The Ethics Resource Center publishes a report of expert views on developments.
Americans are angry. Buffeted by the lash of a painful recession and irate over outsized executive compensation packages at the very Wall Street firms widely blamed for the economic turmoil, they increasingly distrust key institutions and individual leaders. Special ire is directed at the financial services sector, which many believe have rigged the game so that top level executives are rewarded handsomely even when they fail.
Former U.S. Representative and ERC Chairman Michael Oxley, co-author of the Sarbanes-Oxley law that helped overhaul corporate governance for U.S. public companies, said government may ultimately step in.
Although conceding his own reservations about government’s ability to impose an ethical mindset or change human behavior, Oxley told the ERC Fellows that he has been personally “radicalized” by “cowboy capitalism” that has inflated individual wealth while imposing great risks on the economy.
He suggested that the best role for government was to push for enhanced disclosure surrounding compensation practices.
“Instead of trying to force-feed ethics, it seems to me the role of government ought to be to have the business sector be as transparent as possible,” Oxley said.
But he warned that “massive intervention by the government” was possible if boards failed to do a better job of reining in compensation.
“Time is running out to see some courage and some leadership by boards of directors,” Oxley warned. “If that doesn’t happen, somebody is going to do it [reform compensation] for them.”
The ERC believes that a new focus on ethical leadership must be part of fixing compensation policies for the long-term. Ethical conduct and leadership should become a written core component of every executive’s performance goals. Just as tying pay to financial metrics provides individuals the incentive to “make the numbers,” connecting ethics to financial reward will encourage executives to think harder about how they go about their business and the example they set for fellow employees who follow their lead. Compensation plans will be more successful in the context of an ethical culture because it forces the executive to think twice about what is appropriate and what is inappropriate in striving to attain various incentive goals. The impact of ethics is even greater if ethical conduct is an explicit criterion for earning incentive pay.
And this view is gaining currency beyond ERC. For example, the Committee for Economic Development (CED), in a January 2010 policy brief, argues that “promotion of an integrity culture through systems and processes embedded in business operations” should have equal weight with operational results and effective risk assessment in determining compensation for the CEO and other senior executives. CED also would strengthen the link between ethics and compensation by providing for full cancellation of incentive compensation and/ or clawbacks of previous incentive payments due to negligent or intentional acts such as a significant misstatement of company financials or “a major integrity lapse.”17
ERC research shows that companies that have adopted ERC’s metric for ethical leadership as a performance goal benefit from improved organizational cultures. When individual managers meet ethical goals, ERC research shows that their behavior filters down to their direct reports and spreads throughout the organization.
And ethical leadership isn’t just about CEO conduct or compensation plans. Boards, too, need to focus on ethics and insist on ethical conduct across the business. Tone at the top must begin at the board level both in the way the board conducts itself and in setting expectations for how the company operates.
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A review of corporate governance
Sir David, who has held top UK posts in public service and in investment banking, released a report, requested by the UK Government, on the governance implications of the financial crisis. He stressed the crucial importance in improving transparency and integrity. He emphasized the need for greater direct responsibilities for remuneration and risk management by the Board of Directors in financial services firms and for a far more active role for the non-executive chairman of these firms.
He stated at the outset of his report, which contains 39 reform recommendations, that “In an open market economy in which, in normal times, most companies are either listed or in private hands, the achievement of good corporate governance reflects successful balancing among an array of influences which is probably at its widest in case of banks. A critical balance has to be established between, on the one hand, policies and constraints necessarily required by the regulator and, on the other, the ability of the board of an entity to take decisions on business strategy that board members consider to be in the best interests of their shareholders.”
The report asserted that it is clear that governance failures contributed materially to excessive risk taking in the lead up to the financial crisis. Weaknesses in risk management, board quality and practice, control of remuneration, and in the exercise of ownership rights need to be addressed in the UK and internationally to minimise the risk of a recurrence. Better governance will not guarantee that there will be no repetition of the recent highly negative experience for the economy and for society as a whole but will make a rerun of these events materially less likely.
Executive remuneration consultants, comparable with other business professionals, should comply with the fundamental principles of transparency, integrity, objectivity, competence, due care and confidentiality. They should also ensure that, whether or not part of a larger consulting group providing a wider range of services, their internal governance structures promote the provision of objective and independent advice. This Code is designed to be complementary to such governance structures and any other codes relating to the professional bodies of which Consultants may be members.
