No, he isn’t dead but he might as well be as far as his ability to influence Vanguard, the giant mutual fund he founded. John Bogle wants funds to introduce resolutions at companies requiring a 75% shareowner vote in order to make political contributions. Yet, Vanguard has never introduced a single shareowner resolution anywhere that I know of. Bogle believes funds should vote in the interest of their shareowners, not their managers. We see no evidence of that at Vanguard. Corporations, he says, shouldn’t be controlled by their agents. Yet, Continue Reading →
Tag Archives | CEO pay
IRobot (IRBT) is one of the stocks in my portfolio. Their annual meeting is coming up May 24. ProxyDemocracy.org had only one fund voting, CBIS, when I voted yesterday. MoxyVote.com had none. Today is the last day to vote using MoxyVote.com.
Checking the Summary Compensation Table, it appears CEO/Chair Colin M. Angle was paid more than $2.3 million, which is more than the $2.2 million median for a small-cap firm. Using the United States Proxy Exchange (USPX) released draft guidelines and adjusting for company size, I voted against the pay package. However, because the difference was relatively small, I didn’t vote against the compensation committee. Management wanted a say-when-on-pay frequency of three years but I voted for every year. I voted using the MoxyVote.com platform.
|1.1||Elect Director Gail Deegan||For|
|1.2||Elect Director Andrea Giesser||For|
|1.3||Elect Director Jacques S. Gansler, Ph.D.||For|
|2||Approve Executive Incentive Bonus Plan||For|
|4||Advisory Vote to Ratify Named Executive Officers’ Compensation||Against|
|5||Advisory Vote on Say on Pay Frequency||One Year|
Pay continues to be the biggest issue this proxy season. The May 17 edition of Pirc Alert had several articles on point. In “A challenge to high pay” they discuss some of the findings by the High Pay Commission. Here’s a few choice tidbits from the Commission’s report:
- attempts to link top pay with company performance only seem to have resulted in pushing up remuneration, with little corresponding step up in business success.
- the top 0.1% earners – are finance workers (30%), those working in business (38%) and company directors (34%)
- Excessive rewards are undermining relationships with employees and shareholders; they are encouraging harmful risk taking and creating an economic elite which wields enormous power but appears to have lost touch with how the rest of us live.
- Defenders of high pay talk about executives being poached by international competitors but only one FTSE 100 company has been the victim of poaching in the last 5 years, that was from another British firm.
- a feeling that business leaders are ‘in it for themselves’ pervades all discussions on the behaviour of businesses.
- 58% of people either agree or strongly agree there is one rule for the rich and another for the poor; 18% disagree
- The failure of our corporate governance system means that we are now paying more and getting less
The Commission will now look at options, such as “reforms of the Remuneration Committees and the inclusion of other stakeholders.” PIRC has also argued that introducing dissident elements onto committees may restrict excess. We look forward to the Commission’s recommendations later this year.
Yesterday Broc Romanek reported “four more companies filed Form 8-Ks reporting failed say-on-pay votes: Helix Energy Solutions (34%); Curtiss-Wright (41%); Intersil (44%); and Cincinnati Bell (34%). I keep maintaining our list of Form 8-Ks for failed SOPs in CompensationStandards.com’s “Say-on-Pay” Practice Area.” His list was up to 24 when I looked yesterday; it could be higher today. See the agenda for their upcoming November 1 conference.
Thanks in part to “say on pay,” U.S. directors are receiving less opposition from investors this season. As of May 12, the average “withhold” vote was 4.7 percent, as compared with 5.5 percent last year. At S&P 500 companies, the average opposition rate has fallen from 4.1 percent in 2010 to 3.9 percent this year, according to ISS data. (Advisory Votes Help Shield Directors From Investor Dissent, Ted Allen, ISS, 5/19/2011)
The United States Proxy Exchange (USPX) released draft guidelines for shareowners to use in making say-on-pay voting decisions. Our guidelines call for a no vote on “say-on-pay” when the ratio of CEO pay to average workers exceeded a shareowner specified threshold or when the CEO was higher than the median. We also recommend voting against compensation committee members when shareowners vote down pay packages.
Is this a good strategy, or should we wait until the following year to vote out compensation members who don’t take voting down pay packages seriously? That seems to be the strategy of many shareowners this year. What are your ideas on how to ratchet down pay packages that seem to rise every year, regardless of company performance and oblivious to the widening gap between the super-rich and the rest of us?
Comment letters are due by June 2nd to [email protected]. Please put “Say-on-Pay Guidelines” in the e-mail subject line. Letters will be posted to the USPX website, unless you indicate you would rather remain anonymous.
Rovi (ROVI) is one of the stocks in my portfolio. Their annual meeting is coming up May 24. ProxyDemocracy.org had only one fund voting, Calvert, when I looked two days ago. MoxyVote.com had four “good causes” but only one readily identifiable source, Calvert.
Checking the Summary Compensation Table, it appears CEO/Alfred J. Amoroso was paid almost $7 million. That’s too much for what is essentially a small cap where median pay is $4.3 million. Using the United States Proxy Exchange (USPX) released draft guidelines and adjusting for company size, I voted against the pay package, against the stock plan and against Ludwick, Quindlen and O’Shaughnessy, since they served on the compensation committee. Management wanted a say-when-on-pay frequency of three years but I voted for every year. I voted using the MoxyVote.com platform.
|1.1||Elect Director Alfred J. Amoroso||For|
|1.2||Elect Director Alan L. Earhart||For|
|1.3||Elect Director Andrew K. Ludwick||Withhold|
|1.4||Elect Director James E. Meyer||For|
|1.5||Elect Director James P. O’Shaughnessy||Withhold|
|1.6||Elect Director Ruthann Quindlen||Withhold|
|2||Amend Omnibus Stock Plan||Against|
|4||Advisory Vote to Ratify Named Executive Officers’ Compensation||Against|
|5||Advisory Vote on Say on Pay Frequency||One Year|
Interface, Inc (IFSIA) is one of the stocks in my portfolio. Their annual meeting is coming up May 23. ProxyDemocracy.org had only one fund voting, CBIS, when I looked yesterday. Often they seem to vote against just about every management recommendation but not this time. MoxyVote.com had five opinions but only two readily identifiable sources, Calvert and Trillium. They were at odds with each other.
ProxyDemocracy.org had only one fund voting, CBIS, when I looked yesterday. MoxyVote.com had no recommendations. The Summary Compensation Table shows CEO/Chair Kevin R. Johnson earned $10 last year. That’s more than the median pay of CEOs in the S&P 500. I’m voting against all pay packages above the median, including this one and I’m voting against the bonus plan. See Nay on Pay: How Continue Reading →
The United States Proxy Exchange (USPX) released draft guidelines for shareowners to use in making say-on-pay voting decisions. Comment letters are due by June 2nd to [email protected]. Please put “Say-on-Pay Guidelines” in the e-mail subject line. Letters will be posted to the USPX website, unless you indicate you would rather remain anonymous. (Disclosure: I am a member of USPX. Anyone can join for a nominal cost.)
Our draft guidelines lay out the problem of rising CEO pay, largely unrelated to performance. Shareowners now have a “say-on-pay.” However, if we mindlessly vote in favor of executive pay packages we will be adding to the problem, providing “insulation” for compensation committees and CEOs who can then point to shareowner approval.
Indeed, at a webinar earlier this week, Equilar indicated that 77.4% of votes at S&P 500 companies have so far resulted in 90% shareholder support for pay packages. A recent post by Dominic Jones, of IR Web Report, shows that most Investors spend just 5 minutes on annual reports and proxy materials.
To help shareowners make the best use of that five minutes we propose two general tests:
- The ratio test: Vote down all pay proposals where companies paid their CEO more than whatever pay ratio to average pay you think is outrageous. Peter Drucker warned it should be no more than 20. You may willing to pay up to 50, 100, 150 or more. We show you how. (For an interesting series of posts on the effort to kill the Dodd-Frank requirement to report company ratios, see Jay Brown’s series on Executive Compensation and Ratio Disclosure.)
