Jubak's Journal: We're all paying for CEOs' greed
Spring proxy statements have investors seeing red. They show that greedy CEOs took home tens of millions last year while the stocks of the companies they ran tanked. This isn't the case of a few bad apples, either -- it's a fundamental reason the stock market is struggling.
By Jim Jubak
In the 1990s, their faces were everywhere. And it wasn’t just Jack Welch and Louis Gerstner and John Chambers who earned star treatment. CEOs like Jeff Bezos and Michael Armstrong and Richard Brown -- executives without hall-of-fame stats -- also turned up on the covers of Fortune and Forbes.
The huge pay packages earned by superstar CEOs were supposed to make them work extra hard for shareholders. And some CEOs did create massive profits for investors. But now we’re also discovering that the incentives were so great that some CEOs cheated in order to earn them.
Poster children: Xerox and Computer Associates
Take the case of Xerox (XRX, news, msgs). According to the Securities and Exchange Commission, Xerox executives used accounting tricks to avoid missing Wall Street profit targets. In the fourth quarters of 1998 and 1999, the fake profits accounted for almost 40% of Xerox’s pretax earnings. Strip away the accounting tricks and Xerox would have missed targets in 11 of 12 quarters in 1997 through 1999.
The SEC says former Xerox CEO Paul Allaire and his team cheated because it made them a lot of money. Hitting Wall Street’s targets kept Xerox shares high enough that executives could collect $5 million in performance bonuses, according to the SEC, and $30 million from stock sales.
Or how about the compensation package that the SEC is investigating at Computer Associates (CA, news, msgs)? The company decided that then-CEO Charles Wang and two other executives would receive 20 million shares if the stock closed above $53.33 for 60 days within any 12-month period between 1995 and 2000.
Following a series of positive earnings reports, the stock did exactly that in may 1998. But just two months after the grant, the company warned of slowing demand, and in October 2000, Computer Associates changed to a more conservative accounting standard.
Computer Associates stock currently sells for less than $20 a share.
Suspicion extends even to blue chips
Linking CEO compensation directly to earnings growth certainly didn’t create the stock-market bubble that burst in March 2000. But awarding huge sums of money for short-term earnings growth certainly did keep the bubble inflated for extra months or even quarters. Even conservative companies such as Lucent Technologies (LU, news, msgs) succumbed to the temptation to use accounting tricks to make it look like revenue was still growing even after it had stopped.
Now investors reading through spring proxy filings wonder what other CEOs fudged the numbers in order to put a few extra million in their pay envelopes. In the current mood of cynicism, all companies and all CEOs are guilty until proven innocent.
Even legendary former CEOs like IBM’s Gerstner and General Electric’s (GE, news, msgs) Welch are getting second guessed. Is it just coincidence that the companies these guys formerly headed disappointed Wall Street almost immediately after they left?
It doesn’t help investors’ nerves to know that, in January and February, the SEC launched 49 new investigations into financial reporting. That beats the former record of 18 new investigations in the period -- set just last year.
Another reason for small-caps’ rally?
Big companies, often big blue-chip companies, have been the focus of the scandals that have emerged to date and of the new investigations launched by the SEC. Smaller companies, which because of their size have less complex business and pay structures, have largely escaped the spotlight.
The big-cap focus in the investigations feeds into a stock-market bias that has favored small-company stocks for the past year. In the past six months, that preference has turned into a huge performance advantage for small-company stocks.
In the past six months, the small-cap Russell 2000 index has gained 18% while the big-company S&P 500 index has eked out a 0.5% gain. In 2002 to date, small-cap stocks have gained 5% while the S&P has lost 4%.
With investors so cynical about big-company accounting, I think this small-company advantage has a lot longer to run. This is one of those markets in which investors believe small is better. And reading this spring’s proxies, it’s easy to see what’s behind that conviction.
money.msn.com
We consumers need to boycott some of these companies. Jubak could have mentioned precious metals. Gold YTD has outperformed all sectors. Gold looking very bullish - JMHO
Have a nice day. ;-)
Merry |
