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- Warren E. Buffett, chief executive officer of Berkshire Hathaway Inc. - New York Times
The Pious CEO?Religion News Service - by William Bole - August 5, 2002
When Bernard Ebbers felt he had some explaining to do about his part in the WorldCom scandal, he did not look to argue his case before any political or regulatory authorities. Actually, the former WorldCom chief executive refused to answer an onslaught of questions from members of a House committee, instead claiming his rights under the Fifth Amendment to the Constitution.
But a few days earlier, Ebbers did stand before another social body: his Baptist church in Brookhaven, Miss., where he teaches Sunday school. "I want you to know you aren't going to church with a crook," he told the congregation at the end of a Sunday service in late June.
Members of Easthaven Baptist Church vouched for his integrity and good faith -- which led some reporters on the scene to suggest the congregation had proffered forgiveness to the corporate chief. But that is not quite right, since forgiveness implies a moral judgment that an act was wrong. The congregants did not seem to think there was anything to forgive.
Which raises a disquieting question: Did Ebbers go before the faithful because he knew they would go easy on him?
One could further ask if religious communities, from Baptists to Bahais, have any wisdom to share on the question of corporate malfeasance. Do religious traditions have anything to say about executives like Ebbers in the dragnet of recent corporate accounting scandals?
As a legal scholar who specializes in business law, Mark Sargent is amply versed in issues of corporate governance. As a believer who subscribes to his church's social justice teachings, he is also privy to certain understandings of human nature and the need for social structures. "I've always said that one of my reasons for belief in God is that the human capacity for rationalization of its own wrongdoing is so infinite that there must be some Prime Mover," said Sargent, who is dean of Villanova University School of Law, a Roman Catholic institution in Villanova, Pa.
He suspects very few of these executives believe they did anything genuinely wrong. "I think many of them feel they were doing things that had become normative in the business, that they were really doing what everyone else was doing," he said. "I think this is the way they rationalize it for themselves."
It would be morally presumptuous to look into the soul of Ebbers, but fair enough to note that he speaks in the passive voice of someone who accepts little personal responsibility for what has happened. "I don't know what the situation is with all that has been reported. I don't know what is going to happen or what mistakes have been made," he reportedly told his congregation.
Ebbers called the shots at a company that allegedly began cooking the books as far back as 1999. He resigned earlier this year, after landing a $408 million loan from the now-bankrupt telecommunications giant to cover stock losses.
What could members of Easthaven Baptist say to Ebbers that would cause him to reflect more openly on his business life, if he hasn't already?
For starters, a religious community can say that part of being faithful is to rigorously examine your motives, Sargent points out. "We constantly have to ask ourselves if we're acting in such a way that's consistent with our values. It's a question of integrity as well as wholeness. When I use the word `integrity,' I say it's a person who not only has values but also examines those values and then acts consistently with them, even though it may be difficult under some circumstances. And that kind of integrity is implicit in a religious vision of life," he said.
While there are some legal fixes, such as tougher accounting standards and re-regulation, Sargent sees the need for a new conception -- beyond the legally enshrined notion that a corporation exists solely to maximize profit and shareholder value.
"There is an alternative vision of the corporation," he said. "It's expressed in the notion that a corporation has to exist not just to generate wealth for the managers and the shareholders. It has to serve another, broader purpose, subsumed in the notions of community, which requires relationships of trust and reciprocity. It has to (aim for) a common good that lots of people, employees and communities, can share in," he said.
"And if this were the conception of the purpose of large corporations, then this kind of behavior, which is endemic, would be more constrained."
Chances are that Bernard Ebbers did not hear this from the pulpit on many Sundays, but maybe some other executives in the pews will.
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Employee Trust DecliningPR Newswire – August 3, 2002
Levels of Are a Major Threat to Corporate Competitiveness, Watson Wyatt Study Finds
WASHINGTON, Aug 1, 2002 /PRNewswire via COMTEX/ -- Worker trust and confidence in senior management have fallen over the past two years, and unless reversed, present a major threat to future corporate competitiveness, according to a soon-to-be released survey of nearly 13,000 workers conducted by Watson Wyatt Worldwide.