- Median executive compensation: Vote against compensation packages of any firm at which executive compensation exceeds median pay (or some variation of that) in the previous year. Almost every year, median CEO pay rises because no board wants to think of their CEO as average. Paying above average of surveyed peers results in an average that continually ratchets up. Some of us think it is time for CEO pay to ratchet down for a while.
We also recommend that when you vote down a pay package, you also vote against the compensation committee that recommended its approval by the board. At a recent meeting of the Silicon Valley chapter of the National Association of Corporate Directors, Abe Friedman, former global head of corporate governance and responsible investing at BlackRock and Barclays Global Investors, concluded that voting out five compensation committee chairs and putting their pictures in the Wall Street Journal would do more for the pay issue than say on pay rights granted by Dodd Frank.
Again, comment letters are due by June 2nd to [email protected] Please put “Say-on-Pay Guidelines” in the e-mail subject line. Letters will be posted to the USPX website, unless you indicate you would rather remain anonymous.
GovernanceMetrics International recently sampled large corporations and found that CEO pay jumped 27% in 2010 to a median of $9 million.
According to William Lazonick, professor at the University of Massachusetts, in 2010 the S&P 500 jumped 12.8%, capping a two-year gain of 39.3%. Companies in the S&P 500 boosted profits by 47% in 2010, not from boosting sales of goods and services, which rose only 7%, but by cost-cutting and layoffs, says Lazonick. (CEO pay soars while workers’ pay stalls, USA Today 4/1/2011) ) Continue Reading →
ProxyDemocracy.org had only two funds voting when I looked yesterday, CalPERS and CBIS.
ProxyDemocracy.org had only one fund voting when I looked yesterday, CBIS.
MoxyVote.com had seven recommendations, although three were from voting consolidations for categories. I Voted in favor of John Chevedden’s proposal for an independent chair. I will always vote in favor of such resolutions, except, perhaps, in very unusual situations.
I voted against the executive compensation package based on the $15M pay package for Continue Reading →
Paradoxically, it’s often an obsession with fairness that leads people to begin cutting corners in the first place.
“Cheating is especially easy to justify when you frame situations to cast yourself as a victim of some kind of unfairness,” said Dr. Anjan Chatterjee, a neurologist at the University of Pennsylvania who has studied the use of prescription drugs to improve intellectual performance. “Then it becomes a matter of evening the score; you’re not cheating, you’re restoring fairness.”
… people subconsciously seek shortcuts more than they realize — and make a deliberate decision when they begin to cheat in earnest.
… Low-level cheating may be natural and even productive in some situations; the brain naturally seeks useful shortcuts. But most people tend to follow rules they Continue Reading →
On one level, the recent action of General Electric in adding performance related conditions to the vesting of stock options recently granted to its CEO (GE Realigns Immelt’s Incentives, Barrons, 4/19/2011) would seem to reflect improvement in its governance. Tying CEO options to company performance can not be a bad thing for shareholders, so long as the performance criteria are not illusory and do not encourage aggressive accounting or a short term focus. The four year horizon for these criteria seems to make them meaningful.
However, on another level, these criteria beg the questions of what they really do for shareholders and whether they provide sufficient incentives to avoid the near-death experience caused by GE Capital in 2008- i.e. are they an exemplar of good governance? In particular, the requirement that GE’s return on equity meet or exceed that of the S&P 500, by definition is a reward for mediocre performance. Immelt is paid a substantial salary and bonus for “base” performance, so it is unclear why simply meeting this minimum benchmark should warrant additional recognition. As a small GE shareholder desiring Continue Reading →
When GlobeScan began tracking views in 2002, four in five Americans (80%) saw the free market as the best economic system for the future–the highest level of support among tracking countries. Support started to fall away in the following years and recovered slightly after the financial crisis in 2007/8, but has plummeted since 2009, falling 15 points in a year so that fewer than three in five (59%) now see free market capitalism as the best system for the future.
GlobeScan Chairman Doug Miller commented: “America is the last place we would have expected to see such a sharp drop in trust in the free enterprise system. This is not good news for business.”
The results mean that a number of the world’s major emerging economies have now matched or overtaken the USA in their enthusiasm for the free market. The Chinese and Brazilians, 67 percent of whom regard the free market system as the best on offer, are now more positive about capitalism than Americans, while enthusiasm in India now equals that in the USA, with 59 percent rating the free market as the best system for the future.
Among the 20 countries polled in both 2009 and 2010, an average of 54 percent today rate the free market economy as the best economic system, unchanged from 2009.
Americans with incomes below $20,000 were particularly likely to have lost faith in the free market over the past year, with their support dropping from 76 percent to 44 percent between 2009 and 2010. American women have also become much less positive, with 52 percent backing the free market in 2010, down from 73 percent in 2009.
My guess is that these numbers could easily be reversed with higher taxes on the rich, a more equal distribution of the wealth and of productivity gains, as well as more democratic corporate governance. A free market that allows the vast majority of its population to fail or stagnate, while the wealth of the top 1% soars, is not going to win any popularity contests. What are we waiting for?
At a time most employees can barely remember their last substantial raise, median CEO pay jumped 27% in 2010 as the executives’ compensation started working its way back to prerecession levels, a USA TODAY analysis of data from GovernanceMetrics International found. Workers in private industry, meanwhile, saw their compensation grow just 2.1% in the 12 months ended December 2010, says the Bureau of Labor Statistics…
Median CEO pay in 2010 was $9.0 million, based on 158 Standard & Poor’s 500 index companies with the same CEO serving all of 2009 and 2010 that have reported CEO pay, according to the USA TODAY analysis of data from GovernanceMetrics based on proxies that have already been filed. (CEO pay soars while workers’ pay stalls – USATODAY.com, 4/1/2011)
As William Lazonick, professor at the University of Massachusetts points out in the article, while companies in the S&P 500 boosted profit 47% last year, much of that was due to cost-cutting and layoffs. Actual revenues for selling goods and services grew at only 7%. How much longer can businesses grow profits through layoffs and cost-cutting? If businesses are really becoming more efficient, shouldn’t workers expect raises and shouldn’t shareowners expect rising dividends.
I’ve been thinking about “say on pay” votes lately, trying to figure out how I should vote as an individual retail investor. I’m relatively lazy when it comes to researching clawbacks, holding periods, correlations between pay and performance and all the rational factors that go into voting by large institutional investors like CalPERS or voting advice from Glass Lewis or ISS. Usually, I’ll look up on ProxyDemocracy.org or MoxyVote.com to see how others who put time and research into their efforts are voting.
However, after talking with some large progressive institutional investors, I’m concerned that none appear to be using any decision models that address the “Lake Woebegone Effect,” where all the children are above average. Former DuPont CEO Edward S. Woolard, Jr. speaking at a Harvard Business School roundtable on CEO pay said,
The main reason (CEO) compensation increases every year is that most boards want their CEO to be in the top half of the CEO peer group, because they think it makes the company look strong. So when Tom, Dick, and Harry receive compensation increases, I get one too, even if I had a bad year…. (This leads to an) upward spiral.
Every year companies want to pay their CEOs more than average and every year when compensation consultants survey a company’s peers they find that average going up. Yes, it is a little simplistic but one way to stop that spiral would be if every shareowner voted against every CEO pay package that is above the median. For 2010, that would be every pay package above $9 million.
I’m not sure what CEO pay should be but I find it difficult to believe that any CEO would work 30% harder for $12 million than they would for $9 million. Personally, I almost always worked at full capacity no matter what my pay because I enjoyed my work and it was meaningful… I still do and it still is.
I started my career as a teacher. It was long before Alfie Kohn wrote the book Punished by Rewards: The Trouble with Gold Stars, Incentive Plans, A’s, Praise, and Other Bribes but even back in 1970 I felt that rewards and punishments were artificial ways of manipulating behavior that destroy the potential for real learning. Instead, I found it was better to design classroom experiences to provide an engaging atmosphere so that students could act on their natural impulses to explore and gain knowledge.
