CEOs Paid 70% More at Firms Under Scrutiny

The top officers of 23 major companies currently under investigation for accounting irregularities were paid 70% more than the average chief executive officer of a large U.S. company, according to a new study.

The study by the nonprofit advocacy group United for a Fair Economy is aimed at focusing more attention on the increasingly controversial practice of paying top executives with stock options that become valuable only if the company’s market price rises--giving executives the incentive to inflate profits to drive up their companies’ stock prices, critics say.

“The pressure to be ever more aggressive in accounting presentations and distort earnings to keep the stock price rising is largely related to the incentives set forward for executives,” said Scott Klinger, co-director for responsible wealth at Boston-based United for a Fair Economy.

“The Enrons and the WorldComs were the most egregious examples of this, but we think the stock option piece [of compensation] has allowed executives to become very rich while destroying jobs, destroying shareholder value and weakening the companies.”

The 23 executives scrutinized by United for a Fair Economy received an average pay package of $62 million during the three-year period from 1999 through 2001, compared with an average package of $36 million for the chief executives of 365 of the nation’s largest companies, according to the study.

The most highly paid executive on the list, Tyco’s L. Dennis Kozlowski, earned $331 million in salary and stock gains over the period, according to the study, which is due to be released today. Kozlowski has resigned and is facing charges of tax evasion.

Tyco spokesman Gary Holmes said the company is conducting an investigation into issues related to Kozlowski’s departure and could not comment.

Qwest Communications International Inc., Enron Corp., AOL Time Warner Inc., WorldCom Inc., Halliburton Co. and Global Crossing Ltd. also ranked high on the list of companies that paid their executives handsomely but are now grappling with questions from investors and regulators regarding their reported financial results. All 23 are reported to be facing inquiries by agencies such as the Securities and Exchange Commission, the Department of Justice and the FBI.

The study focused only on companies that had market capitalizations of at least $1 billion at some point during the three-year period. Many of the companies have since filed for bankruptcy, laid off the bulk of their workers and left their investors with worthless shares.

Together, the 23 companies targeted by the study paid their CEOs $1.4 billion over the three-year period, while laying off 162,000 workers and losing some $530 billion in market capitalization, according to United for a Fair Economy.

The factor that linked the companies most closely is their aggressive use of stock options--rights to buy company shares at a set price in the future, Klinger said.

These options have become increasingly controversial in recent years, in part because of the massive paydays enjoyed by top executives at companies such as WorldCom and Enron when they cashed out years’ worth of options--often just ahead of sharp declines in the companies’ stock prices.

Another factor is the debate over current accounting standards that don’t require companies to show stock options as a compensation expense in the financial statements provided to shareholders.

These same companies do write off the cost of providing the options on their corporate tax returns, Klinger notes, creating a growing gulf between corporations’ taxable income and reported income. From 1996 through 1998, taxable earnings of U.S. corporations declined incrementally, while earnings reported to shareholders rose 8.5%.

Proponents of stock-based pay plans--particularly technology companies--maintain that stock options are the only tool small, growing firms have to adequately compensate managers in lean years. Making companies account for stock options as an expense would discourage the companies from offering options to a wide swath of employees, according to AeA, a trade group representing the technology industry.

Nonetheless, Sen. John McCain (R-Ariz.) has promised to introduce legislation next month aimed at forcing companies to reflect the cost of stock options in their earnings statements, Senate staffers said Friday.

Even more needs to be done, Klinger said.

“We have nine proposals for reform, but the two really big ones are that we need to expense stock options and we need to look at who is in the board room deciding on compensation issues,” he said.

“We have made some minor progress recently, but boards are still dominated by CEOs, and CEOs have a huge conflict of interest when they are deciding on the pay of their fellow CEOs.”