also, e.g., Investigation Into Edison, 2009 WL 801553 (Cal. PUC as a common feature of a market Any And All Matters Related To Mar. 12, 2009) (‘‘We reject SCE’s competitive pay program in the utility Commission Approval Of Participation request to include $23.304 million in industry.’’).