Most social psychology studies show the more you reward someone for doing something, the less interest that person will tend to have in whatever he or she was rewarded to do. Instead, their focus moves to the reward itself. Isn’t leading a Fortune 500 company intrinsically rewarding? Shouldn’t $9 million be enough for anyone for one of those jobs?
As long as shareowners approve outrageous pay packages for CEOs the averages will keep ratcheting up and the disparity between the top 1% and the rest of us will continue to grow. We need to ratchet down the Lake Wobegon effect and bring our CEOs down to earth.
Yes, I’m still going to check ProxyDemocracy.org and MoxyVote.com to see how others are voting. If Florida SBA or CalSTRS are voting against a pay package I’m likely to join them. However, a couple of weeks ago, I voted against Andrew Gould’s $15 million pay at Schlumberger just because it was too much. I might just do that for all pay packages over $9million. What do you think? Can $9 million ever be too little?
Schlumberger, one of the stocks in my portfolio of about 50 companies, has an Apr 06, 2011 Annual Meeting coming up. I’ve decided to vote early this time, since I’m in New Orleans and may be too busy to research much while there. I checked in with MoxyVote.com, ProxyDemocracy and OTPP.
MoxyVote had no recommendations as of 3/29, as I post this, but I expect they will soon. OTPP voted against the proposal to increase authorized common share capital. I voted with them on that issue. At ProxyDemocracy I see that Trillium voted against all directors. Maybe they’re doing it because Schlumberger is second only to Halliburton in providing fracturing services to natural gas companies? I don’t know.
Florida SBA voted against Tony Isaac and K. Vaman Kamath. AFSCME voted against Chairman and CEO Andrew Gould. I went with these recommendations. Maybe it is just me but $9 million in options awarded to Gould last year on top of the rest of his pay for a total of about $15 million just seems over the top.
For say when on pay, I went with annual, along with disclosed votes by CBIS, Florida, Trillium and AFSCME. When I checked on 3/27 ProxyDemocracy was showing that CalPERS voted with management for a frequency of every two years. However, after contacting CalPERS I learned they actually voted for annual voting on SWOP. Both parties looked into the glitch and as of 3/28 it was fixed.
I also voted against the officers compensation proposal. As I said before, $15 million for Gould seems over the top to me. I’m not sure where the cut-off point is for reasonable pay but as long as shareowners approve such packages the averages will keep ratcheting up and the disparity between the top 1% and the rest of us will continue to grow. We need to ratchet down the Lake Wobegon effect.
For all other proxy items, I voted with management using the MoxyVote platform.
The Weinberg Center for Corporate Governance has won funding to begin a yearlong fellowship for research into such issues as CEO pay and has created an online training course for board directors.
The Edgar Woolard Fellowship (funded by the Investor Responsibility Research Center) — named in honor of the former DuPont Co. CEO — will fund the research of 21-year-old university senior Craig Ferrere, a finance major who is looking to find better ways of matching executive pay with performance.
Ferrere said he aims to find analytical tools that measure an executive’s worth more objectively and more accurately than peer comparisons, which has been a primary cause of escalating pay.
Earlier this year, Charles Elson, director of the Weinberg Center, helped put together an Internet multimedia course on the complex legal and philosophical dynamics of being a board member. “How to Be(come) a Director” was commissioned by the National Association of Corporate Directors, with the goal of teaching the essentials of board governance: ethics, accountability and competence.
The self-paced course costs $395, and includes video presentations from Elson and other experts. In today’s corporate world, a savvy, capable board is critical, Elson said, but directors can come to the role without adequate appreciation for the balancing act they’ll be expected to pull off.
Regarding CEO pay, Nell Minow recently wrote, “there is a little flicker of light at the end of the long, dark tunnel of outrageous pay.” Her signs of hope:
- Required advisory “say on pay” (SOP) vote. Last year after a “no” vote, Occidental Petroleum’s board reduced the pay package for CEO Ray Irani and announced his retirement. Shareowners have voted down pay plans at several companies already. Additionally, “Some companies are adjusting their pay plans in anticipation of a new level of scrutiny by shareholders, tightening pay-performance links and getting rid of especially unpopular compensation components like “gross-ups” (paying the executive’s taxes).”
- Shareowners at four of seven companies proposing a triennial say when on pay (SWOP) vote instead voted for an annual vote.
- The UK may soon require new additional disclosures.
- “Groups like Public Citizen are working to remove further legislative and regulatory obstacles to shareholder oversight on pay and disseminating information on the bonuses of bailout-company executives.”
- The FDIC is moving forward with rules to requiring pay-performance links in bank executive compensation as part of insurance risk assessment.
“These are all welcome signs that compensation is finally being seen as an essential element of securities analysis and risk management, and that’s what markets are all about.” (The Days of Outrageous CEO Pay May Be Ending | BNET, 2/14/2011).
High CEO pay is symptomatic of a host of issues. An important one for me is income inequality. It seems to me that a disappearing middle class is not good for America. This seems to be a concern of many, but we still seem to be heading in the wrong direction. For some interesting research on American opinion in this area, see The Return of Dan Ariely: The Survey Results Are In (ChrisMartenson.com, 2/7/2011). His conclusion:
Taken as a whole, the results suggest to us that there is much more agreement than disagreement about wealth inequality. Across differences in wealth, income, education, political affiliation and fiscal conservatism, the vast majority of people (89%) preferred distributions of wealth significantly more equal than the current wealth spread in the United States. In fact, only 12 people out of 849 favored the US distribution. The media portrays huge policy divisions about redistribution and inequality – no doubt differences in ideology exist, but we think there may be more of a consensus on what’s fair than people realize.
From Eagle Rock Proxy Advisors, most companies are generally recommending that shareholders vote for say-on-pay votes once every three years. Here is a snapshot of overall board recommendations/ intentions for recommendation at the beginning of the season:
As we previously reported, shareowners are pushing for the annual option, so I expect many more rejections of triennial proposals. See “Say on Pay” to be Annual. Timothy Smith, Senior Vice President, Director of ESG Shareower Engagement at Walden Asset Management recently sent out an e-mail noting he is among many strongly opposed to the triennial proposals by management and is “frustrated that we even had to have a frequency vote (thanks to Idaho Senator Crapo’s midnight amendment).” But the surge of votes for annual say when on pay SWOP is “helping investors pay more attention to the value and use of SOP votes. In the end this frequency vote may help solidify the importance of SOP to investors vindicating the initiative AFSCME, Walden and others started 6 years ago.”
Yes, with SOP and SWOP votes this year and companies reporting the ratio of executive pay to the average of all employees for the first time, the topic of CEO pay may come into focus more this year than in the past and shareowners will now at least have the power to voice their opinion.
However, I see little evidence that any of the current measures address the “Lake Woebegone” effect documented by Rachel M. Hayes and Scott Schaefer. According to those researchers, “no ﬁrm wants to admit to having a CEO who is below average, and so no ﬁrm allows its CEO’s pay package to lag market expectations.” (CEO Pay and the Lake Wobegon Effect, December 11, 2008, Journal of Financial Economics (JFE) Their analysis suggests SOP votes might be counterproductive. Before SOP was required by Dodd-Frank, many voices warned it would simply provide boards and managements with cover for a continued upward spiral. Hayes and Schaefer offer up a “potential solution to the problem of shareholder myopia.” Delegate pay decisions to directors and motivate them through contracts “to take a longer-term view.” But isn’t that what we’ve been trying all along? Clearly, something more is needed.
India’s Sonia Jaspal does a good job of citing some of the more more relevant papers and issues that have received too little attention to date. (The Negative Impact of CEO Pay & Power on Corporate Culture and Governance, 2/15/2011) Jaspal’s concern was apparently set off by a recent study conducted by Economic Times of India, which showed that in 2009-2010 CEOs of top companies earned 68 times the average pay of employees, up from 59 times their prior year. To Americans facing a pay disparity of 264 (with a high point of 558 in the year 2000), the differences in India may seem paltry. (Mind the Compensation Gap, Portfolio.com, 1/26/2011)
Many of us “feel” an injustice when CEOs earn so much more than average workers, but Jaspal points to academic studies that show the potential impacts are more harmful to society than simply hurt feelings.
