The meltdown of the financial industry — accompanied by rich golden parachutes to deposed bank chiefs — is proof to many Americans that the way companies reward their executives doesn’t work.
Executive pay remains high, with little connection to performance, critics say, despite efforts to fix the problem in the wake of Enron and other scandals.
Congressional Democrats were pushing hard Friday to impose executive pay limits on companies participating in an embattled $700 billion bank bailout plan. Under consideration were restrictions on severance packages, advisory voting rights for shareholders on executive pay and “claw back” provisions allowing companies to take back bonuses that were based on incorrect financial results.
The contentious issue was not guaranteed to survive the negotiations.
Critics blame corporate boards for failing to rein in executive pay and properly tie financial rewards with company performance.
“There is too much of a good-old- boy and good-old-girl network on corporate boards. They don’t ask the hard questions and be the tough people they have to be,” said Denver attorney Raymond Friedlob, a former EchoStar Communications Corp. director. “CEOs maneuver quite effectively to put their kind of folks on boards. That works well when the tide is rising all ships, but when you get into a scary situation like we’re in now, it doesn’t work at all.”
Friedlob, with Kamlet Shepherd & Reichert, said companies haven’t moved quickly enough to diversify their boards and should be forced to by the government.
CEOs get piles of money
Stories emerging from the wreckage of the financial industry are stoking public outrage. Deposed Citigroup CEO Charles Prince walked away with $39.5 million and former Merrill Lynch CEO Stan O’Neal took $161.5 million in stock and options when he departed.
CEOs of large U.S. companies earned an average total compensation of $10.8 million in 2006, more than 364 times the pay of the average U.S. worker, according to the advocacy group United for a Fair Economy. That was down, however, from 2000, when executive pay was 525 times workers’ pay.
The Sarbanes-Oxley Act of 2002, passed after a spate of corporate accounting scandals, took aim at a key culprit in skyrocketing executive pay: weakness of corporate board members and committees. But effectiveness of the measure is debated.
Sarbanes-Oxley prohibited the CEO and board chairman from holding voting seats on board committees that nominate directors, perform audits and determine executive compensation. It also established conflict-of- interest rules for members of those committees.
These and other new regulations have improved board independence and accountability, experts in corporate governance said. Yet the disconnect between executive pay and performance remains.
“Their behavior is not changing,” said Paul Hodgson, senior research associate with the Corporate Library, an independent corporate-governance research firm. “They still designed compensation plans that didn’t insulate shareholders from the risks being taken.
“There is a certain amount of peer pressure within a board. Don’t stick your head above the parapet. Don’t disturb the status quo. Don’t really take the CEO to task,” he said. “It’s very difficult for a board member to say, ‘We’re doing great, but I think our compensation program should be redesigned.’ Why would you want to rock the boat?”
Moves toward performance-based pay have similarly failed. Stock and stock-option awards give executives too short a perspective, critics said, allowing them to sell when prices are high, regardless of future risks. This was particularly evident in the banking industry, where executives sold millions of shares before their banks’ bad loans began to crumble.
“There’s nothing unusual about these financial executives. They thought they were smarter than they actually were,” said Sanjai Bhagat, a finance professor at the University of Colorado Leeds School of Business. “But they were given a lot of stock and they sold shares right away. They made millions, and now the investing public is basically in the tank.”
Bhagat, a specialist in executive compensation and corporate governance, proposes awarding executives, in addition to cash pay, restricted stock that they cannot sell until two to four years after they leave their company.
“The CEO realizes that he can’t do things that make share price look good today, then sell out; then three years later the stock falls and he says, ‘Too bad, but I’m not involved in that anymore.’ ”
Old ideas get new look
The proposals under consideration in Washington, which would apply only to companies choosing to participate in the bailout, aren’t new ideas.
Shareholder activists have been promoting “say-for-pay” for years. It would give shareholders a right to a nonbinding vote on executive pay as part of their annual proxy ballot. A similar system is used in the United Kingdom, with mixed results.
“Claw back” provisions give companies the right to take back bonuses executives earn if they are based on flawed financial results. They can be set off by a restatement of earnings and are being written into an increasing number of executive pay contracts.
Lawmakers have targeted severance pay before, but the issue has proven difficult to legislate because companies are under pressure to agree to them when trying to lure top executives. Some companies and executives are voluntarily reducing lucrative severance packages because they are so unpopular with shareholders.
Regulators stripped rich severance packages of $12.6 million from the departing CEOs of Fannie Mae and Freddie Mac when the government bailed out those companies. However, those CEOs will receive 401(k) plan assets valued at $9.6 million, according to published reports.
The public ire over the bank bailout and intense focus in Washington on executive compensation during the past few weeks will likely spur broader debate on the issue and put pressure on corporate boards across all industries, experts said.
“With this push, compensation committees are going to feel the heat a lot more. This will energize the debate, and it will be a continuing debate,” said Robert Bearman, a corporate governance lawyer at the Denver office of Patton Boggs. “They will see that if they don’t take actions by themselves, they’re looking at increased federal legislation. Shareholders also will become more vocal.”
Greg Griffin: 303-954-1241 or ggriffin@denverpost.com
Editor’s note: Corrections were made on this story.
