After years of watching the top echelons of corporate management
take home billions, shareholders want to know: Will
inflated pay packages get slashed?
By David S. Hilzenrath, Staff Writer
Sunday, December 21, 2008
Angelo R. Mozilo, whose Countrywide Financial came to symbolize
the failings of the mortgage industry, took home more than half
a billion dollars from 1998 to 2007, including $121.7 million
from cashing in options last year alone. Charles O. Prince, who
led Citigroup to the brink of disaster, was awarded a retirement
deal worth $28 million. Now, in a show of purported restraint,
top Wall Street executives are going without bonuses.
What are we to make of all this?
If you're angry that so many executives got paid so much for
screwing up so spectacularly, you might take solace in the fact
that shares they still hold have lost value, too. But if you
think executive pay is finally succumbing to the force of
gravity -- if you'd like to believe that an epic destruction of
investor wealth will fundamentally and permanently change the
way chief executives are paid, or that you, dear shareholder,
have the power to join forces with others just like you and
create a more rational order -- don't bet on it. The nation's
financial crisis could change the rules of executive pay, but if
history is any guide, you'll have a lot more to complain about
in the years ahead.
Through nearly two decades of tinkering, each new twist in
executive pay has proved flawed. Incentives meant to reward good
management have done just the opposite, and efforts to reform
the system have in some respects made matters worse. From the
bursting of the dot-com bubble to the collapse of companies like
Enron and WorldCom, from the rampant backdating of stock options
to the current meltdown of the global financial system, the
so-called pay-for-performance movement has led to colossal
windfalls, reckless risk-taking and fraud.
At a time when the government is using taxpayer funds to rescue
financial titans -- when ordinary Americans are watching their
retirement savings evaporate -- announcing that top executives
will forgo bonuses has obvious public-relations benefits. But
unless a bonus was warranted, it's a hollow gesture. And it does
nothing to alter certain underlying realities.
For the most part, executive pay is set by executives.
Executives dominate corporate boards, and corporate boards are
self-perpetuating. As a practical matter, shareholders have
little say in the selection of directors, and once directors are
in the compensation boat, they have little incentive to rock it.
If you're a director and you go along with generous chief
executive pay, "you get to sit on more boards," said Fabrizio
Ferri, an assistant professor at
who studies executive compensation.
According to one school of thought, the scale of executive pay,
if not the particular form, is unlikely to change substantially
unless the balance of boardroom power changes.
There are several ways the crisis could shake things up.
First, short of a revolution in the way corporations are
governed, there are efforts afoot to make it harder for
executives to profit from mismanagement while investors are left
holding the bag.
Some shareholder activists are calling on boards to hold
incentive pay hostage to a company's long-term fortunes, and
investor anger could put pressure on directors to comply. The
American Federation of State, County and Municipal Employees
plans to ask shareholders to vote next year on resolutions
urging boards to take two steps: stretch out the payment of
annual bonuses over multiple years and hold on to a significant
portion of equity awards until the executive has been gone from
the company for two years.
The resolutions are purely advisory.
Second, through its bailout programs, the government can set
conditions for companies that accept federal funds. For example,
the government is requiring participating firms to eliminate
incentives for executives to take "unnecessary and excessive
risks that threaten the value of the financial institution."
It's unclear how companies will apply such a nebulous standard.
In the spirit of both the AFSCME proposal and the Treasury
mandate, the investment firm Morgan Stanley recently said it
will make a portion of annual bonuses subject to recapture by
Third, either Congress or the Securities and Exchange Commission
could make it easier for big shareholders to put their own
candidates for board seats on the corporate ballot. In theory,
that could make directors much more accountable. For it to work,
shareholders, especially institutions like pension and mutual
funds, would have to take a more active role than many have had
the stomach to play in the past.
The plan could backfire. If executives are forced to confront
shareholders with real power, would they be any less motivated
to deliver short-term results, or the illusion of short-term
results -- even if those compromise the company's interests over
the long run?
Outrage about executive pay is far from a new phenomenon.
Back in 1990, two professors warned that something very bad was
taking place in
boardrooms: Executives were being paid too little.