Watson Wyatt's WorkUSA 2002 survey -- conducted earlier this year -- found that fewer than two out of five (39 percent) employees trust senior leaders at U.S. companies. Moreover, there was a five-point drop from 2000 to 2002 in both the percentage of employees (45 percent) who say they have confidence in the job being done by senior management and the percentage of workers (63 percent) who believe their companies conduct business with honesty and integrity.
"Falling levels of employee trust are a major threat to future corporate competitiveness," says Ilene Gochman, Ph.D., Watson Wyatt's national practice leader for organization measurement and author of the survey. "Unless Corporate America can resolve the crisis of confidence among its employees, it has little hope of restoring the trust and confidence of investors that is so crucial in these economic times."
Watson Wyatt has been conducting its WorkUSA survey since 1987. The study is one of the largest and most current statistically representative surveys on the attitudes of U.S. workers. The 2002 survey includes responses from 12,750 workers at all job levels and in all major industries. In addition to worker trust and confidence, the complete WorkUSA 2002 survey -- to be released in September -- will examine employee attitudes toward decision-making and business strategy, work-related change, communication, HR effectiveness, pay and benefits and performance management.
Trust and the Impact on the Bottom Line
Left untouched, low employee trust levels will exact a high financial price, Gochman warns. "Employee trust levels and corporate performance are closely linked. In fact, our survey found that the rate of three-year total returns to shareholders is almost three times higher at companies with high trust levels than at companies with low trust levels," she explains.
To restore employee trust and confidence, companies must focus their efforts in several areas, including assessment, communication and effectively managing business change.
"With fewer than half of employees expressing confidence in senior management, no company has been left untouched by the fallout from recent turmoil in the business environment. By assessing just how far trust levels have fallen at their specific organizations, companies can gain insight into the depth of the problem among their workers and establish a baseline against which to measure the success of their efforts to restore trust," Gochman says.
Watson Wyatt & Company, the primary subsidiary of Watson Wyatt & Company Holdings (NYSE: WW), is an international human capital consulting firm that provides services in the areas of employee benefits, human resources technologies and human capital strategies. The firm is headquartered in Washington, D.C., and has more than 4,200 associates in 62 offices in the Americas and Asia-Pacific. Together with Watson Wyatt LLP, a leading European-based consulting partnership, the firm operates globally as Watson Wyatt Worldwide. Watson Wyatt Worldwide has more than 6,200 associates in 87 offices in 30 countries.
CEOs Are a Dime a DozenNew York Times – by David Leonhardt – July 29, 2002
(7/28/02) - Welcome to story time in corporate America.
The old story went like this: chief executives were in such demand that they were apt to jump ship at any moment.
The new story says that the scrutiny of large companies has caused some C.E.O.'s to consider resigning and others to balk at a promotion to the corner office.
The next story is already emerging. It says executives will begin quitting in droves if boards force them to hold on to their company stock in an effort to tie the executives' pay to their company's long-term health.
The storytellers have most often been the executives and the recruiters and pay consultants they hire. By suggesting that the job market for chief executives is fluid, the tales of executive wanderlust have conveniently offered an economic rationale for enormous executive pay. The evidence, however, is about as impressive as the wardrobe of the emperor in that other fairy tale.
The job of C.E.O. is fabulously attractive, allowing somebody to lead thousands of people, often in an organization where they have spent years. Few people leave voluntarily before they are ready to retire. Surprisingly few have even been willing to leave one corner office for another elsewhere.
This is a crucial point at a time when policy makers and corporate leaders are both struggling to stop the bleeding on Wall Street and to help the fitful economic recovery. It means that reforming executive pay — a central part of re-establishing corporate America's credibility — may not be nearly as hard as some people think.
Set that aside for a moment, though, and return to the first story, the one about jumpy C.E.O.'s ditching one company for another.
Since 2000, a year in which executive turnover spiked, 77 of the 200 biggest companies have hired a new boss, according to Pearl Meyer & Partners, a compensation consulting firm in New York. How many of those companies had to do so because their chief executive took another corporate job? Two.
David M. Cote left TRW for Honeywell, and John H. Dasburg left Northwest Airlines for Burger King. That was the sum total of the wanderlust.
