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An All-American Compensation Plan

Here's the troubling truth: Most public companies' managers are about as loyal to you, the common shareholders, as Benedict Arnold was to the Continental Army. But you can't try your holdings for treason, especially when the most egregious executive compensation plans (like this one) are perfectly legal. What's a Fool to do? I suggest you comb through financial filings to understand how the managers working for you get paid. Sometimes, you'll hit the jackpot in your research.

That's what happened to me last week. As I pored over filings with the Securities and Exchange Commission, I discovered one from clothing retailer American Eagle Outfitters (Nasdaq: AEOS  ) . As this 8-K describes, the company is implementing a new compensation plan under which CEO James O'Donnell stands to make more than $3 million during 2006.

Naturally, with that much money on the line, I got curious. So I checked the most recent proxy statement. There, I found that Mr. O'Donnell had also done well the year before, taking home nearly $3 million before stock awards. But the compensation committee's report really struck me, especially this part (emphasis mine):

Mr. O'Donnell's compensation for Fiscal 2004 was determined by the Compensation Committee, with the advice of an independent consultant retained by the Committee, and it was based on the subjective perception of his performance and his historical and anticipated future contributions to the success of the Company. The determination was not based on specific objective criteria and no specific weight was given to any of the factors considered.

You'll understand why this is important when you read the 8-K again, especially this part:

The actual annual cash bonus payment will range from zero at threshold, to 100% at target and 200% if the Company's outstanding annual cash bonus and restricted stock EPS goals are achieved for Fiscal 2006.

In other words, subjective judgment is out the window, and accountability is in. A spokesperson I talked to confirmed the change, adding that American Eagle used to offer partial bonuses when annual earnings targets were met. No longer. From now on, it only counts if management knocks one over the fence.

Well done, American Eagle. You've set an example. Much as I distrust EPS targets (because of the limitations of traditional GAAP accounting), this improvement takes a stricter approach to executive compensation than most firms'. I can only hope that the turncoat managers who remain at other companies have taken due notice.

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Fool contributorTim Beyersdoesn't often shop at American Eagle, but he loves the name nonetheless. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Foolprofile. The Motley Fool has an ironcladdisclosure policy.

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