The Executive Pay Scam
The New York Times / Editorial
April 14, 2002
You win, I win. You lose, I lose." That was the seemingly unassailable deal corporate chieftains struck with their shareholders at the outset of the bull market in the early 1980's, when they aggressively linked their compensation to their companies' stock prices. The arrangement allowed chief executives like Roberto Goizueta, Michael Eisner and Jack Welch to amass fortunes that would once have been unthinkable for mere hired hands. Their pay, we were constantly reminded lest we should become resentful, reflected their performance. What could be more fair, more in keeping with the American spirit of meritocracy?
The deal looks like a sham now that the roaring bull market has run its course. "You lose, I still win" is the new message shareholders have been hearing from companies' top managers. In a down market, most chief executives should have suffered under the model that was applied on the way up. At some companies that has happened, but at others management rewrote the rules. While base pay did decline in 2001, some companies made up the difference in performance pay, where the real money is to be had.
Take Cisco Systems, one of the highfliers of the Nasdaq run-up that has fallen on hard times recently. The company lost $1 billion in its last fiscal year, and its stock price took a nose dive, so it should come as no surprise that John Chambers, its chief executive, saw his base salary fall to $268,000 from $1.3 million the year earlier. But with the six million stock options he got, it is estimated that his pay might be a third higher. At Coke, the board reset the performance targets the chief executive, Douglas Daft, needs to meet to earn a million shares. If only shareholders could reset the clock like that.
The pay-for-performance model is blessed by tax laws that prevent companies from deducting as an expense any portion of an executive salary in excess of $1 million but place no limit on the deductibility of so-called performance-based pay. Yet even before it came to be egregiously violated, the policy was flawed. Too many mediocre corporate leaders made their fortunes merely by riding the bull market. Stock option packages became so outlandish that they began to undermine the principle they were meant to serve. A number of chief executives are now motivated to prop up the stock price at any cost until they can cash in their options.
The common thread running through these excesses is the acquiescence of boards of directors. Instead of overseeing management on behalf of shareholders, boards have acted as servants of management. Among the supposedly independent directors at Enron were individuals who received consulting deals from the company and one whose medical center got Enron donations.
The New York Stock Exchange is considering a requirement that directors on audit and compensation committees be independent. The definition of an independent director also needs tightening to exclude not only past and present employees, but also anyone else beholden to the company through financial dealings. A more rigorous rule under consideration would preclude the same person from serving as board chairman and chief executive.
Congress ought to consider ways to hold corporate executives more accountable. Instead, the House last week passed a so-called pension reform bill that might actually encourage companies to drop lower-paid employees from pension plans to direct even more resources to top executives. Employees lose, the chief executive wins.
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