When Executives Rake in Millions: Meanness in Organizations. “Higher income inequality between executives and ordinary workers results in executives perceiving themselves as being all-powerful and this perception of power leads them to maltreat rank and file workers.” Some powerful executives perceive those with lesser power as sub-human. They demonstrate reduced empathy, being inclined to objectify and dehumanize others through behaviors such as sexual harassment and an increase likelihood of unethical and corrupt behavior.
Jaspal also points to another real impact of this dehumanization, “the fact that CEOs who fired the maximum number of employees during recession in US, received the biggest pay packets.” They apparently felt little remorse in benefitting from the tragedy they impose on others. “The social and psychological consequences of income disparity are borne by the society” and the consequences may be greater in the United States than it is in India because of the much larger average disparities.
An article published by The Economist titled The psychology of power: Absolutely looks at experiments that appear to confirm Lord Acton’s dictum that “Power tends to corrupt, and absolute power corrupts absolutely.” According to the studies, “The powerful do indeed behave hypocritically, condemning the transgressions of others more than they condemn their own… It is not just that they abuse the system; they also seem to feel entitled to abuse it.” Researchers conclude that “people with power that they think is justified break rules not only because they can get away with it, but also because they feel at some intuitive level that they are entitled to take what they want.”
Of course The Economist comes to a different conclusion than many of us would: “Perhaps the lesson, then, is that corruption and hypocrisy are the price that societies pay for being led by alpha males (and, in some cases, alpha females). The alternative, though cleaner, is leadership by wimps.” I’d say the lesson, instead, highlights the need to ensure leaders remain accountable, knowing corruption and hypocrisy will not be tolerated.
We keep Searching for a Corporate Savior in our CEOs but ending up with charismatic narcissists, with too many focused on short-term profits when we know we should be promoting CEOs from within to move from Good to Great.
Fraudulent Financial Reporting 1998-2007- An Analysis of U.S. Public Companies by the Committee of Sponsoring Organizations of the Treadway Commission found that CEOs were involved in 72% of the 347 alleged cases of fraudulent financial reporting listed with SEC during 1998-2007 period. The average period of fraud was 31.4 months. Why Do CFOs Become Involved in Material Accounting Manipulations? shows that 46.15% of CEOs involved in fraudulent activity benefitted financially from accounting manipulations. “CFOs are involved in material accounting manipulations because they succumb to pressure from CEOs, rather than because they seek immediate personal financial benefit from their equity incentives.” Since CEO performance and benefits are measured by financial numbers submitted to the stock market, CEOs rationalize the need to report fraudulent financial numbers to protect their own positions.
Based on this analysis, Jaspal makes the following recommendations (I’ve taken liberty to reword some slightly.):
- The law should place a limit on the number of times CEO pay can excede the pay of average workers. This will ensure some balance is maintained.
- Because studies show that some powerful people tend to dehumanize their underlings and studies on emotional intelligence indicate that emotionally intelligent people are aware of their own and others emotions and drivers, we should explore methods to keep CEOs emotionally connected.
- Since research found that women are less likely to feel a sense of entitlement or power we should appoint more women CEOs to maintain a balance and keep senior management grounded.
- Independent board members should be included on compensation committees. “This will ensure that a realistic view is taken of CEO and other top executives’ salary. Basing salary structures on performance rather than favorable circumstances is required.” (This is already the norm in the United States; unfortunately, it doesn’t appear to “ensure a realistic view.”
- Employees may be empowered by forming trade unions and using whistle blowing lines inside and outside the organization. (Again, we have this in the United States and the whistle blowing tools are improved under Dodd-Frank.)
- Last but not the least, the public should play an active role in curtailing income disparities. The issues should be brought to government and media attention. (Name and shame seems to have little impact but perhaps heightened awareness of the issues will lead to real sanctions.)
It is a nice list. I certainly agree with the idea of keeping CEOs emotionally connected, appointing more women CEOs, and getting the government involved in reducing income gaps. However, for the most part Jaspal’s recommendations don’t provide much guidance for shareowners entering the proxy voting booth. The one exception is placing a limit on the number of times CEO pay can exceed the pay of average workers.
Institutional investors have developed a plethora of guidelines and scorecards for voting down CEO pay. For example, section 3 of the CalPERS Global Principles of Accountable Corporate Governance, which contains too much to cover in this brief post but here are a few examples:
- To ensure the alignment of interest with long-term shareowners, executive compensation programs are to be designed, implemented, and disclosed to shareowners by the board, through an independent compensation committee.
- Executive contracts be fully disclosed, with adequate information to judge the “drivers” of incentive components of compensation packages.
- A significant portion of executive compensation should be comprised of “at risk” pay linked to optimizing the company’s operating performance and profitability that results in sustainable long-term shareowner value creation.
- Companies should recapture incentive payments that were made to executives on the basis of having met or exceeded performance targets during a period of fraudulent activity or a material negative restatement of financial results for which executives are found personally responsible.
- Executive equity ownership should be required through the attainment and continuous ownership of a significant equity investment in the company.
- Equity grant repricing without shareowner approval should be prohibited.
- “Evergreen” or “Reload” provisions for grants of stocks and options should be prohibited.
We can find many more lists, but again they don’t seen to be too helpful for the average investor who isn’t going to hire a proxy advisor or put a lot of time into analyzing the proxy. Last year, the Council of Institutional Investors issued a brief paper, Top 10 Red Flags to Watch for When Casting an Advisory Vote on Executive Pay aimed at addressing this issue. “Many investors, however, lack the time and resources to do deep dives on compensation at each of the hundreds of companies in their portfolios. They need rules of thumb to identify executive pay programs that are ticking time bombs.” That statement might even ring truer for retail investors holding a dozen or fewer companies. Again, even CII’s “top 10” are too extensive to list here because many items are broken into multiple items. Here are the top 10 with much of that elaboration stripped away:
- Do top executives have paltry holdings in the company’s common stock and can they sell most of their company stock before they leave?
- Does the company lack provisions for recapturing unearned bonus and incentive payments to senior executives?
- Is only a small portion of the CEO’s pay performance-based or is the basis a single metric?
- Are executive perks excessive or unrelated to legitimate business purposes?
- Is there a wide pay chasm between the CEO and those just below?
- Stock options should be indexed to a peer group or should have an exercise price higher than the market price of common stock on the grant date.
- Did the CEO get a bonus even though the company’s performance was below that of peers?
- Does the company guarantee severance or change-in-control payments not in the best interest of shareowners?
- Does the disclosure fail to explain how the overall pay program ties compensation to strategic goals and the creation of long term shareowner value?
- Does the firm advising the compensation committee earn much more from services provided to the company’s management than from work done for the committee?
Key to the the usefulness of CII’s advice is how easily answers can be obtained by individual retail shareowners. A second major concern is even if all this advice is followed, how will we ratchet down the Lake Woebegone effect and decrease the growing disparity between the rich and the rest of us? That seems important if we are to move from a culture of narcism, where many of the rich feel entitled to break the law and treat underlings with disrespect.
Members of the United States Proxy Exchange will soon begin working on a paper to address the issue of CEO pay. I think it is likely to revolve around the issue of what pay packages to vote down. Most retail shareowners don’t subscribe to ISS, Glass Lewis or other services that can rapidly assess pay packages. We need simple metrics so that we can gather all the information we need to vote in just a few minutes. Three possible examples:
- Pay that is over 100 times average pay.
- Pay that takes more than 5% of a company’s net profit.
- Majority of those disclosing votes in advance on ProxyDemocracy.org recommend against.
For less than $4 a month, your voice can be heard by joining in this important effort.
Using a sample of U.S. S&P 1500 firms from 2007-2009, Naqiong Tong and Wei Cen provide new evidence showing that CEOs of firms engaging BIG6 consultants receive lower equity payments and lower total compensations compared to that of firms engaging SMALL consultants. In addition, they also find that a switch in a firm’s compensation consultants influences its CEO pay via two directions.