Most departing chiefs retired and remained on their company's board, according to news accounts. A good number were forced out.
Yet many companies, including USX and Verizon, lavished their executives with so-called retention bonuses. Dozens of others cited retention to justify big pay packages, even — as was the case at Enron recently — when the executives could hardly expect to be sought-after candidates for other jobs.
The new version of the myth says the recent criticism of corporate America has turned the chief executive's job into an unappealing one. David F. D'Alessandro, the chief executive of John Hancock Financial Services, recently said that he had run into a peer at Yankee Stadium who told him: "I'm thinking of actually getting out, retiring. I didn't sign up for this."
There is no reason to doubt Mr. D'Alessandro, but don't expect the unnamed executive to make good on the threat. In fact, check back six months from now to see if anybody running a healthy company ceded his power and perks.
The idea that executives have little loyalty, however, serves an important political purpose. It allows them to argue against a serious idea for altering executive pay.
Senator John McCain, Republican of Arizona, has proposed requiring top executives to hold all their company stock as long as they are in their jobs. Congress is unlikely to adopt the plan, but some analysts think that boards of directors might enact milder versions of the policy on their own. Executives have begun to fight the effort, saying that talented leaders would quit after their stock price had risen, sell the stock and find new work.
If boards are wise, though, they will realize that finding a new company to run is not easy. Bank One and Citigroup already have stock-holding rules for top executives, and neither has suffered an exodus. Boards can also backload pay packages, giving executives an incentive to stay.
The economic theory needed to design such a contract is fairly basic. Boards and investors simply have to decide that they will not bend to executives' wishes as often as they did in the slap-happy 1990's.
The idea is not perfect, of course. Some executives, anticipating a big stock decline, will still decide that quitting and selling makes more sense than sticking around to receive more shares. Should anybody really be worried, however, if a company loses an executive with that mind-set?
The 10 Habits of Highly Defective CorporationsScott Klinger with Holly Sklar – July 29, 2002
To make your company as Enron-like as possible within the bounds of law, just practice these 10 easy habits:
Risks for Workers, Rewards for Executives
To read the full 58 pages, click the link below:
Huge Pension Fund Makes DemandsThe Washington Times – by Carter Dougherty – July 26, 2002
(7/25/02) - The nation's largest institutional investor called on corporate America yesterday to treat stock options as expenses to improve the integrity of their books.
New York-based TIAA-CREF, a huge pension fund and asset-management group that handles $265 billion in investments, wrote the chief executives of 1,754 publicly traded companies yesterday, urging them to account for options as liabilities.
"Corporate America should adopt a strategic policy strongly encouraging accounting of the highest quality," wrote John Biggs, the TIAA-CREF chairman, president and chief executive. "One important element of this strategy would be for companies to employ an accounting model that reflects a realistic cost of stock options."
A vast majority of U.S. companies regards stock options, which are rights to buy new stock at a fixed price regardless of current market value, as having no effect on a company's bottom line.
But omitting stock options from income statements allows companies to inflate profits by understating expenses and encourages executives to use improper accounting to boost the value of their options, according to TIAA-CREF.
A study released yesterday by Bear Stearns and Co., a New York investment bank, concluded that expensing stock options would have sliced 20 percent off the earnings per share of the Standard & Poor's 500 companies. Profits in 2000 would have dropped 8 percent, the study said.
After accounting scandals at Houston-based Enron Corp. and other major companies, the approach has come under fire from investors who say stock options, a major component of executive pay, drove corporate chiefs to inflate earnings to drive up share prices.
Federal Reserve Chairman Alan Greenspan has advocated treating options as expenses, as has legendary investor Warren Buffet. Coca-Cola Co., Bank One, Fannie Mae, Freddie Mac and Amazon are among the major companies that already have taken this step.
But technology companies, many of which use stock options to substitute for cash compensation, have fought a legislative mandate to expense options. In particular, they helped defeat legislation pushed by Sens. Carl Levin, Michigan Democrat, and John McCain, Arizona Republican.
"My industry is always going to be opposed to expensing stock options," said Caroline Graves Hurley, tax counsel and director of tax policy at AeA, a high-tech industry association.
