Time for CEOs to pay the piper

TheStar.com – Business – Time for CEOs to pay the piper: Public outrage over ‘obscene’ corporate compensation deals spurring calls for reform
July 26, 2009.   David Olive

It wasn’t the U.S. government’s $173 billion (U.S.) bailout of American International Group Inc. (AIG), whose insurance coverage of losses on global banks’ holdings of soured U.S. subprime mortgages made it “too big to fail,” that was cause for public outrage.

It was the news that AIG, under its new, government-appointed CEO, Ed Liddy, was paying $165 million in contractually agreed bonuses to 77 top employees that elicited the hate mail directed at Liddy. One letter read: “You guys should each be strangled with piano wire until you are dead.”

The current populist anger with “this remarkable demonstration of rapacious compensation” was inevitable, said William Dimma, a veteran Canadian professional corporate director and author on corporate-governance reforms.

Leslie Gaines-Ross, chief reputation strategist at U.S. consulting firm Weber Shandwick, says focus groups once described outsized CEO pay as “excessive” or “overly generous.” Now they use terms like “obscene” and “immoral.”

The same absurd saga has played out at Nortel Networks Corp. Soon after filing for bankruptcy protection in January, Nortel won bankruptcy-court approval to make $45 million in bonus payments to about 100 top executives. Meanwhile, CEO Mike Zafirovski said it “wasn’t feasible to pay severance” of any kind to the 5,000 or so lower-ranking Nortel employees the firm laid off in November. Yet it somehow made sense, to Zafirovski and his compliant board, to pay “retention” bonuses at a company soon to be dismantled.

The widespread corporate wreckage, symbolic of the capitalist failure that plunged the world into its worst economic downturn since the Great Depression, has spurred calls for reforms including “say on pay,” which would enable ordinary shareholders to vote on executive pay packages; and a more extensive use of “clawbacks” to retrieve executive compensation later shown to be the result of fraud or other misbehaviour.

Those reforms had been in the air for a few years. But today’s economic downturn, in which 6.5 million Americans have lost their jobs, has given them Congressional impetus. The examples of excessive-pay outrages are simply too plentiful to ignore, along with their role in encouraging CEOs to embark on high-risk gambits that. If successful, these reckless moves enrich CEOs with stock gains. If unsuccessful, failed CEOs are rewarded with a huge severance packages.

The current economic meltdown has made a mockery of the “pay for performance” notion by which CEOs justified their escalating pay of recent years.

Rick Wagoner was paid a total of $65 million during his last five years running General Motors Corp., a period in which GM accumulated a staggering $82 billion in losses. Stanley O’Neal collected $233 million for managing Merrill Lynch Inc. into the ground. (Merrill has been forcibly merged into Bank of America Corp.)

In 1980, pay for the typical CEO was about 40 times what the average worker was paid. By 2007, that multiple had grown to an outlandish 433 times. The obvious questions arise: Are corporate CEOs 393 times smarter than they were in 1980? Have they been producing 393 times more wealth for shareholders? Well, no, of course.

“Pay for performance” is a cruel joke in the mind of Graef Crystal, the leading U.S. expert on executive compensation. He calculates that the median U.S. CEO’s pay actually rose 2 per cent during the recession year of 2008, while the Standard & Poors’ 500 Index lost 27 per cent of its value. “The shareholders took a 27 per cent haircut, and in return, the CEO got a 2 per cent raise,” Crystal said. “This is the Marie Antoinette school of management at its best.”

“An effective way to offset the inclination to offer the promise of too much reward for too little performance,” said Dimma, “is to tie all rewards to several years of outcome. And to provide for eventual clawback if performance in the later years detracts from earlier gains.”

Clawbacks are a provision of the Sarbanes-Oxley Act of 2002, which was a reaction to the accounting scandals at Enron Corp. and Worldcom Inc. They give the SEC the right to seize payments to CEOs and chief financial officers at firms that have restated previous years’ financial statements “as a result of misconduct.”

The rarely deployed clawback was used in 2007 to recover $448 million in pay from William McGuire, CEO of HMO giant UnitedHealth Corp. during an options-backdating scandal. Last week, the SEC set a precedent by demanding that Maynard Jenkins, former CEO of auto-parts firm CSK Auto Corp., forfeit $4.1 million in pay he collected during an alleged accounting fraud at the firm in which he has not been implicated.

“This is not punishment,” said Nell Minow, co-founder of the Corporate Library, a U.S. firm that champions corporate-governance reforms. “This is fixing the mistake. It was never really his money.”
“Say on pay” is immensely unpopular with CEOs. They argue it would distort the carefully calibrated incentives that result in superior performance. It would drive talent to private companies and make the U.S. less globally competitive.

Those arguments might be convincing had CEOs not made such a mess of things in recent years under the status quo. In any case, “say on pay”, favoured by U.S. President Barack Obama and the Democratic-controlled Congress, is already the law of the land in Britain, Australia, Norway, Spain and France, where it is non-binding. Only in the Netherlands are shareholder votes on executive pay binding.

CEOs argue that say on pay is an intrusion on a boardroom prerogative. But quiescent boards in thrall to CEOs are hugely culpable in the runaway pay and in approving incentives that don’t encourage sound management but rather CEO-enriching reckless risk-taking.

Many CEOs are quick to turn the argument around and ask why congressmen don’t propose similar laws governing their pay.

But politicians have to answer to the public for their pay and perks, which are quaintly modest in comparison with the average U.S. CEO annual pay of $11 million. And elected politicians enjoy less job security.

After the spectacular underperformance of corporate CEOs in recent years, that probably isn’t an argument in which CEOs want to engage members of Congress. In debating a bill to claw back the unseemly AIG bonuses by imposing a 90 per cent tax on them, Democratic Congressman Earl Pomeroy asked if the AIG bonus recipients had “no shame at all.” He added: “You are disgraced professional losers. And by the way, give us our money back.”

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