When a firm switches its consultant from SMALL to BIG6 consultants (SMALL to BIG6), its CEO receives lower bonus, lower equity and lower total compensation. By contrast, when a firm switches its consultant from BIG6 to SMALL consultants (BIG6 to SMALL), its CEO receives higher salary, higher bonus, higher equity and higher total compensation.
Their evidence supports the argument that big consultants tend to design more optimal contract to reduce CEO’s “excess pay” with their superior expertise on pay structure and concerns of high reputation cost. (SSRN-Big or Small: Compensation Consultant Selection, Switch and CEO Pay by Naqiong Tong, Wei Cen)
Shareowners may wish to give greater scrutiny in “say on pay” votes when pay packages are the product of smaller consultants.
In case you missed it, SEC staff reversed course on a no-action request, clearing the way for Navistar shareholders to vote on a Teamsters’ proposal related to golden parachute agreements, which urges the board to adopt a policy of obtaining shareowner approval for future severance agreements that contemplate paying out more than two times the sum of an executive’s base salary plus bonus. Navistar argued that Dodd-Frank’s say-on-pay vote would substantially implement the proposal’s objective. The SEC staff agreed.
In their request for determination, the Teamsters cited Congressional intent that financial reform requirements not preclude shareholders from taking action on specific elements of executive pay and their request was granted.
Shareowners might do well to contemplate introducing several such limitations on CEO pay at several companies. (see also, CEO Pay in an Age of WikiLeaks: Reporting, Rationale and Ratios and the members-only discussion at USPX.)
As has been widely reported, WikiLeaks will soon release thousands of documents revealing malfeasance, greed and incompetence at the highest levels of a major American bank, most likely Bank of America. According to WikiLeaks’ Julian Assange, this may be the biggest expose of unethical corporate behavior since the Enron scandal. (Facing Threat From WikiLeaks, Bank Plays Defense, NYTimes, 1/2/2011) For broader “leaks,” see Ex-Banker Gives Data on Taxes to WikiLeaks, NYTimes, 1/17/2011.
This will focus new attention on the subjects of greed, fraud and abuse at the highest levels of Corporate America. See Gary Larkin’s post, Wikileaks Episode Should be Wake-Up Call for Companies. (The Conference Board Governance Center Blog, 1/14/2011)
Last year’s Dodd-Frank bill includes Section 922, which provides that the SEC must pay rewards to whistleblowers who provide original information about violations of the federal securities laws that leads to successful enforcement actions resulting in more than $1 million in penalties. (Concerns Grow Over New Dodd-Frank Act Whistleblower Provisions). Additionally, a pay disclosure rule will require many U.S. companies to report the ratio of CEO pay to median employee pay in the annual proxy statements and also requires votes on corporate proxies concerning how often shareowners will have a “say on pay.”
A recent Towers Watson poll of 135 U.S. publicly traded companies found that 51% expect to hold annual say-on-pay votes, while 39% prefer the vote be held every three years, and 10% anticipate holding biennial votes. Meanwhile, nearly half 48% of companies surveyed are making some adjustments to their executive pay-setting process, while 65% are devoting more attention to explaining their programs in the Compensation Discussion & Analysis (CD&A). Some of the best advice for companies on these issues can be found regularly at CompensationStandards.com, including a program today, The Proxy Solicitors Speak on Say-on-Pay.
Clearly, the issue of executive pay is one that stay with us for years to come but 2011 could set the tone, not just in America but around the world. One of the more interesting discussions I’ve read is in the recent posts of an an Indian blogger, Sonia Jaspal, who cites a recent report of COSO “Fraudulent Financial Reporting 1998-2007- An Analysis of U.S. Public Companies,” which states that CEOs are involved in 72% of the 347 alleged cases of fraudulent financial reporting listed with SEC during 1998-2007 period. (see Fraud Symptom 1- Insatiable hunger of CEO, Fraud Symptom 2- A Weak CFO, and Fraud Symptom 3 – Board’s failure to exercise judgment. We need mechanisms to reduce the likelihood of collusion between CEOs and CFOs, such as making directors and/or audit committee responsible for recruiting and terminating CFOs and not linking CFO pay to stock market performance.
Shareowners are also grappling with how to address the issues. Manifest, a UK-based proxy advisory firm has something of an advantage, since UK shareowners have had a say on pay for many years. See an example of relatively recent discussion at “Excessive” bonuses lead to higher dissent. Other sources of advice include books such as Money for Nothing: How CEOs and Boards Enrich Themselves While Bankrupting America and the classic Pay without Performance: The Unfulfilled Promise of Executive Compensation.
Members of the United States Proxy Exchange have initiated a forum to discuss where individual shareowners and USPX should come down on pay issues. Get in on the conversation for $3.95 a month, if only to monitor what direction this increasingly influential group will take. There are thousands of sites providing investment advice but USPX is one of only a few on investors as owners.
While I have often advocated that any any principles regarding limits should be grounded on academic research, it is difficult to envision a mass movement based on the complex formulas and principles contained in most CD&As, even if they may be grounded in research. Should founding CEOs be given a pass? I don’t think so. CEOs like Steve Jobs of Apple and John Mackey of Whole Foods can easily afford to work for minimum wages because they own a substantial portion of their companies. Their real pay comes through ownership, not by working.
CEOs will try to convince their boards they should be paid in the top 25% of their peers and we have the Lake Wobegon Effect. Since companies will be reporting the ratio of annual CEO pay to median annual total compensation for all employees, that number may drive a popular movement. What will be considered fair? 1 to 25? 1 to 50? 1 to 100? 1 to 200?
In 2007, CEOs in the S&P 500, averaged $10.5 million annually, 344 times the pay of typical American workers, but that was a steep drop in the ratio from 2000 when CEOs earned 525 times average pay. With companies forced to report their ratios, expect more pressure than ever from shareowners in 2011.
ISS Issues 2011 Policy Updates – TheCorporateCounsel.net Blog, 11/22/2010. Broc Romanek provides highlights of ISS policy changes.
Dan Harris provides readers with his recent speech on Emerging Market/China Outsourcing Issues, China Law Blog, 11/21/2010. Also interesting, The China Rich….Are Not Like Us?, 11/19/2010.
The proposal to expand the executive branch’s role in oversight over financial institutions may represent the beginning of an incremental encroachment on SEC authority. Similarly, the proposed Consumer Financial Protection Agency could absorb a portion of the SEC’s traditional investor protection role. In the end, the SEC’s survival depends on whether its leadership takes effective action to restore its credibility andregain the public trust in the years to come.
On October 21, 2010, the Securities and Exchange Commission announced enforcement actions against Office Depot, Inc. and two executive officers for violating Regulation FD by selectively conveying to analysts and institutional investors that Office Depot would not meet analysts’ earnings estimates. (SEC Enforcement Action Under Regulation FD For Implicit Communications To Selected Analysts, Corporate Securities Law blog, 11/17/2010)
Across a matched group of more than 2,000 North American CEOs, annual pay climbed a slight 1.63 percent for the year. When increasing the pay scope to also include option profits and vested stock, compensation declined slightly, by 0.28 percent. Indeed, while we anticipated a second straight year of pay declines as of this spring, it’s evident that pay more or less stayed the same for the matched group as a whole.
(CEO Pay is Treading Water, The Corporate Library, 11/16/2010)
Robin Ferracone hits the right buttons in her new volume (Fair Pay, Fair Play: Aligning Executive Performance and Pay) when she describes how to develop of an “alignment” report that can be used by boards and shareowners to ensure executive pay will be judged as “fair.” She also interviewed the right people to work in a reasonable degree of wisdom from the perspective of shareowners. However, she falls short in glossing over high executive pay as a potential problem, a “myth.”