Instead, AeA wants legislation requiring the Securities and Exchange Commission to study how to treat options in financial statements.
TIAA-CREF, which handles pensions for employees of educational and research institutions, appears to be settling in for a protracted campaign to convince major companies to list their options as expenses. Peg O'Hara, managing director of the Washington-based Council of Institutional Investors, a trade association, said TIAA-CREF has a history of getting its way.
"They're very dogged," she said. "They will keep on an issue until they get results."
Kenneth Bertsch, TIAA-CREF's director of corporate governance, said the company will follow up with selected blue-chip firms in the hopes of getting a critical mass of companies to follow the lead of Coca-Cola and others. He added that many of these companies' directors, who have been making the case for a change in financial report of options, have urged TIAA-CREF to jump into the fray.
"Our sense is that this issue will move pretty quickly," Mr. Bertsch said.
TIAA-CREF will also solicit support from other major institutional investors, he said. The Council of Institutional Investors in March endorsed the change in accounting for options, but TIAA-CREF is the first major player to begin pressuring individual companies.
In June, the board of directors of the California Public Employees' Retirement System, which manages $149.3 billion in pension money, rejected a proposal similar to the one TIAA-CREF is making.
Who Really Cooks the Books?New York Times – by Warren E. Buffett – July 25, 2002
(7/24/02) - OMAHA — There is a crisis of confidence today about corporate earnings reports and the credibility of chief executives. And it's justified.
For many years, I've had little confidence in the earnings numbers reported by most corporations. I'm not talking about Enron and WorldCom — examples of outright crookedness. Rather, I am referring to the legal, but improper, accounting methods used by chief executives to inflate reported earnings.
The most flagrant deceptions have occurred in stock-option accounting and in assumptions about pension-fund returns. The aggregate misrepresentation in these two areas dwarfs the lies of Enron and WorldCom.
In calculating the pension costs that directly affect their earnings, companies in the Standard & Poor's index of 500 stocks are today using assumptions about investment return rates that go as high as 11 percent. The rate chosen is important: in many cases, an upward change of a single percentage point will increase the annual earnings a company reports by more than $100 million. It's no surprise, therefore, that many chief executives opt for assumptions that are wildly optimistic, even as their pension assets perform miserably. These C.E.O.'s simply ignore this unpleasant reality and their obliging actuaries and auditors bless whatever rate the company selects. How convenient: Client A, using a 6.5 percent rate, receives a clean audit opinion — and so does client B, which opts for an 11 percent rate.
All that is bad, but the far greater sin has been option accounting. Options are a huge cost for many corporations and a huge benefit to executives. No wonder, then, that they have fought ferociously to avoid making a charge against their earnings. Without blushing, almost all C.E.O.'s have told their shareholders that options are cost-free.
For these C.E.O.'s I have a proposition: Berkshire Hathaway will sell you insurance, carpeting or any of our other products in exchange for options identical to those you grant yourselves. It'll all be cash-free. But do you really think your corporation will not have incurred a cost when you hand over the options in exchange for the carpeting? Or do you really think that placing a value on the option is just too difficult to do, one of your other excuses for not expensing them? If these are the opinions you honestly hold, call me collect. We can do business.
Chief executives frequently claim that options have no cost because their issuance is cashless. But when they do so, they ignore the fact that many C.E.O.'s regularly include pension income in their earnings, though this item doesn't deliver a dime to their companies. They also ignore another reality: When corporations grant restricted stock to their executives these grants are routinely, and properly, expensed, even though no cash changes hands.
When a company gives something of value to its employees in return for their services, it is clearly a compensation expense. And if expenses don't belong in the earnings statement, where in the world do they belong?
To clean up their act on these fronts, C.E.O.'s don't need "independent" directors, oversight committees or auditors absolutely free of conflicts of interest. They simply need to do what's right. As Alan Greenspan forcefully declared last week, the attitudes and actions of C.E.O.'s are what determine corporate conduct.