Board Roles and Pay
Recommendations on Pay Include:
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The Group of 20 Summit, meeting in London on April 2, was presented with key compensation principles by the Financial Stability Forum - the official group of central bank governors that had been tasked with developing approaches that all regulators of banks and other financial services firms should use in their oversight activities. Below is the introduction by the FSF and the new principles - ones that the are very similar to principl;es proposed by the global financial services industry in mid-2008.
Principles for Sound Compensation Practices
Compensation practices at large financial institutions are one factor among many that contributed to the financial crisis that began in 2007. High short-term profits led to generous bonus payments to employees without adequate regard to the longer-term risks they imposed on their firms. These perverse incentives amplified the excessive risk-taking that severely threatened the global financial system and left firms with fewer resources to absorb losses as risks materialised. The lack of attention to risk also contributed to the large, in some cases extreme absolute level of compensation in the industry.
These deficiencies call for official action to ensure that compensation practices in the financial industry are sound. While national authorities may continue to consider short-term measures to constrain compensation at institutions that receive government assistance, it is essential that steps also be taken immediately to make compensation systems as a whole sound going forward.
To date, most governing bodies (henceforth “board of directors”) of financial firms have
viewed compensation systems as being largely unrelated to risk management and risk
governance. This must change. While voluntary action is desirable, it is unlikely to
effectively and durably deliver change given competitive pressures and first-mover
1. The firm’s board of directors must actively oversee the compensation system’s design and operation. The compensation system should not be primarily controlled by the chief executive officer and management team. Relevant board members and employees must have independence and expertise in risk management and compensation.
2. The firm’s board of directors must monitor and review the compensation system to ensure the system operates as intended. The compensation system should include controls. The practical operation of the system should be regularly reviewed for compliance with design policies and procedures. Compensation outcomes, risk measurements, and risk outcomes should be regularly reviewed for consistency with intentions.
3. Staff engaged in financial and risk control must be independent, have appropriate authority, and be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the firm. Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management’s influence on incentive compensation.
Effective alignment of compensation with prudent risk taking
4. Compensation must be adjusted for all types of risk. Two employees who generate
5. Compensation outcomes must be symmetric with risk outcomes. Compensation systems should link the size of the bonus pool to the overall performance of the firm. Employees’ incentive payments should be linked to the contribution of the individual and business to such performance. Bonuses should diminish or disappear in the event of poor firm, divisional or business unit performance.
6. Compensation payout schedules must be sensitive to the time horizon of risks. Profits and losses of different activities of a financial firm are realized over different periods of time. Variable compensation payments should be deferred accordingly. Payments should not be finalized over short periods where risks are realized over long
7. The mix of cash, equity and other forms of compensation must be consistent with risk alignment. The mix will vary depending on the employee’s position and role. The firm should be able to explain the rationale for its mix.
Effective supervisory oversight and engagement by stakeholders
8. Supervisory review of compensation practices must be rigorous and sustained, and deficiencies must be addressed promptly with supervisory action. Supervisors should include compensation practices in their risk assessment of firms, and firms should work constructively with supervisors to ensure their practices conform with the Principles. Regulations and supervisory practices will naturally differ across jurisdictions and potentially among authorities within a country. Nevertheless, all supervisors should strive for effective review and intervention. National authorities, working through the FSF, will ensure even application across domestic financial institutions and jurisdictions.
9. Firms must disclose clear, comprehensive and timely information about their compensation practices to facilitate constructive engagement by all stakeholders. Stakeholders need to be able to evaluate the quality of support for the firm’s strategy and risk posture. Appropriate disclosure related to risk management and other control systems will enable a firm’s counterparties to make informed decisions about their business relations with the firm. Supervisors should have access to all information they need to evaluate the conformance of practice to the Principles.
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In the midst of the biggest banking failure in U.S. history, senior financial executives are having to answer why they are being paid millions when they effectively drove their companies into the ground. Nell Minnow of The Corporate Library makes a strong case that poorly designed pay packages, which she says are uncorrelated to performance, are a cause of the companies’ meltdown.
A U.S. Congressional Committee recently grilled former senior executives at AIG and Lehman Brothers over their compensation decisions, despite displaying low, if any, performance. While former AIG CEO Martin Sullivan received a $47 million severance package when he stepped down, the U.S. government took control of AIG on Sept. 16 with an $85 billion loan, Financial Week reported. Testimony from experts on executive pay said Mr. Sullivan’s pay helped contribute to the demise of the insurance giant.
Nell Minnow, editor of the Corporate Library, an independent research firm specializing in corporate governance, started her testimony saying she was sorry to say “We told you so.” In a rating system that assesses the effectiveness of company boards, The Corporate Library has given Lehman Brothers C ratings and below since 2003.