That’s understandable, given that she is a pay consultant. Shouting out that most CEOs are overpaid isn’t likely to win clients, since most compensation committee members still look to CEOs and other incumbent directors, not shareowners, to hold them accountable… although that may be changing. The book is clearly aimed at compensation committees but shareowners will also find the book useful, once they get past some of the contradictions in Ferracone’s analysis as an amateur sociologist and into the tools she has developed to better align pay with performance.
Warren Buffett, who doesn’t use compensation committees or consultants at Berkshire Hathaway thinks the best way to effect irresponsible board members and overpaid CEOs is to embarrass them. Nell Minow advises that stories on overcompensated CEOs loudly name all members of the compensation committee.
In contrast, Ferracone hopes that “solid and consistent analysis, not embarrassment” using her “Alignment Model” will lead corporations to “self-monitor and adjust their executive pay practices, and that voluntary reform will obviate the need for additional government intervention and allow government to go back to helping solve other problems in our society, such as issues in education and the environment.” Yes, and if companies would just take the necessary steps voluntarily, governments won’t have to mandate measures to address global climate change. We can all imagine it; but will it happen?
As a result of the recent financial crisis, many investors have seen their 401(k) plans reduced to 200½(k) plans. Those who haven’t lost their jobs and still hold some equity in their homes count themselves lucky. Ferracone’s says, “The notion that America’s wealthy people have become wealthier by virtue of seizing the wealth from others instead of creating it is just simply misguided logic.”
The rich may not have “seized” our wealth at the point of a gun, but they did largely take control of our government through false advertising… dramatically reducing their own taxes, overturning laws and regulations designed to guard against fraud and externalizing corporate costs, filling regulatory agencies with executives who believe companies will “self-monitor.” Citizens United further entrenches CEO power, since they spend company funds to install candidates friendly to their own entrenched power.
The rich now bring home the largest proportion of income since the 1920s. One out of seven Americans lives below the poverty line, while the top 2% fight to retain Bush tax cuts amounting to $700 billion over 10 years. Upward mobility in the USA is now lower than in almost all other developed economies. The only industrialized democracy with a higher concentration of wealth in the top 10% than the United States is Switzerland. (Poverty Rises as Wall Street Billionaires Whine, Huffington Post, 9/18/10; Wealth, Income, and Power by G. William Domhoff, updated August 2010)
The American Dream was based on a growing middle class and the prospect that by working hard, you could rise from log cabin birth to business tycoon or President. While the dream is still alive, myths often take time to die.
Ferracone wants to dispel myths, but she focuses her pitch at helping boards find that zone of acceptability, where pay is aligned with value delivered. High pay can still be justified, even in a “say on pay” environment.
While Ferracone’s alignment model is a surer route to justifying pay at most companies than putting up the pirate flag of Larry Ellison or hiding behind all-virtual shareowner’s meetings, such as that held by Symantec, I can’t give Ferracone a free pass as myth buster, even though her actual discussions on how to pay for performance are on target.
According to Ferracone, the vast majority of CEOs are not overpaid. Their compensation, adjusted for company size, industry, performance and inflation, has been virtually flat over the last 15 years, only increasing 1.6 times. Productivity gains alone account for all but $400,000 of the increase.
Investors agree. “About 75% of the investors surveyed by the Center On Executive Compensation in 2008 said that they had no real concerns about the levels of executive compensation in the United States.” Who are the members of the Center? They are the chief human resource officers of 300 of the large companies. They work for the CEOs! (See their comments to the SEC requesting a narrow view on Dodd-Frank) Who were the investors surveyed? They were the top twenty-five institutional U.S. equity investors. Many, like Goldman Sachs, JP Morgan, and Morgan Stanley were the same “investors” who took the financial services sector from 20% of the economy to 40% before the crash, through bets on synthetic derivatives and other nonproductive “investments.”
Even after driving the world economy to the abyss and being bailed out, the CEOs of many of these large investment firms still got huge bonuses. Ask the beneficial owners if CEOs are overpaid; you’ll get a different response. They didn’t put “say on pay” or a requirement to report pay ratios into the Dodd-Frank bill because 75% of the biggest institutional investors surveyed had no concerns. They did so because beneficial owners and average Americans are outraged.
Unfortunately, the American Dream and the personal aspirations of too many CEOs are built around the trinity of wealth, power and fame. These superficial values have become too embedded in the American consciousness. As we strive to resolve the financial crisis, we would do well to examine the need for a constructive shift in values. (See, for example, Corruptions of the American Dream: Wealth, Power and Fame by Joseph Yumang, a graduate student at Saint Mary’s College Of California). CEOs should be looking more to their mission, rather than their pay, to measure their success. Having one’s mission of dying with the most toys and money should no longer be socially acceptable.
Ferracone contends people are angry because a small percentage of companies have distributed excessive pay packages, which she rather arbitrarily defines as companies paying at the 95th percentile or higher… coupled with low performance. Yes, it is hard to argue that outlier CEOs paid anywhere from 15 to over 250 times median performance-adjusted pay deserved what they got. Does that mean those who weren’t outliers earned their pay?
No, not even according to Ferracone. Many companies say that they align pay with performance, but most don’t know whether, in fact, they’ve achieved alignment. Only 8% of variation in Performance-Adjusted CompensationTM (i.e., compensation after performance happens) is explained by variations in performance, defined as Total Shareholder Return (TSR); on the other hand, 30% of variations in Performance-Adjusted CompensationTM (PACTM) is explained by differences in company size, 11% is explained by industry, and 51% is unexplained. With only 8% explained by performance, how can Ferracone argue the vast majority of CEOs are not overpaid?
In a study Ferracone herself conducted, she found the vast majority of board directors and executives feel as though greater government intervention will not only not solve the Alignment issue, but could make matters worse. Is this supposed to be a revelation? Of course they don’t want government intervention.
Ferracone does offer some degree of balance in her Epilogue. She notes, “executive compensation should mostly be a matter that is between shareholders and the executives they employ.” Government “needs to make sure shareholders have the rights they need to appropriately influence the companies in which they are invested.”
Unfortunately, the first right she goes on to mention is the ability to buy and sell shares in a level exchange process. While that’s important, the “Wall Street Walk” encourages poor pay alignment, since if the investors who are unsatisfied walk away the more passive investors who are left are unlikely to take action regarding pay abuses.
She adds that shareowners “need to be in a position to elect board directors and vote on key proposals that affect their equity.” Good, but I would have felt better if she had inserted the word “nominate” with regard to selecting directors. Those interviewed by Ferracone for the book overwhelmingly indicated that retention is an overblown argument for increasing executive pay. Most CEOs identify strongly with their companies and generally won’t leave companies because of pay. If true, why are so many of them paid so much? Of course, the problem isn’t just incentives for CEOs. After all, traders at AIG Financial Products practically brought the entire economy down, and none were senior executives.
Ferracone’s firm, Farient Advisors LLC, is one of a growing number of pay advisers that sprung up to meet the needs of compensation committees that don’t want to be seen as conflicted by hiring the same firm that simultaneously works for management. That’s certainly a positive step in the right direction, as is Ferracone’s discussion of how to align pay and performance. Ferracone moves beyond Corporate America’s Pay Pal (NYTimes, 10/15/10) by wanting to be the shareowner’s pay pal too. If both sides converge around her Performance-Adjusted CompensationTM that would be another good move.
Yonca Ertimur, Fabrizio Ferri and Volkan Muslu offer some further hope in their paper, Shareholder Activism and CEO Pay (download pdf). They studied a sample of 134 vote-no campaigns and 1,198 non-binding shareholder proposals related to executive pay between 1997 and 2007 and found that shareholders are sophisticated enough to identify firms with excess CEO pay, both when targeting firms and when casting their votes.
Proposals that try to micromanage level or structure of CEO pay receive little or no voting support. Instead, shareholders favor proposals related to the pay setting process (e.g., subject certain compensation items to shareholder approval). These proposals are also more likely to be implemented. In some cases, compensation-related activism has a moderating effect on CEO pay levels. Firms with excess CEO pay targeted by vote-no campaigns experience a $7.3 million reduction in total CEO pay. The reduction in CEO pay is $2.3 million in firms targeted by proposals sponsored by institutional proponents and calling for greater link between pay and performance. (Hat tip to Stephen Davis for tweeting about the study.)
