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Shareholders take aim at Sun

Shareholder activists want Sun to end its "poison pill" takeover defense, make executive stock option awards more performance-based.

Shareholder activists are calling for Sun Microsystems to do away with its "poison pill" takeover defense and realign its executives' stock option plan to be more performance-based, according to a Sun proxy filed Tuesday.

The move comes after Sun issued a salary hike and a cash bonus to its chief executive, Scott McNealy. McNealy received a base salary of $121,789, up 21 percent from the previous year, as well as a $1.1 million cash bonus, even though he missed performance targets identified in Sun's regular bonus plan, according to the proxy.

Sun, whose stock underperformed those of competitors such as Dell and key indexes such as the S&P 500, has been struggling to turn its business around and push its lackluster share price beyond the $3 to $4 range, where it has traded for most of the past couple years. The company also restated its financial performance for fiscal years 2003 and 2004, and updated its 2005 results because of tax-accounting errors.

McNealy's total compensation for fiscal 2005, including the $11.8 million in options he exercised, reached approximately $13 million. McNealy also received an additional 1.25 million options in fiscal 2005.

Sun's shareholders, meanwhile, have expressed concern about the terms under which Sun's board has awarded stock options to top-level executives, and one group is calling for a shareholder vote to remedy the issue during the company's annual meeting Oct. 27.

The Service Employees International Union is asking investors to approve its proposal, which would tie the exercising of options to performance-based metrics. The proposal calls for options to be priced based on an industry index and above the current market price at the time they are granted. The proposal also states that options could vest only when a performance target is met. Many companies have options vest on a regular, yearly schedule over a certain period of time.

"From 2001 through 2004, Sun Microsystems CEO Scott McNealy was awarded options to buy (7.5 million) shares of Sun Microsystems stock. Such grants can result in substantial compensation for only modest gains in share price," the SEIU states in its proposal. "If sun Microsystems' stock price increases by only $1 per share, Mr. McNealy could reap over $7.5 million, even if Sun...underperformed its competitors during that period."

Sun's board, however, said a large portion of its executive compensation is already performance-based.

"Executive compensation practices are influenced by a wide range of complex factors, including changes in strategic goals, regulatory developments and the competitive compensation practices of other companies," Sun's board stated in the filing, advising shareholders to vote against the SEIU proposal. "As a result, it is important that the (compensation) committee retain the flexibility to select incentives that balance these influences."

Sun will also face another shareholder proposal at the meeting that calls for the company to do away with its shareholder rights plan, otherwise known as a "poison pill."

Poison pills flood the market with additional shares of the target company, should an undesirable buyer attempt to take over the company. As a result, such plans can make unwanted takeover attempts prohibitively costly to pursue.

"Poison pills...prevent shareholders, and the overall market, from exercising their right to discipline management by turning it out. They entrench the current management, even when it's doing a poor job," William Steiner, a Sun shareholder, stated in his proposal in the proxy filing.

Sun's board, however, advises shareholders to vote against Steiner's proposal and notes that shareholder rights plans enhance shareholder value in the event of a friendly or hostile-takeover attempt.

Shareholder initiatives calling for the removal of "poison pills" and a tighter relationship between pay for performance is nothing new, though Sun's shareholders have remained largely quiet over the last few years, putting forth few shareholder proposals.

McNealy's compensation has remained rather stagnant over the last couple years. He has received no new pay increases and no bonuses since 2003. While he has received in excess of 1 million shares annually over the past few years, that is below the industry norm of those awarded to other CEOs, when considering the total number issued to employees, said Jon Holman, who runs executive recruiting firm The Holman Group.

Nonetheless, investors at the annual shareholders meeting may still take issue with McNealy's special bonus of $1.1 million, given that he, along with other top Sun executives, failed to meet the goals established under the company's bonus plan.

"While the company met its free cash flow goal and improved its performance with respect to operating income in comparison to...2004, the company did not achieve its operating income goal," Sun's proxy states. "Additionally, the company did not meet the earnings-per-share requirement. As a result, none of Sun's executive officers received a bonus under the bonus plan for...2005."

The company generated $369 million in positive cash flow from operations. Based on contributions made throughout the fiscal year, according to the proxy, the board awarded discretionary bonuses to McNealy and other top executives in part to help retain top talent at the company.

In addition, Sun said in a regulatory filing Tuesday that Lynn Turner, managing director of research at Glass Lewis, will leave Sun Microsystems' board on Oct. 27. Turner, who had been a professor at Colorado State University's Center for Corporate Financial Reporting when he joined Sun's board in 2002, now works for a company that advises institutional shareholders on how to vote on proxy matters.

Turner effectively will be replaced by Pat Mitchell, the chief executive of the Public Broadcasting Service, who joined Sun's board earlier this month.

CNET's Stephen Shankland contributed to this report.