Indeed, actions by Congress and the Securities and Exchange Commission have the potential of creating a smoke screen that will prevent real accounting reform. The Senate itself is the major reason corporations have been able to duck option expensing. On May 3, 1994, the Senate, led by Senator Joseph Lieberman, pushed the Financial Accounting Standards Board and Arthur Levitt, then chairman of the S.E.C., into backing down from mandating that options be expensed. Mr. Levitt has said that he regrets this retreat more than any other move he made during his tenure as chairman. Unfortunately, current S.E.C. leadership seems uninterested in correcting this matter.
I don't believe in Congress setting accounting rules. But the Senate opened the floodgates in 1994 to an anything-goes reporting system, and it should close them now. Rather than holding hearings and fulminating, why doesn't the Senate just free the standards board by rescinding its 1994 action?
C.E.O.'s want to be respected and believed. They will be — and should be — only when they deserve to be. They should quit talking about some bad apples and reflect instead on their own behavior.
Recently, a few C.E.O.'s have stepped forward to adopt honest accounting. But most continue to spend their shareholders' money, directly or through trade associations, to lobby against real reform. They talk principle, but, for most, their motive is pocketbook.
For their shareholders' interest, and for the country's, C.E.O.'s should tell their accounting departments today to quit recording illusory pension-fund income and start recording all compensation costs. They don't need studies or new rules to do that. They just need to act.
Warren E. Buffett is the chief executive officer of Berkshire Hathaway Inc., a diversified holding company.
Crack Down on Corporate CrooksTime.com - by Daniel Eisenberg – July 25, 2002
(7/14/02) - When it comes to cracking down on corporate crime, retribution seems to be the order of the day in Washington. Not long after Treasury Secretary Paul O'Neill spoke of hanging wayward CEOs from the highest tree, President Bush announced the formation of a "financial-crimes swat team." Unfortunately, the proposals most likely to pass into law have more bark than bite. Here's a look at some solutions that are more than just tough talk.
1. More Orange Jumpsuits
There is similar posturing in Congress but also some substantive proposals. An amendment introduced by Senator Patrick Leahy of Vermont would make it a felony to defraud shareholders — making it easier to prosecute executives — and also provide more protection to whistle-blowers. Another proposed law would make CEOs liable for the accuracy of their firm's financial statements, a measure supported by nearly 90% of those surveyed in a new TIME/CNN poll.
2. Get Rid of Pet-Rock Boards
Board members also need to stop spreading themselves thin on five or 10 boards at a time. They should be subject to 10-year term limits and annual elections. The terms should not be staggered, so shareholders can throw out all board members at once if they wish. Companies should be required to give shareholders election materials about rival candidates; as it stands, small investors who want to wage upstart campaigns don't stand a chance.
To avoid getting too cozy with management, directors need to meet regularly by themselves and with auditors without any of the company's top executives present. They should appoint a lead independent director to balance the power of — or even serve as — the chairman, who these days too often happens to be the CEO. (That should not be allowed.) Finally, directors should be paid primarily with long-term grants of stock, rather than collect a check for showing up occasionally. At AutoZone, a $5 billion-a-year parts-supermarket chain, each board member must invest at least $100,000 in company stock within three years of joining.
3. Price the Options
One reason options are troubling is that they encourage executives to expose the company to more risk than they would otherwise; executives have much to gain from reckless or shortsighted tactics and little to lose. Paying top executives mostly in restricted stock would force CEOs to "ride it up and down," says Charles Elson, director of the Center for Corporate Governance at the University of Delaware. And prohibiting CEOs from selling their company stock until after their tenure has ended would remove the incentive to manage earnings for the short term. McCain has called for such a restriction, which 70% of TIME/CNN poll respondents support.
4. Stop Bribing Auditors
5. End Stock Pimping
6. Unlock Those 401(K)S
All these measures may help a bit, but they will not do the job entirely. Companies need to stop using a dizzying array of earnings measures, from pro forma and cash to EBIDTA, and focus on a uniform standard that doesn't give a misleading picture of the balance sheet. Also, many observers, such as John Brennan, CEO of mutual-fund giant Vanguard, think earnings should be reported only semiannually so that business can be run for the long term. And without changes in the current, complex tax code, which practically encourages companies to play games, many think the skulduggery will continue. But in an election year, politicians are relieved that — so far, at least — most of the blame is sticking to management.