Perhaps the increasing power and sophistication of shareowners, combined with somewhat more neutral firms, like Farient Advisors LLC, will make the difference. Probably even more important, is the need for a shift in cultural values so that CEOs are driven by more altruistic missions than simple greed.
See also, Executive Compensation and Corporate Governance in Financial Firms: The Case for Convertible Equity-Based Pay (pdf) by Jeffrey N. Gordon, July 2010 and What’s your CEO really worth? INSEAD’s Corporate Governance Initiative creates a model, 9/22/2010.
Corporate buybacks are now a daily news item. In 2007 US companies spent an astounding one trillion dollars on stock buybacks that exceeded dividends paid and accounted for two-thirds of net income that year. Since 2000 those same companies distributed three trillion dollars to shareholders through buybacks.
By any measure, these amounts are staggering and evidence a substantial distribution of cash to shareholders, which might otherwise be put to other uses, like investing in new technologies and creating jobs!
exclaimed Paul Griffin, who recently completed research with Professor Ning Zhu focusing on why executives and boards spend these substantial sums. Their work was recently published in the June 2010 issue of Journal of Contemporary Accounting & Economics, titled “Accounting Rules? Stock Buybacks and Stock Options: Additional Evidence.”
When a company engages in stock buybacks (buying its own stock) it removes stock from the market thus increasing earnings per share and, hopefully, stock price. Buybacks are meant to benefit all shareholders, but Griffin and Zhu found that weak governance and unclear accounting allow companies to tilt the playing field in favor of their executives, who receive additional compensation because the buyback makes their stock options more valuable. Previous research did not show a reliable relation between higher CEO stock option compensation and the decision to engage in a buyback. Explained Griffin,
This is how managers can receive additional compensation, and for some, especially in recent years, this aspect of compensation has been sky-rocketing. Few people are aware that these buybacks are being used to enhance CEO compensation, and certainly not the regulators.
The researchers also discovered a positive relation between CEO insider selling following a buyback and the number of shares repurchased, also consistent with governance not protecting outside shareholders.
Professor Paul A. Griffin is an internationally recognized specialist in the areas of accounting, financial valuation and the role of information in security markets. He has published extensively in leading accounting and finance journals, and has written research monographs for the Financial Accounting Standards Board and case books on corporate financial reporting.
It’s ironic that the same week Jim McRitchie reports on lingering opposition to and attempts to circumvent the new proxy access rules Funds Preparing Candidate Pool and Proxy Access Avoidance: Subversive or Accelerating Preemption?, in part because of concerns that directors elected in this manner will focus on extraneous matters and private agendas, we see the HP board – having no significant minority shareholder representation – force out its CEO, Mark Hurd, over matters having little to do with the results of his stewardship. All of this illustrates the need for a sharpening of the focus of corporate law and corporate governance efforts to ensure they serve the purpose of incenting management to emphasize maximization of bona fide shareholder value.
I don’t deny the HP board had little choice under existing law. If they had left Hurd in place amid the scandalous revelations, they would have faced criticism and litigation at every turn on a multitude of theories. That’s the problem: as I have argued on this site and elsewhere, existing law places too much emphasis on process and matters having nothing to do with corporate performance (Require Affirmative Proof in Specified Circumstances of “Too Big to Fail Companies” in Order to Meet the Business Judgment Rule). We need changes in the legal regimen to force boards to evaluate management on its business strategy and performance, as well as corporate compliance with legal obligations.
I’m not condoning what Hurd did, and the board could not and should not ignore it under any legal regimen without compromising the company’s compliance posture, but it appears that by any overall metric he was a good CEO who, following the tumultuous, unfocused reign of Carly Fiorina, delivered excellent financial performance (H-P Chief Quits in Scandal, WSJ, 8/7/10) and created substantial shareholder value with the stock doubling during his tenure.
He was removed for what was ultimately a fairly minor personal indiscretion and de minimus problem with his expense reporting, which may have been handled by his assistant. I’m not sure what was accomplished through his removal other than an eight figure severance payout; the market cap of HP dropped by 8% (perhaps temporarily) when the news broke. One wonders if all concerned wouldn’t have been better off with a stern, private admonition from a board member to ‘knock off the garbage!’
Based upon what we have seen in the financial sector and the Delaware holding in the Citigroup case, it is doubtful if the board would have removed him this quickly if he had been pursuing a questionable business strategy resulting in poor results or heavy debt, encouraging aggressive accounting or overseeing activities resulting in legal claims by suppliers or customers. Witness the litany of cases where boards did nothing in the face of ever-more dubious strategy and results: AIG, Citigroup, WaMu, Merrill Lynch, Fannie/Freddie, Lehman, Bear Stearns, …. Need I ask which approach was better for society?
Indeed the board did not even remove him in the wake of the 2006 pretexting scandal, which in my estimation had more to do with the company’s integrity than the most recent episode.
As we move forward in the proxy access era, we all need to keep our eyes on the ball of corporate governance, namely, ensuring that firms are run for the benefit of shareholders. Of course, this means proper oversight of management compensation and ethical compliance. However, it also means keeping things in perspective when management is performing competently, in pertinent areas. There is no question that this will require changes in law to incorporate a more substantive perspective. With the new focus on governance as a key tool of social policy, one hopes that doctrine will evolve to change the emphasis to where it needs to be for the field to drive beneficial social change.
Publisher’s Note: Thanks for guest post from Martin B. Robins, an adjunct professor in the Law School of Northwestern University. He is presently, and for the past 10 years has been, the principal of the Law Office of Martin B. Robins where his practice emphasizes acquisitions and financings, technology procurement and licensing, executive employment and business start-ups. The firm represents clients of all sizes, from multinational corporations to medium sized businesses to start-ups and individuals.
According to the above cited WSJ article, Charles Elson, head of the Weinberg Center for Corporate Governance, praised HP directors for forcing out Hurd rather than simply allowing him to repay the disputed expense money. By falsifying expense accounts, he “committed a serious, career-ending error and there should be some financial consequences,” said Nell Minow, of The Corporate Library. (Mark Hurd Neglected to Follow H-P Code, WSJ, 8/8/10) Minow also posted the following and much more (The Real Mark Hurd Scandal at HP, TCL Blog, 8/9/10):
In order to do any business with the government (including eligibility for certain licenses to do business abroad), companies need to be able to demonstrate that they have ‘tone at the top’ ethics and compliance in place. In the post-Enron, post-meltdown world, the government is not impressed with color brochures and fat books of guidelines. They insist on seeing how violators are treated. And if a middle manager would be fired for fiddling with his reimbursements, then the guy who’s been paid more than $100 million has to be fired, too… While most CEO contracts exempt poor performance as a reason for “termination for cause,” there is no reason to permit a departure following an ethics violation to be characterized as a resignation – when the result is a $50 million payout that would otherwise stay in the corporate bank account.
Minow later Tweeted: “HP settled a $50 million fraud claim with the government last week. http://www.wtop.com/?nid=111&sid=2017563. Why isn’t that the news story?” Activist John Chevedden says, “The conduct of Hurd was compounded by the HP board giving him a humongous going-away present.” In my own opinion, “termination for cause” is currently defined much too narrowly.
I’ll close with the following from my friend Dan Boxer who assembled a few talking points for his U.Maine School of Law, Fall 2010 Governance, Ethics and Corporate Responsibility Seminar. DBoxer, Aug. 9, 2010.
And then there is the sad, and very recent, tale of HP and its now departed CEO and Chair, Mark Hurd, who resigned abruptly in early August of 2010. The governance and ethics experts are still sorting out the facts and the decisions which were made, or should have been made differently, by the Board. We will deal more with this in the ethics part of our class, but since we have already touched on required codes of conduct, some facts and commentary, followed by questions to ponder in class are appropriate at this point. Simply put:
- Mr. Hurd was viewed as wildly successful by the investment community and had done wonders for the stock price through tough financial discipline and new business efforts. He was also viewed as a non imperious, low ego kind of guy who stayed out of trouble and tolerated no inappropriate behavior.