"On average, corporate
pays its most important leaders like bureaucrats. Is it any
wonder then that so many CEOs act like bureaucrats rather than
the value-maximizing entrepreneurs companies need to enhance
their standing in world markets?" professors Michael C. Jensen
and Kevin J. Murphy wrote in the Harvard Business Review.
Executives, not surprisingly, embraced the idea. In a way, so
did their toughest critics. At the time, some shareholders were
up in arms about million-dollar executive salaries. They
demanded that pay be based on performance, and they bought into
the notion that chief executives should be able to make more
money as long as they earned it.
President Bill Clinton and Congress got into the act in 1993,
dictating that companies could no longer take tax deductions for
executive pay packages of more than $1 million -- unless the pay
What followed was a massive proliferation of stock options,
making it possible for executives and workers alike to attain
fortunes that were previously unimaginable. Options give the
holder the right to buy shares of stock at a fixed price --
ordinarily, the price at which the shares are trading when the
options are granted. If the market price of the stock climbs,
the holder can exercise the options and sell the shares at a
If the executive is awarded options to buy 500,000 shares at $10
each and the stock price climbs to $100 -- well, you do the
Corporate boards claimed that they were aligning the interests
of executives with those of shareholders. They were wrong.
Options can reward any increase in the share price. That became
painfully clear in the bull market of the 1990s when executives
benefited from rising share prices even if their stocks lagged
behind competitors or market averages.
Then came an epidemic of accounting scandals, which showed that
options gave executives powerful incentives to cook the books
and kite their stocks. More recently, many companies were found
to have secretly manipulated the terms of options. By backdating
the awards -- in other words, falsely claiming that the options
were granted when the stock price was especially low --
companies lowered the performance hurdle and made the options
much more valuable.
As an alternative to options, or in addition to options, many
boards shower executives with stock that vests over a period of
years. But those awards are widely mocked as "pay for pulse"
because they have value even if the stock price falls. Some
boards layer on additional requirements -- for example, the
executives can't collect the stock unless the company's profit
or share price hits certain targets. If the targets aren't easy
to hit, they can introduce more incentives to cheat.
Meanwhile, boards have a history of openly changing the rules to
benefit the boss. When performance targets proved too hard to
meet last year, a bunch of companies dispensed with their
criteria and awarded bonuses anyway, according to a report this
month by the Corporate Library.
Government efforts to reform executive pay have had mixed
When the government limited the tax-deductibility of executive
salaries, many boards stuck shareholders with the added taxes
instead of capping the salaries. When the government mandated
clearer disclosure of executive pay, it gave shareholders fresh
ammunition to complain -- but it also gave executives more
information about their peers, which gave them new leverage in
pay negotiations, Joseph E. Bachelder III, a lawyer for top
executives, wrote in the New York Law Journal last year.
In 1992, after the SEC adopted some of the most significant
reforms, one leading compensation critic suggested that the
actions could put him out of business. "I may be like the Maytag
repairman, with nothing to do, sitting here waiting for somebody
to be overpaid," Graef Crystal joked. Sixteen years later,
is still fulminating.
At last check, the chief executives of companies in the Standard
& Poor's 500-stock index received pay packages valued at an
average of $10.5 million, which was 344 times the pay of the
typical American worker, according to a study by the Institute
For Policy Studies and United for a Fair Economy, which says
that "concentrated wealth and power undermine the economy."
Murphy, a co-author of the 1990 Harvard Business Review article,
predicted that executive pay will resume its upward climb.
"I think we have a history that shows that uproars over
executive compensation at most create short-run changes in pay.
And then what usually happens is the government enacts some
knee-jerk reactions that at the end of the day end up increasing
executive pay," he said.
Chief executives "prefer to play a heads-I-win, tails-you-lose
game with shareholders, and so far they've been successful,"
said Jensen, the other author of the 1990 article. "It's
changing, but compensation committees [of corporate boards]
still tend to be under the control of the CEO," he said.
Though it may be counterintuitive, the current crisis could
plant the seeds for a new bumper crop of executive riches.
As compensation committees ponder their next round of pay
decisions, one of the questions they are trying to answer, board
advisers said, is how to factor in the decline in stock prices
when determining how many shares to award executives. They could
give out the same number of shares as in past years, delivering
much less value. Or they could give out many more shares to make
up for the reduced value of each individual share, setting
executives up for huge gains if stock prices recover.