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The High Cost of Kozlowski's Keep


Each time Tyco International's (TYC) embattled chief, Dennis Kozlowski, answers one question lately, three more seem to pop up. Yet nobody second-guessed him during a Feb. 6 conference call with Wall Street analysts after he declared, "No one wants this stock to rebound faster than I do." Not counting his options on 10.4 million Tyco shares, Kozlowski had just seen the 3 million shares he owns outright plunge in value by $108 million since Jan. 1.

That Kozlowski's interests and shareholders' interests are one and the same has been a tenet of faith among Tyco bulls. By most accounts, this has been true. Tyco stock has returned an average of 32.5% a year since he became CEO in July, 1992, vs. 13.7% for the Standard & Poor's 500-stock index. Just the same, it's now worth noting the appearance on Jan. 22 of a small rift in this rewarding communion. Kozlowski that day got 800,000 shares of restricted stock, given to him by Tyco's board of directors. Unlike millions of shares in stock Kozlowski has received in the past (table), this fresh grant will vest year by year without Tyco having to clear a single performance hurdle.

Investors can find the deal summarized in Tyco's Jan. 28 proxy statement and detailed fully in its Dec. 31 10-K filing with the Securities & Exchange Commission in an exhibit labeled "Retention Agreement." In return for Kozlowski's continuing service as CEO, the agreement calls for 100,000 shares to vest each January, 2002 through 2008. The eighth block vests on Nov. 16, 2008, his 62nd birthday.

When they were granted on Jan. 22, the full 800,000 shares were worth $38 million at that day's closing price of $47.55 a share. The 100,000 shares that vested immediately came nearly to $4.8 million, and Kozlowski had the option to sell them right back to Tyco for cash. Mark Swartz, Tyco's chief financial officer, enjoys a similar retention deal, for 500,000 shares, worth almost $24 million when granted. None of his is set to vest until January, 2006, however.

Why should Tyco shareholders give up $62 million in equity? "To make sure that we could keep Dennis and Mark as key executives for as long as possible," said W. Peter Slusser, president of a Manhattan investment firm, Slusser Associates, and a veteran of the Tyco board's compensation committee. Stephen Foss, chairman of the committee and CEO of fabric maker Foss Manufacturing, told me, "We kept getting asked by analysts, `What golden handcuffs do you have?"' Kozlowski and Swartz "are top managers and very attractive for companies to recruit."

In the past, however, Tyco's compensation committee has taken pains to explain its big awards of cash bonuses, stock, and options to Tyco's top executives as payment only in return for superior performance. Tyco's 39% jump in net income and 31% gain in cash flow during fiscal 2001, for example, earned Kozlowski a $4 million cash bonus atop his $1.65 million salary. The board last October also spurred him on with 600,000 shares of stock. They vest over three years, but only if Tyco meets aggressive financial goals. This brand of performance-based pay has never worked better than at Tyco, Slusser told me.

So why change course? In January, 2001, when Tyco directors first approved the retention deals without demanding any financial hurdles, Slusser recalls they felt they "had to pay that price to make sure [Kozlowski and Swartz] would stay." Yet since then, much has changed at Tyco. It's now splitting into pieces, with Kozlowski set to wind up as chief of an electronics and security-services outfit half Tyco's size. Neither he nor Swartz, who plans to stay as CFO, commented. But it's an open question whether their deals are too rich given their new, more modest jobs. "It's something that will have to be discussed," Foss said. Investors saw Tyco shares sink 33% since these latest grants of stock. They will want to ensure their leaders keep faith, taking only what they earn. By Robert Barker


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