Below are excerpts from her testimony:
“As I have mentioned in previous testimony before this committee, there is no more reliable indicator of litigation, liability, and investment risk than pay that is not linked to performance. I think it is fair to say by any standard of measurement that this pay plan is as uncorrelated to performance as it is possible to be.
Pay that is out of alignment is one of the causes of poor performance but it is also an important symptom – of an ineffective board.
We have looked at bad boards for several years and we often see patterns other than poorly designed pay packages that recur in the boards later proved to be the most dysfunctional. A number of those patterns are present in the Lehman board. They include inadequate expertise and too-long tenure. Currently serving on the board is Broadway producer Roger Berlind, 76, the longest tenured member of the Lehman board, his only public company directorship. While we do not recommend over-boarding, it is usually not a good idea to have people on boards who have no other board or sector experience.
Another point worth noting is that Lehman’s Finance & Risk Management Committee, which is chaired by 80 year old director Henry Kaufman, only met twice in 2007, and twice in 2006. Kaufman has served on the Lehman board for 14 years; he was also a member of the Freddie Mac board, from which he retired in 2004 after 13 years of service. A company in this sector should have a risk management committee that is vitally involved and has a great depth of expertise. A company that had $7 billion in losses after becoming embroiled in the global credit crisis had a risk management committee that did not understand or manage its risk.
As I said earlier, we judge boards on results. But once we have judged them, we can make an educated guess about what led to those results. In this case, the board was too old, had served too long, was too out of touch with massive changes in the industry, had too little of their own net worth at risk, and was too compromised for rigorous independent oversight. There is a lot of blame to go around in a failure like this one.”
Ms. Minnow then proceeds to name explicitly those responsible:
Roger S. Berlind
The end of her testimony provides a number of recommendations on how a crisis might be prevented in the future:
To see full testimony, download .pdf
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The Canadian Center for Ethics and Corporate Policy issued an analysis in its latest newsletter of proposed changes to executive compensation disclosure in Canada. In a flagging global economy, more and more executives are being asked to justify their high salaries. As part of good corporate governance, more pressure is being put on companies to provide more disclosure on how Boards of Directors calculate pay.
The Canadian Securities Administrators (CSA) have proposed amendments to the rules governing executive compensation disclosure which would go into effect on December 31, 2008. The analysis states that CSA believes the rules governing the specifics of what must be disclosed are out of date and that current disclosure requirements do not provide investors with adequate information about the basis on which Boards of Directors make decisions about senior executive compensation. The proposed amendments would require inclusion of a Compensation Discussion and Analysis section in its annual disclosure to help investors better understand all significant elements of compensation awarded to its most senior executive officers. The Compensation Discussion and Analysis would include the following:
Another amendment proposed is changing the Summary Compensation Table, such as providing a Total Compensation column for each executive to help compare compensation across the company.
To read the full analysis, please download the entire newsletter, Managing Ethics. The newsletter also includes discussion on topics such as ethical corporate culture, ethics and compliance and workplace ethics.
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Long a major issue of controversy, the very substantial compensation awarded to top U.S. corporate executives is now, more than ever, at center stage in diverse, yet overlapping, fora. As shareholders meet for annual meetings of giant corporations this month, so many confront resolutions promoted by shareholders (usually opposed by the corporate board of directors) to limit top pay and make it the subject of shareholder votes.
Meanwhile, as Senator Barrack Obama moves towards becoming the Democratic Party’s presidential candidate, awareness has increased that he would be at the forefront of efforts to legislate corporate pay limits if ever he claimed the White House. Against this background, leading corporate HR professionals have formed a Washington DC association (the Center on Executive Compensation) to oppose legislation on this issue, but they claim to be generally supportive of voluntary actions that address excesses.
As an example of developments in front of corporate annual meetings, The California Public Employees’ Retirement System (CalPERS) announced on May 15, 2008 its support for shareholder proxy efforts to promote a “Say-on-Pay” proposal at Interpublic Group, one of the world’s largest advertising and marketing companies. CalPERS is the largest public pension fund in the U.S. with assets totaling more than $247 billion.
The proposal requests the right of shareowners to cast annual advisory votes on executive compensation. While this is a common practice in the U.K. and in Australia, noted CalPERS, it is rare in the U.S. This company was selected because its share price has fallen significantly and its overall performance for the last five years has trailed that of its key competitors, and yet executive pay has risen sharply. CalPERS, which owns 3.3 million shares in Interpublic Group said, “ Given recent actions taken by the Compensation Committee that will likely result in even higher compensation levels, we believe that shareholders might rightly have concerns about the company’s compensation practices and that they should be given a venue (other than that afforded by a vote against members of the Compensation Committee), in which to voice their concerns.”