-- REPORTED BY JULIE RAWE AND ERIC ROSTON/NEW YORK AND ADAM ZAGORIN/WASHINGTON, WITH OTHER BUREAUS
Corporations Must Count Cost of OptionsPublic Citizen – Press Release – July 25, 2002
The conferees to the corporate accountability legislation should not meet in private on an issue that intimately affects the lives of so many Americans. The public is outraged about the current corporate crime wave and will be suspicious of any deals cut behind closed doors. A closed conference gives lobbyists the power to secretly and anonymously water down the reforms that are so badly needed. To root out corporate crime, we need sunshine in politics as well as in the boardrooms.
To restore investor confidence, the conferees must strengthen this legislation by slicing away the biggest incentive for corporate officials to cook the books. That incentive is stock options, the favorite vehicle for insiders to loot corporations and rob shareholders of their equity while hiding behind phony profit numbers. If the Congress is serious about cleaning up the systemic corruption infecting the body of Corporate America, stock options must be addressed. The McCain amendment forces companies to count stock options as the drain on corporate profits and shareholder equity that they really are. It should be adopted so that consumers can get an accurate reading of profits and so executives will no longer be rewarded with millions of dollars for creating bogus profits that drive short-term stock prices upward.
Exorbitant stock option packages are the common thread running through all of the corporate scandals that grace the headlines. Enron executives cashed in hundreds of millions before the company collapsed. Other companies, including many that have not been implicated in accounting scams, use these options to award obscene compensation to executives. Larry Ellison, the CEO of Oracle, for example, exercised stock options for a $700 million gain in 2001 - a year in which his company's stock fell by 52 percent. Try explaining that to the investing public. In the telecom industry, reported profits in 2001 would have been 23 percent lower if corporations had told the truth about stock options. That is a fraud on the public and it must be stopped.
Congress should take the lead on stock options. SEC Chairman Harvey Pitt said recently that it is no longer a matter of whether stock options should be expensed, but when and how. Just a week ago, the International Accounting Standards Board decided unanimously to require such treatment for stock options and it will be required by 2005 in the European Union and Australia. Some large U.S. companies also have decided on their own to make this change. But it should be done across the board so that investors can accurately compare profits from one company to the next.
The American people are closely watching the congressional poker game. These conferees hold the cards in their hands. It's time for some honest dealing for a change.
Give That CEO a Pay Raise!MSNBC.com – by Daniel Gross – July 24, 2002
July 16 — Yesterday, the Senate approved President Bush’s proposal to forbid corporations from extending loans to top executives. The measure, almost certain to become law, will come far too late for companies like WorldCom, which has virtually no hope of collecting the $400 million it lent to former CEO Bernard Ebbers. And there’s little reason to believe the ban will reduce runaway executive compensation. But it is sure to have some unintended consequences. Consider what happened the last time Congress played executive compensation consultant: It inadvertently set the table for today’s scandals.
IN THE EARLY 1990s, angered by coincident downsizings and reports of large executive payouts, Congress ended the deductibility of executive salaries above $1 million. Before the change, all salaries paid to workers and executives were deductible from a company’s taxable income. The new law penalized companies that paid outsized salaries to their top five officers. If General Motors wanted to pay its CEO $5 million, $4 million of that sum would no longer be tax deductible. Assume a 40 percent tax rate for companies (as compensation consultant Pearl Meyer & Partners does) and that $4 million would cost GM an extra $1.6 million.
But the measure excluded from the $1 million limit items that the Internal Revenue Service deems to be incentive-based or performance-based. As a result, the ban encouraged companies to funnel executive compensation into these murky areas, which are far more difficult for investors and the public to understand, and which are prone to abuse. Indeed, the ban created tax-based incentives for companies to craft some of the pornographic CEO compensation practices that helped get us into the current mess.
Companies like to operate in a tax-efficient manner, which is a euphemism for saying they like to avoid paying taxes. They’ll move to Bermuda, hire lobbyists to change the tax code, and shell out vast sums to accountants for advice - all to lower their tax burden.
