Shareholders join others in calling for reductions in CEO packages
Shareholders and corporate activists have been complaining for years about runaway executive pay. But in 2002--the year of Enron, E-Trade and Ebbers--the voices for change finally are finding an audience.
Across corporate America this spring, company managers have been fighting shareholder resolutions seeking to put limits on how much the top bosses can be paid.
Financial leaders such as Federal Reserve Chairman Alan Greenspan are calling for accounting changes to staunch the flood of stock option giveaways to executives. And big institutional investors increasingly are asking tough questions when a company’s stock price fails to keep up with its chief executive’s paycheck.
Why the sudden outburst? Call it the “Enron effect.”
The collapse late last year of energy trader Enron Corp. and the subsequent allegations of self-dealing, questionable accounting and self-enrichment--including the roughly $150 million that CEO Kenneth L. Lay raked in during 2000--provided a catalyst for critics of the state of corporate governance and its effect on the way America’s top executives are compensated.
“Something fundamentally changed with Enron,” said Scott Klinger, co-director of responsible wealth at Boston-based United for a Fair Economy, a group dedicated to narrowing the gap between the upper and lower classes.
“People are becoming skeptical about what’s behind the numbers.”
But Enron wasn’t the only case that drew fire from compensation critics. News this spring that regulators are looking into millions of dollars in personal loans that Bernard J. Ebbers received while CEO of WorldCom Inc. drew a sharp response from investors, who have watched WorldCom’s stock plunge 90% over the last year.
Menlo Park, Calif.-based E-Trade Group Inc. also created a furor a month ago when it revealed CEO Christos Cotsakos’ $71million pay package for 2001--a year in which the online brokerage lost $24million. The criticism was so intense that Cotsakos agreed to return part of the pay package.
More broadly, critics such as Klinger contend that in the United States, CEO compensation outstrips the paycheck of the average worker by a much greater degree than in other industrialized nations such as Japan and Germany.
Ironically, the clamor over compensation comes amid a rare slump in executive pay.
In a study of 350 large U.S. companies, Mercer Human Resource Consulting found that the average chief executive’s pay package fell almost 1% last year. The average salary increased 4.7%, but bonuses fell 13.5% and the plummeting stock market drastically reduced the value of many executives’ stock option packages.
That provided ammunition for those who contend that executive pay reflects corporate performance, and that companies that hope to keep top-notch executive talent must pay the market rate.
“We are hitting an interesting tension,” said Blair Jones, senior vice president at Sibson Consulting, an executive- pay advice arm of benefit-consulting firm Segal Co. “We have talked about pay-for-performance being really important, and it is. But you have to balance that against the driver of attracting top talent. That makes it tough for companies to toe the true pay-for-performance line.”
Responded Klinger: “The people who have the skills to run a company deserve to be compensated. But there are limits.”
But what are they? Trillium Asset Management Corp., a money management firm whose investments are determined in part by a set of social principles, has developed a straightforward yardstick for the companies whose shares it owns: The firm votes against any CEO compensation plan that exceeds a combined $5 million a year in cash and stock.
“These numbers are arbitrary,” acknowledged Simon Billenness, senior analyst with Trillium in Boston. “But you have to ask yourself, how much more do you need?”
There’s no right answer, of course.
“If you get the right leadership, it can be worth a lot of money,” said Jones of Sibson Consulting. “I think where we have gone wrong is in thinking that everybody is worth that.”
Changing that thinking won’t be easy, as even critics of executive pay trends acknowledge.
“Because the problem is very gross doesn’t mean it has an easy solution,” said Charles T. Munger, vice chairman of Berkshire Hathaway Corp. and CEO of Pasadena-based Wesco Financial Corp.
“Every sign I see indicates that the situation is getting worse, and I think it’s going to be very difficult to fix.”
Shareholder activism has been the weapon of choice recently. Corporate annual meetings have produced a wave of shareholder resolutions, including initiatives at EMC Corp, Jones Apparel Group Inc. and Bank of America Corp., seeking to rein in executive pay.
Resolutions to force changes in corporate governance--almost always opposed by management--usually are easily defeated. But a proxy advisory service that tracks shareholder resolutions said last week that 39% have received a majority of shareholder votes this year--well ahead of the previous record of 25%.
“This year is shaping up to be quite extraordinary,” Ann Yerger, research director of the Council of Institutional Investors, said of the findings by the Investor Responsibility Research Center.
Some analysts noted that shareholders typically become restive when the stock market is slumping, as it has been for the last two years. But others stress the role played by shareholders disillusioned by corporate scandals and massive executive pay packages.
“The lesson of this is that shareholders have to be active and involved in electing directors, who are supposed to be their representatives at the company,” said Bill Patterson, director of the AFL/CIO office of investment.
“Runaway executive pay is a symptom of how boards are captives of CEOs. The price of having a captive board is enormous when you are investing in a company like Enron or [telecom firm] Global Crossing,” which now are in bankruptcy proceedings.
Much of the noise about executive pay and corporate governance in general is coming from big institutional investors--the mutual fund companies, pension funds and other big money managers that can own big chunks of a company’s stock and thereby wield a lot of clout at voting time.
Mutual fund and pension giant TIAA-CREF has long been active in corporate governance issues. But it was joined this spring by a potentially formidable group of investment managers that includes Jack Bogle, founder of Vanguard Group, the nation’s second-largest mutual fund company, and Bill Miller, the well-known fund manager for Legg Mason Inc.
But even among institutional investors, there is a lack of consensus on how to proceed. Many fund managers said their duty when confronted with profligate corporate management is to sell the stock--not to try to change the company.
Another forum for change could be Congress.
One bill introduced last year would cap executive paychecks at 25 times the wage of the company’s lowest-paid worker. That would mean that if a company employed workers who were paid the national minimum wage of $5.15 an hour, it couldn’t pay the CEO more than about $250,000 a year without running afoul of the law.
Though that cap may be too draconian, imposing one would both limit executive pay and put a spotlight on a living wage for everyone, Klinger said.
“I don’t know what the right ratio is, whether it should be 25 times or 100 times,” he said. “But I’d guess it would be somewhere in between.”
Given the lackluster record of Enron-related reform legislation, it’s unlikely such a cap would ever become law.
A more effective strategy may be the push to change accounting standards to reveal the cost of issuing stock options.
Greenspan backs this approach, as do pay critics such as Munger. But it has generated intense opposition among corporations--especially tech companies, some of which could see their reported profits turn into huge losses.
Companies aren’t required to list the cost of stock options as an expense on their income statement. That allows boards to grant millions of options to managers each year without fully disclosing the effect on both the company’s bottom line and on shareholders, whose ownership interest becomes increasingly diluted as more shares are issued to satisfy the option grants.
How bad can it get? TIAA-CREF just successfully fought a company’s incentive stock option plan that would have diluted public shareholders’ ownership stake by 40%, said Peter Clapman, TIAA-CREF’s senior vice president and chief counsel.
“If that’s happening year after year, your stock position is constantly being eroded,” Clapman said. “Meanwhile, the CEO would get an extraordinary amount of money if the stock price went up [just] 5% per year. These are great payoffs without any performance.”
In the end, though, the case for pay reform involves more than fair play for shareholders or fairness for rank-and file-workers, compensation critics contend.
“If the existing system keeps going on and on in its present direction, large American businesses are going to be widely hated and distrusted by the citizens of America,” Munger said.
“That is not a good outcome.”