Protests on CEO Pay at Schering Plough
A May 19, 2008 headline on Forbes.com declared: Should Schering Plough's Chief Give Back His Bonus?
The article notes: "It would certainly make me want to investigate the situation further, particularly if I was shareholder," says Paul Hodgson, senior research associate at The Corporate Library, a corporate governance research firm. Forbes’s story goes on to state, “Schering justifies the payouts to executives by saying that it needs to retain top leadership talent. Schering denies the study could have been ready in 2006, when Hassan received $9 million of the cash bonuses, and argues that Forbes' analysis of the potential hits to Schering's earnings, revenues and market cap are therefore based on "false premises." Forbes added, “Hassan received $29.6 million in 2006, including a $19 million cash and stock bonus he is still receiving.”
The Obama Factor
Financial Week reported on May 15, 2008 that “A new business lobbying group has arisen to challenge the Business Roundtable’s pre-eminence in Washington on issues related to executive compensation. The group of 36 Fortune 500 companies, united under the banner of the Center on Executive Compensation, was formed with the expectation of a much more antagonistic White House and Congress in 2009.”
The article by reporter Stephan Barlas points out that this new group, as well as other business associations, are concerned about the possible enactment in 2009 of a Shareholder Vote on Executive Compensation Act, which had strong support in the U.S. House of Representatives last year, but was defeated in the U.S. Senate – the legislation was sponsored by Senator Barack Obama. The reporter noted that Republican Party presidential candidate Senator John McCain has been a vocal critic in the past of very high corporate compensation.
The Center on Executive Compensation
The Center on Executive Compensation, newly established in Washington DC, says it is dedicated to developing and promoting principled pay and governance practices and advocating compensation policies that serve the best interests of shareholders and other corporate stakeholders. It is hosted by and largely funded by the HR Policy Association, which represents the senior human resource officers of more than 250 of the largest corporations in the United States.
The Center announced that its role is to “develop and promote principled pay practices and advocate compensation policies that serve the best interests of shareholders and other corporate stakeholders.” Specifically, the Center:
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Chief Executives at Citigroup, Merrill Lynch, and Countrywide all attempt to justify their high compensation levels in times of low performance.
On March 7, 2008 the U.S. House Oversight and Government Reform Committee held a hearing on CEO compensation in light of the U.S. sub-prime crisis. Chairman Henry Waxman requested documents and testimony from the CEOs of three leading financial companies who were in charge during the “meltdown.” Chairman Waxman’s opening statement reflects the central question he and many Americans are interested in – when companies fail to perform, should they give millions of dollars to their senior executives?
The following are excerpts from testimony given by the three CEOs. All three companies have suffered enormous losses. Countrywide lost $1.6 billion in 2007 and its stock lost 80% of its value. Merrill Lynch lost $10 billion and its stock lost 45%o of its value. Citigroup also lost $10 billion and its stock lost 48% of its value. Despite enormous losses, the CEOs were still paid substantial amounts. Their statements reflect their views on how their respective compensation committees justly determined their compensation. All were critical of “over-exaggerated” compensation estimates in the media and outlined their company is doing now to alleviate the housing crisis.
Charles Prince, Citigroup ($10 million bonus, $28 million in stock options, $1.5 million in annual prerequisites upon retirement)
The Citigroup Board of Directors has instituted processes designed to ensure fair executive compensation. As you will hear in more detail from Mr. Parsons, the Board conducts an independent assessment of executive performance and relies on an independent compensation consultant. (A recent hearing of this Committee highlighted the importance of independent compensation consultants.) Citigroup has worked hard to align management’s interests with the interests of shareholders. For example, Citigroup’s Stock Ownership Commitment requires senior executives to retain at least 75% of the equity awarded to them while employed by Citigroup. Citigroup executives are required to take and hold substantial portions of their annual compensation in stock awards. The primary purpose in mind when we imposed this requirement was to tie our executives’ long-term personal financial interests with those of the company and its stockholders. Now well-recognized as a corporate compensation best practice, Citigroup has had this requirement in place for more than a decade.
Last fall, it became apparent that the risk models which Citigroup, the various rating agencies, and the rest of the financial community used to assess certain mortgage-backed securities were wrong. As CEO, I was ultimately responsible for the actions of the company, including the risk models that eventually proved inadequate. In the interests of the company I had worked so hard to build, I immediately submitted my resignation, and the Board of Directors accepted it a few days later.
