U.S. Corporate Scandals
and
The Laws of Unintended Consequences
Michael Hennigan
The revelations of U.S. corporate excess in the 1990’s have inevitably produced a
clamour for new regulations and controls. The huge destruction of shareholder value
for many Americans combined with revelations of top executives massively enriching
themselves, has prompted speedy legislative action from the Congress and White
House, in this election year. Time will however tell what unintended consequences
will follow from the Sarbanes-Oxley Act of 2002, which President Bush signed into
law on July 30th.
In the early 1990’s, in response to concerns about the growth of top executive pay,
the U.S. Congress provided the spur to the central role of stock option grants in
executive pay. CEO’s were given huge incentives to boost their stock prices and
many resorted to various accounting tricks when required. There was seldom a
downside and even when fired, the price of failure was usually counted in millions of
dollars. When Lucent Technologies fired its then chief executive Richard McGinn in
2000, he walked away with more than $12m in cash and stock.
Each decade produces its poster boys of U.S. corporate excess. Junk bond king
Michael Milliken and the character of the ruthless Gordon Gekko as played by actor
Michael Douglas in the movie Wall Street, represent the 1980’s. Gekko’s mantra
greed is good has not faded from public consciousness and a variation was recently
used as the title of a Sunday Telegraph editorial which claimed that ‘the greedy are
least harmfully occupied in money-making ventures which create products and
services that other people want.’ As with all these rationalisations of self-interest
being common interest, tolerance generally only extends to its application by the
already powerful in society. There is no fear that the newspaper would extol for
example, the self-interest of striking low paid public service workers.
There will be no shortage of characters vying for the 1990’s role of poster boy. ExCEO of the bankrupt energy trader Enron, Jeffrey Skilling could fill the bill. During
the recent hearings on Capitol Hill, Skilling induced a ripple of laughter when he said
that he could not recall receiving a $5 million bonus. His memory lapse may well
have been genuine as the top executives had cashed in over $1 billion worth of
shares, in the past few years while many workers were prevented from selling the
company’s stock, that was held in their retirement saving accounts. There’s Bernie
Ebbers, ex-CEO of WorldCom and more that we will likely hear of in coming months.
Apart from the characters, what is stunning about the 1990’s in the U.S. is how top
executive pay as a multiple of the earnings of the average worker jumped from 45
times in 1980 to 458 times in 2000.
Average Pay of CEOs and Workers 1980-2000 *
(In 2000 dollars)
1980
1990
1995
1996
1997
1998
1999
2000
CEO
$1.306m
2.635m
4.242m
6.345m
8.362m
11.198m
12.817m
13.100m
Production and
Nonsupervisory Worker
$28,950
27,432
26,863
26,983
27,404
28,083
28,465
28,579
CEO-Worker Pay Ratio
45
96
160
236
305
399
450
458
* Worker pay: production and nonsupervisory workers (four-fifths of private, nonfarm workforce) working full
time based on average hourly wage (U.S. Bureau of Labor Statistics). CEO pay: average compensation of CEOs at
major corporations including salary, bonus and other compensation such as exercised stock options (Business
Week). Ratio not equivalent to past Business Week ceo-worker pay ratios, which are based on factory worker
pay.
Source: Holly Sklar, Laryssa Mykyta and Susan Wefald, Raise the Floor 2002 (Ms. Foundation for Women).
Many of the CEO’s who were richly rewarded were hired hands as distinct from
individuals like for example Bill Gates who built up great companies from scratch.
Robert Goizueta,who was CEO of Coca Cola from 1981 until his death in 1997,
accumulated company stock worth $1 billion-America's first corporate manager to
achieve billionaire status through owning stock in a company he didn't help found or
take public. Under Goizueta's leadership, the value of Coca-Cola's stock increased by
more than 7,200 percent. What marked Goizueta apart from other corporate
managers was that it was reported on his death that he hadn’t cashed in one
company share in the previous two decades. That record was certainly a rare
exception as so many others made huge fortunes through selling their share grants
while so many investors ultimately lost hugely by holding onto stock.
The story of the software company Computer Associates vividly illustrates the gulf
between those at the top who needed huge work incentives and the rest of their
employees. In 1999 Charles Wang, CEO of Computer Associates topped Business
Week magazine’s 1999 annual survey of CEO’s pay with a staggering 12-month
earnings total of $655.4 million. In 1995, the Computer Associates board granted the
top executives a total of 20.3 million shares in free stock if the company's share
price recorded a 20 percent increase for sixty days in any 12-month period during
the contract's five-year period. As the rally in tech stocks took off, the bar looked far
from challenging. Just 2 months after the payout bonanza of $1.1 billion to the
executives, the company issued a warning of slowing demand. In October 2000,
Computer Associates adopted a more conservative accounting standard.
According to a New York Times report, in January 2001 the company began firing
hundreds of workers for what it claimed were performance reasons, which allowed it
to avoid paying severance pay. In an article that was published 8 months before
Enron collapsed, under the headline 'A Software Company Runs Out of Tricks', the
newspaper accused the company of 'accounting tricks' to cover up a 'mirage' of
revenue growth. The report said that: ‘Over the years, it has gained a reputation as
a callous employer that dismisses workers without warning while top executives take
home eight- and sometimes nine-figure pay packages.
The runner up to Charles Wang on the 1999 Business Week list was the then Tyco
International CEO Dennis Kozlowski, who got a $170 million payout. Kozlowski, who
was indicted for tax fraud in June this year, claimed in 1999 that he was worth every
penny of his compensation. "The way I calculate it," he told the magazine, "while I
gained $139 million [in stock options], I created about $37 billion in wealth for our
shareholders." Nobody else or the general bull market apparently had nothing to do
with it.
In 1993, the U.S. Congress had capped the amount of CEO pay that could be tax
deductible and boards shifted the weight of executive pay to stock options. It
appeared that management incentives would be aligned with that of shareholders
but executives suffered no penalty when the stock declined. Compliant boards were
generally at the ready to reduce the exercise price of the stock options to maintain
their incentive value. Besides the benefits for the executives, options which could be
eventually worth up to hundreds of millions of dollars, were not charged as an
expense, thereby masking their real cost to the company and its shareholders.
With the pressure of quarterly reporting, in particular a fall in the stock price if there
was to be any decline from pre-published analyst expectations, the pressure to
manipulate was strong. There was also the strong incentive as a ‘gun-for-hire’ to
cash in the chips before things turned sour. Once the exercise price of the stock
options had been reached there was seldom a restriction on selling the stock.
Besides, there would always be more option grants on the way.
Detached ownership under the control of fund managers, compliant boards,
conflicted analysts and auditors, and stock options schemes ripe for abuse, are
issues to be addressed by regulators and legislators. However, in the first year of the
Clinton Administration when the U.S. Congress tried to control runaway executive
pay, it hadn’t bargained for the likes of Mr. Charles Wang’s pay bonanza incentive of
$655.4 million, five years later. The laws of unintended consequences will inevitably
produce some new gem again, in response to the latest period of corporate excess.
Click for Barons of Bankruptcy Scoop $3.3 bn from Failure
FT ranking of the stunning gains by the masters of failure
From Fortune Magazine's September 2002 Issue:
THE GREEDY BUNCH
You Bought. They Sold.
Meet the 25 companies with the greediest executives. Of the big companies whose
stocks dropped 75% or more from their boom-time peak, these are the ones where
officers and directors took out the most money via stock sales from January 1999
through May 2002. An exclusive study by FORTUNE, Thomson Financial, and the
University of Chicago’s Center for Research in Securities Pricing.
Click for Fortune Magazine's Rankings