- HP, and Mr. Hurd in particular, implemented, promoted and supposedly enforced with zero tolerance for violation, a model code of business conduct and ethics.
- A company contractor, through her attorney, sent a letter to Mr. Hurd alleging sexual harassment. He immediately turned the letter over to the General Counsel who sent it to the Board which began an investigation.
- The investigation found that Mr. Hurd did not harass the contractor, but that he had violated the code by having a nonsexual, non harassing dalliance (my word) with a female contractor and hiding the costs of dinner and travel in expense accounts (which he said were not prepared by him).
- The board immediately forced his resignation and he left with huge severance compensation. Here is a relevant excerpt from an HP official statement:
The H-P board asked for Mr. Hurd’s resignation in large part because of the conflict between his actions and the code of conduct, which he publicly championed in 2006 following a boardroom scandal, H-P said.
Mr. Hurd’s statement included a confession of sorts:
As the investigation progressed, I realized there were instances in which I did not live up to the standards and principles of trust, respect and integrity that I have espoused at H.P.
6. The company stock lost $10Billion in value the next day and a lot more today.
This situation could be a course in itself and there are many more interesting facts not laid out above, or which remain to be learned. Nevertheless, the whole mess raises some interesting questions and teaches some good lessons which we will discuss. Here are a few:
- Codes of conduct and tough ethical standards don’t mean much if they are not followed or equally applied. However—should they be equally applied if the result is a massive loss of shareholder income? But if they aren’t equally applied, does the ensuing reputation for unfair and arbitrary application of company standards ultimately undermine the integrity of the company and create a rogue mentality which is worse for the shareholders in the long run?
- Human frailty, weakness, greed, lust, etc. cannot be contained by laws (SOX, etc.) or rules. So are we wasting our time enacting them?
- The Board knew that the stock would take a big hit, but showed real courage in confirming a zero tolerance culture and demanding Hurd’s immediate resignation. This is refreshing since we have seen so many examples of CEOs hanging onto their jobs when they have demonstrated questionable conduct.
- It would have been interesting to be a fly on the wall and hear the Board discuss whether its duty was to protect/maximize shareholder wealth (e.g.,stock price) vs. the obligation to other stakeholders, vs. the obligation to the company as an institution to be preserved for the long term, vs. balancing responsibilities to shareholders (among which there are long and short term interests) for both the short and long term?
- Was this actually a fire-able offense? In similar situations employees might well be required to go through sensitivity training, reimburse the company for questionable expenses or be placed on some sort of probation. Would Hurd have been treated less harshly if he were a top performer but not the public persona of the company? A lower level employee? Did the Board overreact? Should the top person who can affect the future of the company be cut more, or less, slack since he can affect so many careers and pocketbooks?
- What would the public disclosure requirements have been had the board sought to deal with this as an internal matter?
- Cynically, was the Board only “cutting its losses,” since it looks like it concluded it could have a public relations disaster and an unmanageable work situation with an ineffective and distracted CEO under various scenarios of keeping Mr. Hurd in place and then having the facts come out? Very recent information seems to indicate that the contractor was a former “soft porn” actress appearing in R-rated films. In other words, was the decision a purely business/economics one, not an ethical one? Did the board do the right thing for the wrong reason?
- Would things have been different if HP had split the roles of CEO and Chair?
- Did the board show a lack of courage and send the wrong signal when it agreed to pay massive severance (recognizing that this is a contract issue depending on the terms and they may have had little choice)?
- Ms. Fisher, the contractor, is a case study all her own in disingenuous and unethical behavior. According to today’s reports (Aug, 9, 2010) Ms. Foster put out a statement: “I was surprised and saddened that Mark Hurd lost his job over this,” Fisher said in a statement. “That was never my intention.” What did she think could be a likely outcome when she put the whole thing in motion, she hires a lawyer with a reputation for tough, no holds barred, aggressive attacks on powerful people in order to get money for her client?
Here is just a sample of some articles with the facts as known to date and some speculation about facts and ethics:
- Boss’s Stumble May Also Trip Hewlett-Packard, New York Times, Aug. 8, 2010.
- Mark Hurd’s Leadership Failure, Business Ethics Magazine, Aug. 7, 2010
- Division of Roles Could Help HP, New York Times, Aug. 8, 2010
- The Shot ‘Hurd’ Round the Boardroom, Jeffrey M. Cunningham, NACD, Aug. 10, 2010
And here is the actual HP code of conduct.
The Investor Responsibility Research Center (IRRC) Institute and PROXY Governance Inc. (PGI) today released a new study, “Compensation Peer Groups at Companies with High Pay,” that identifies a subset of S&P 500 companies with high pay that is not aligned with high performance. The data reveal that high executive pay companies self-select larger than appropriate peers – in terms of market capitalization and revenue – for compensation benchmarking purposes. The self-selected peer groups also are better performers. Then, not content with systemically skewing the comparables for the purpose of setting executive compensation, the boards of directors of the high pay companies basically ignore the peer groups to compensate chief executive officers (CEO) an average of more than double, or 103 percent, above the median of the self-selected peer group. By contrast, the baseline, or non-high pay, companies paid CEOs an average of 15 percent lower than the median of benchmarking peers. The key research findings are as follows:
While all companies in the study tended to select larger compensation peers, the differential was more dramatic for companies with high pay. Measured by market capitalization, companies with high pay were an average of 45 percent smaller than self-selected peers versus an average of 5 percent smaller among baseline companies. Measured by revenue, companies with high pay were an average of 25 percent smaller than self-selected peers, while baseline companies averaged only 17 smaller.
- Unlike baseline companies, companies with high pay tended to select higher-performing companies as compensation peers. On average, companies with high pay performed 7.7 points worse than self-selected peers, based on the studyʼs aggregate scoring metric. By contrast, baseline companies performed an average of 3.0 percentile points better than their self-selected peers.
- Companies with high pay were also more likely (21 percent) than baseline companies (17 percent) to select other companies with high pay as compensation peers. Conversely, however, the average company with high pay appeared in fewer S&P 500 compensation peer groups, at 8.5, than the average baseline company, at 10.3.
- Companies with high pay compensated their CEOs an average of 103 percent above peer group median despite being 25 percent smaller than those peers by revenue. Baseline companies, by contrast, paid their CEOs an average of 15 percent below peer group median – a discount roughly in line with approximately 17 percent smaller average revenue.
- Companies with high pay also structured their larger CEO pay packages with a disproportionately richer mix of equity awards (69 percent of total pay) than either their self-selected peers (62 percent) or baseline companies (61 percent). Full value equity awards at companies with high pay constituted 41.3 percent of total pay, versus 35.2 percent among self-selected peers and at baseline companies.
- Contrary to general perceptions, having an external CEO on the compensation committee appeared to act as a mild deterrent to high pay. Among the S&P 500 companies, 6.5 percent of companies with high pay had external CEOs on the compensation committee, versus 9.0 percent of baseline companies. Across the broader Russell 3000, only 1.7 percent of companies with high pay had external CEOs on the compensation committee, versus 10.5 percent of baseline companies.
- Nearly 65 percent of companies with high pay had a CEO who was also chairman, slightly higher than the 60 percent rate among baseline companies. Baseline companies, however, were moderately more likely to have a classified board (29 percent versus 24 percent) or have had a shareholder pay proposal on the ballot in the prior three years (29 percent versus 24 percent).
In my experience, companies that benchmark to larger than appropriate peers do so because they pick their peer group based on aspiration, rather than reality. Yeah, I’d like to play like Tracy McGrady. If my board pays me to match his $23,239,561, will that motivate me enough to play as well as McGrady?
Pay without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors. After thoughtful analysis, they find “systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives.” The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and “perverse incentives” for managers to “misreport results, suppress bad news, and choose projects and strategies that are less transparent.” Continue Reading →