I recognize that some have raised questions about my compensation, and much of the information reported in the media is incomplete or inaccurate. I therefore welcome the opportunity to provide the Committee with the complete information.
See complete testimony.
Stanley O’Neal, Merrill Lynch ($161 million upon retirement)
I think it is important to note that the compensation of senior management at Merrill was determined through a rigorous and independent process, and consistent with pay levels in the industry. In January of each year, after a review of the Company’s performance during the prior year, the Board of Directors set performance targets for the following year for all of senior management, including me. Those targets included a mix of revenue objectives, return on equity measures, and some strategic objectives. At year end, the Compensation Committee of the Board, which consisted exclusively of independent directors, met with senior executives to discuss their performance. The Committee then met by itself to set compensation.
Following those meetings, the Board of Directors informed me what my total compensation would be for that year and what my base salary would be for the following year. As a result of the extraordinary growth at Merrill during my tenure as CEO, the Board saw fit to increase my compensation each year. Most of that compensation consisted of restricted stock and stock options. I was required to hold the majority of the stock and options that I was awarded. In fact, I myself initiated a requirement that all of senior management hold onto at least 75% of their stock and options. Therefore, my compensation and my assets increased only when Merrill Lynch performed well for its shareholders and employees, and decreased when it did not.
While I was in charge of Merrill overall, I did not manage the day-to-day aspect of Merrill’s business that invested in mortgage backed securities. However, the sub-prime issues at Merrill arose during my tenure. Thus, when the Board asked me to retire shortly after we announced a large sub-prime related write-down in late 2007, I agreed to step down.
There has been some press about my so-called “severance package.” These stories are inaccurate. The reality is that I received no severance package. I received no bonus for 2007, no severance pay, no “golden parachute…” By having given me a significant part of my compensation in stock and options, the Board ensured that my personal financial interest was closely aligned with the shareholders of the Company. If the shareholders did well, I would do well too. It is true that top executives at public companies in the United States, especially in the financial services industry, are highly compensated. But a great percentage of that compensation, certainly for me, was and is at risk.
In short, I believe the compensation process was independent and functioned to ensure that my interests and those of Merrill’s shareholders were closely aligned and remain closely aligned.
Angelo Mozilo, Countrywide Financial ($120 million in compensation and sales of Countrywide stock)
The Board has adopted a compensation policy that aligns the interests of top executives with shareholders by making compensation largely performance based. That philosophy guided my compensation. From 1982 through April 2007, our stock price appreciated over 23,000 %. As a result, earlier in this decade, I received substantial income from performance-based bonuses earned under a formula based on earnings per share.
This bonus formulation was approved on at least two separate occasions by the company’s stockholders. Over the years, a significant portion of my compensation was in the form of stock options rather than cash. As the stock appreciated, the value of my own holdings also increased in value. In December 2004, in consultation with my financial advisor as we prepared for my retirement, I exercised a number of outstanding options, a significant number of which were about to expire, and sold the underlying stock pursuant to plans established with the advice of counsel. Notwithstanding these sales, today I remain one of the company’s largest individual shareholders, because I believe in Countrywide.
In recent years, the issue of executive compensation and severance pay has been a focus of governance experts, regulators, the media and the general public. In my case, there have been reports that I stood to collect $115 million in severance. While those numbers were grossly exaggerated, I have voluntarily elected to forego the specific severance payments that had been included in my contract in the event of a transaction like the one with Bank of America.
As I reported in a press release, upon completion of the Bank of America transaction, I will give up approximately $36.4 million in severance payments, and an additional $1.1 million in future consulting fees and other perquisites, for a total amount foregone of approximately $37.5 million. I will continue to receive my pension, which accrued over my almost 40 year career with the company, as well as several prior years’ earned compensation which I had voluntarily deferred. Neither constitutes severance, and both would be payable to me on my retirement, whether or not the company entered into a transaction with Bank of America or any other entity.
See complete testimony.
A complete list of testimony given at the hearing is posted on the House Committee’s website.
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Recent news articles report the extent of the paradox
At a time when the finance industry is taking substantial hits, year-end bonuses are soaring. Just last week, Seattle-based Washington Mutual awarded Chief Executive Kerry Killinger 3.2 million stock options for 2008, despite a share price drop of 70 percent last year due to mortgage losses, Reuters reported.