Companies also like to be tax efficient when crafting compensation plans for their employees generally and for top employees in particular. So, when the new law took effect, CEO base salaries predictably stagnated, because they butted up against the $1 million limit. Between 1996 and 2002, according to Pearl Meyer, the average base salary for CEOs at the top 200 U.S. corporations rose just 15 percent, from $896,385 in 1996 to $1,031,184. But in the same years, alternate types of compensation that received more favorable tax treatments skyrocketed, notably incentive-based payment such as restricted stock, performance bonuses, long-term incentive plans, and stock-option grants. As a result, between 1996 and 2002 overall CEO compensation doubled from $5.8 million to $11.5 million, according to Pearl Meyer. Yet the base salary constituted only 9 percent of CEO pay.
Some of the most richly compensated executives of recent years received base salaries of less than - or exactly - $1 million. At Enron, Jeffrey Skilling’s 2000 base salary was a mere $850,000. At Tyco where compensation abuses were rife, only one of the top five officers - alleged tax-dodging ex-CEO Dennis Kozlowski - had a base salary of more than $1 million in 2001. Michael Eisner of Disney has a base salary of exactly $1 million a year. At Citigroup, both Sanford Weill and Robert Rubin take home million-dollar bases. Bernard Ebbers of WorldCom had a base salary of $1 million. A coincidence?
THE BASE PROBLEM
The base-salary limit has helped cause the enormous problems with incentive-based compensation that plague us today. With the surge in performance-based pay like stock options, as Alan Greenspan put it today, stock options have “perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising.” It is clear that executives at many companies used aggressive and occasionally illegal accounting methods to protect the source of their greatest compensation: the company’s stock price.
Scott Sullivan, the WorldCom CFO who allegedly engineered the misallocation of $3.8 billion in costs, received a 2001 salary of $700,000. However, that year he was awarded 619,140 options with an exercise price of $15.62 - adding to the 2.6 million options he already held. Their potential value dwarfed his salary.
The rise of incentive-based compensation also provided an easy justification for companies to pay their top executives far more than they ever could if they were simply paying straight salaries. For a large part of the 1990s, bosses could hold their hands up and say, with a straight face, that their salary was merely in the high six figures, and that it was their daring performance that had earned them their untold millions. After all, much of the compensation came in restricted stock and options, whose value could fluctuate with the stock price and was theoretically at risk.
I say theoretically, because companies in recent years have proved ingenious at defining performance in ways that benefited top executives. Stock options were frequently issued far below the market price. Companies began to engineer arrangements by which CEOs would receive a percentage of any increase in net income. When stocks fell, making existing option grants worthless, companies repriced options at lower strike prices or issued new ones at lower prices. As a result, CEOs routinely received substantial “performance-based” bonuses in years where their stocks fell or lagged the broader indices.
In 2001, a year when Citigroup’s stock stagnated, Sandy Weill received a $16.9 million performance-based bonus. In 2001, Scott Sullivan of WorldCom received a $10 million retention bonus for “remaining with WorldCom for at least two years after September 2000.” For Sullivan, 100 percent of “performance” was just showing up.
From the public’s perspective, the shift away from cash salaries served to muddy the waters. While base salaries are easily comprehensible, incentive-based compensation packages are frequently opaque. It is difficult for laypeople to determine the value of options and restricted stock. As a result, the media frequently offer conflicting numbers when reporting on executive salaries.
Let’s imagine, for a moment, that the $1 million limit was rescinded, and paying cash became the most tax-efficient means of compensating top executives instead of the least. Companies would pursue the path of least tax resistance and pay larger base salaries. And the clarity of a salary, its comprehensibility, its easy comparison with our own, would shine a bright light on executive compensation. It would provide a clear picture of precisely which shareholder resources are being doled out to the bosses. Many companies that currently have no compunction about dishing out options grants worth $50 million would not dare to write $50 million checks to top executives.
If Enron had disclosed that it paid Jeffrey Skilling and Kenneth Lay $30 million or $40 million salaries, investors and regulators would likely have raised red flags far earlier. And if Enron cut back on its lavish stock options, Skilling and Lay might not have used accounting trickery to boost the company’s share price.
Daniel Gross is the author of “Bull Run: Wall Street, the Democrats and the New Politics of Personal Finance” and writes frequently about Wall Street.