Washington Mutual is certainly not the exception. The lead in a Bloomberg article stated “Wall Street's five biggest firms are paying a record $39 billion in bonuses for 2007, a year when three of the companies suffered the worst quarterly losses in their history and shareholders lost more than $80 billion.” Bonuses actually exceeded the $36 billion distributed in 2006 when the industry reported all-time high profits. Merrill Lynch, the largest U.S. brokerage, said it paid $15.9 billion of compensation and benefits for 2007, exceeding the company's $11.3 billion of revenue, Bloomberg reported. These bonuses are coming at time when New York-based companies are also cutting jobs, an action which has been attributed to the collapse of the subprime mortgage market.
House Oversight and Government Reform Chairman Henry Waxman plans to question CEOs involved in the subprime mortgage crisis about their multi-million dollar pay packages, reported The Politico, an American political news online publication. They will most certainly be asked to justify their sky-high compensation at a time when their companies are losing billions of dollars due to the mortgage meltdown. The hearing is scheduled for February 7.
Mounting pressures seem to be encouraging some to rethink executive compensation. The Wall Street Journal reported that the chairman and chief executive officer of Countrywide Financial Corp., Angelo Mozilo, is giving up $37.5 million of severance pay, fees and benefits in the face of the mortgage crisis. He won't give up retirement benefits and deferred compensation that he has already earned, according to Countrywide. He retains a pension plan and supplemental retirement plan whose present value totaled about $24 million as of December 2006. Despite his benevolent efforts, Mozilo is one of the CEO’s requested to testify during the Waxman hearings on February 7.
Martin Wolf, in his Financial Times column, attributes huge bonuses on the basis of short-term performance to problems in the financial industry. By paying these bonuses, “banks create gigantic incentives to disguise risk-taking as value-creation.” As recent history shows, Mr. Wolf argues that banking is very much tied to the public interest. He recommends that it is therefore necessary that regulators get involved to ensure incentives are aligned to outcomes. (Editorial Cartoon from The Financial Times)
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Statement from The Corporate Library on executive compensation titled "Too Little, Too Late" by Senior Research Associate, Paul Hodgson.
Stanley O’Neal’s departure from Merrill Lynch with “no severance” and no 2007 bonus would seem to present a picture of a decisive board in control. Yet, when “no severance” equals $161.5 million and an office and executive assistant for three years, what else did they think they needed to give him?
Such a situation highlights the dire condition of executive compensation in this country. When a compensation committee retains discretion over whether a severance package will be offered, it would seem to suggest that it will exercise that discretion in favor of shareholders. Yet all this meant was that it decided not to pay the approximately $30 million in cash severance that might have been due had Mr. O’Neal pulled off a merger with Wachovia. The remainder of his “non-severance” was outside the discretion of the compensation committee altogether and was governed by the rules of the retirement plan and the equity plans. Both compensation plans were approved by the board; these dictated that once Mr. O’Neal reached the age of 55 he was retirement eligible. He was therefore immediately vested in his retirement benefits—which cost, at this age, twice the amount they would have had he retired at 65. And his vested stock and options, as always the most substantial part of any separation package, continue to vest on their normal schedules.
In this way, his stock and options are likely to be worth more than if they had vested immediately and had to be exercised within a specified period. If another CEO is employed who begins to sort out the mess the company is in right now, the stock price might rise—as will the value of Mr. O’Neal’s holdings—and he will end up benefiting from someone else’s labor.
Only when boards wake up to the fact that long-term incentives that are supposed to be based on service and performance should only vest if those service and performance conditions are met will such a situation be impossible.
But while the board is trying to present itself as decisive and in control now, where was its oversight when the strategic decisions that led to this massive write-off of value were being made. Since it also looks as if the board may be considering an external candidate who would likely cost more than $161.5 million to recruit, it appears to have failed in yet another of its most important duties: ensuring a proper succession plan is in place.
Finally, The Corporate Library has rated the Merrill Lynch board as a high risk board for all but 18 months of the five years we have provided ratings on company governance. This level of disquiet was based largely on concerns about compensation practices at the firm.
Nell Minow, The Corporate Library’s editor, has aptly described Merrill’s board as “sub-prime.” Its actions now are too little, too late.
So, where does Mr. O’Neal’s “non-severance” stack up against some of the most egregious severance packages of this millennium? Table 1 gives a list of perhaps not the 10 most excessive, but certainly 10 of the most excessive golden goodbyes. Despite “not” receiving any severance, Mr. O’Neal still manages to come in fifth. The Corporate Library has written in detail about each of these separations and has also provided a blueprint of how to avoid them in two reports, called Golden Parachutes and Cushion Landings and Paying CEOs to Stay at Home.
The problem of excessive severance is not a problem that is going to go away very soon, despite all the shareholder activism surrounding it, unless boards and CEOs come to some agreement as to how to curtail some of the benefits of being fired.
Offering protection for taking a risky job is not inherently a bad idea. From a governance point of view, it is usually a good one. But when such protection rises to the heights we have seen, it raises the spectre of a conflict of interest, it makes it sometimes more profitable to be fired than to go on working, and it makes it sometimes more profitable to arrange a merger even where there are no long-term benefits to be had from the transaction. And when the benefits continue to be paid regardless of whether the CEO walks into another job a day or a year or three years after being fired, it doesn’t even make sense.
See The Corporate Library's website.
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Financial Times Study Uncovers Huge Executive Pay Gaps, SEC Reviews Executive Pay Reporting Methods
A U.S. study conducted by the Financial Times has found the pay gap between Chief Executive Officers and the second most highly paid top executive to be astronomical. Chief executives have been paid up to 10 times more than their top lieutenants. The Financial Times reported on October 8, 2007 that “the gap has been steadily rising since the 1960s and 1970s, partly due to the recent explosion in options awards for chief executives.”
The CEO at Sallie Mae, Thomas Fitzpatrick, earned more than 10 times that of June McCormack, the Executive Chief Vice-President. At more than 30 other companies the Financial Times reviewed, the gap ranged from four to seven times.
By coincidence, the Financial Times survey was published as the U.S. Securities and Exchange Commission released new and revised rules to improve on disclosure standards for executive compensation that were first published almost a year ago. In developing its new rules, the SEC conducted a review of how 350 companies complied with the original standards in their reports to shareholders. The SEC’s findings were released in early October 2007.
Two trends emerged from the SEC’s review – the required Compensation Discussion and Analysis section of companies’ reports should be more focused on how and why a company arrives at specific executive compensation decisions; and, the manner in which companies present their reports.
In its comments to companies who sent in their disclosure reports, the SEC noted, “Where a company provided a lengthy discussion about its compensation philosophies, we suggested that it improve its Compensation and Discussion and Analysis by explaining how and why those philosophies resulted in the numbers they presented in the required tables. Similarly, where a company provided a lengthy discussion about its decision-making process, we suggested that, rather than explaining the process, it explain how its analysis of relevant information resulted in the decisions it made.”
The SEC also encouraged companies to present their information in a clearer and more precise manner – one that is better organized and presented for both the lay reader and the professional. The SEC explained that its reviews are ongoing. Not less than 45 days after it completes the review of a company’s filing, it posts the correspondence containing its comments on its EDGAR system. This is the website where all companies, foreign and domestic, are required to file registration statements, periodic reports, and other forms electronically. This information can be downloaded and is free to the public.
Meanwhile, in the Financial Times story, Christopher Ailman, a money manager at the California State Teachers’ Retirement System, is quoted as saying, “Paying chief executives an excessive amount relative to their number twos is a warning signal that the chief executive may have the compensation committee sewn up and that the board is not doing a god job of the succession plan.”
However, the newspaper also reported some business reactions to the SEC’s new disclosure rules. Centrex, a homebuilder, said the new policy “oversimplifies to the point of misleading about the context” of pay awards. Many companies feel justified in granting their CEOs such hefty salaries, which they now have to more carefully outline in their reports. Some companies cited share price performance, CEO responsibilities, and length of service as other valid methods of determining executive pay.
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The U.S. Corporate Library - Monitoring Corporate Governance - Issues its"FINAL SCORE"
CEOS UP $1.26 BILLION,SHAREHOLDERS DOWN $330 BILLION
The Corporate Library’s latest study – Pay for Failure II: The Compensation Committees Responsible – highlights twelve of the largest companies in the U.S. that combined high levels of CEO compensation and poor performance over the past five years.
The Corporate Library’s latest study of executive incentive compensation practices finds in its five-year analysis that twelve large U.S. companies display the most pronounced gap between pay and performance. Within this group, the boards’ compensation committees authorized a total of $1.26 billion in pay to CEOs who presided over an aggregate loss of $330 billion in shareholder value.
Each of the twelve companies earned a High Risk rating from The Corporate Library; paid their CEOs in excess of $15 million in the last two available fiscal years; brought a negative return to shareholders over the last five years; and underperformed their peers over the same period. “While there are a few companies in this year’s Pay for Failure report that also featured in the first report published in 2006, there are seven new companies, many of them suffering from the same compensation faults,” said the report’s author, Senior Research Associate Paul Hodgson.
This year’s Pay for Failure companies are:
Affiliated Computer Services, Inc.
Eli Lilly and Company
Ford Motor Company
Home Depot, Inc.
Time Warner Inc.
Verizon Communications Inc.
Wal-Mart Stores, Inc.
Qwest Communications International Inc.
The complete study examines in detail the incentive policies at each of the twelve companies, finding high proportions of fixed pay, poorly-chosen performance metrics, and rewards for below-median performance. The report also looks at the makeup of the compensation committees at the companies, listing the members by name, along with their compensation.
The Pay for Failure II — The Compensation Committees Responsible, Published: May 2007, By Paul Hodgson, Senior Research Associate, available from The Corporate Library’s online store.
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The pace of pay growth for the chief executives of the U.S.’s biggest companies increased in 2006, reported a new study by the New York-based Mercer Human Resources Consulting for The Wall Street Journal (4/9/07). According to the study, which polled 350 major US corporations, salaries and bonuses of chief executives grew 7.1% after growing at the same rate in 2005 and skyrocketing 14.5% in 2004. The 2006 gain outpaced the 3.7% increase in pay for white-collar staffers.
According to the study:
The following graph is excerpted from Mercer's website:
10 year trends (percentage change over prior years)
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ISS Compares Severance Pay and 'Golden Parachute' Practices Across Countries
In its report, Exit Pay: Best Practices in Practice, US-based Institutional Shareholder Services, a provider of proxy voting and corporate governance services, argues that the long-time controversial issues of CEO severance pay and 'golden parachute' packages (awarded to executives who suffer a loss in position when the company experiences a change in control) will likely become even more prominent in the US this year.
The report explains key issues surrounding the topics, gives examples of company best practices reform suggestions, and compares US systems to those in other countries.
Among the reports findings:
Best Practice in Severance and Golden Parachutes
For the full report visit ISS' website.
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It is possible that the U.S. will adopt a similar system: on February 14, the same day that Aflac announced its decision, U.S. Congressmen Barney Frank, Chairman of the House Financial Services Committee, announced that the committee will hold a hearing on executive compensation on March 8. According to Reuters, the hearing is part of Frank’s plan to legislate increased shareholder participation in determining executive compensation. Mr. Frank responded to earlier comments made by President George Bush (see News), in which the president blasted excessive compensation at U.S. companies, but placed responsibility for capping pay packages on corporate boards, not the government or shareholders. "I agree with President Bush that excessive executive compensation has become a problem, but disagree with his view that we should do nothing about it," said Frank.
"Shareholders expect compensation committees to establish appropriate measures that tie
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In 2005, the average CEO in the United States earned 262 times the pay of the average worker, the second-highest level of this ratio in the 40 years for which there are data, reported the Economic Policy Institute on June 21, 2006. In 2005, a CEO earned more in one workday (there are 260 in a year) than an average worker earned in 52 weeks.
The 1980s, 1990s, and 2000s have been prosperous times for top U.S. executives, especially relative to other wage earners. This can be seen by examining the increased divergence between CEO pay and an average worker’s pay over time, as shown in Figure A. In 1965, U.S. CEOs in major companies earned 24 times more than an average worker; this ratio grew to 35 in 1978 and to 71 in 1989. The ratio surged in the 1990s and hit 300 at the end of the recovery in 2000. The fall in the stock market reduced CEO stock-related pay (e.g., options) causing CEO pay to moderate to 143 times that of an average worker in 2002. Since then, however, CEO pay has exploded and by 2005 the average CEO was paid $10,982,000 a year, or 262 times that of an average worker ($41,861).
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In 2004, one-half of executives in leading U.S. corporations enjoyed total compensation (including salaries, bonuses, and stock options) - that was more than 104 times the average pay of U.S. workers pay, while 10% of executives earned more than 350 times the average workers’ pay. The best compensated U.S. corporate executives took home over 700 times the compensation of the average America in 2004, according to data compiled by Pearl Meyer & Partners, an affiliate of Clark Consulting, and published on April 9, 2006 in The New York Times in a special report on executive pay by Eric Dash. The report is the first in a series of articles, entitled "Gilded Paychecks," on the subject of compensation.
The data shows a drastic widening of the gap between executive pay and average worker compensation in the U.S. from the early 1980s. In 1940, for example, half of executives earned more than 56 times the average workers pay. The latest numbers provide a broad context for an extensive discussion about the appropriateness of major compensation packages to America’s business leaders. It is an issue that is under review at the U.S. Securities and Exchange Commission and is being raised at many annual meetings of U.S. companies that are currently taking place.
No issue in this framework has created more concern for shareholders than the awarding by boards of directors of substantial compensation rises to chief executive officers of companies whose stock price has declined. The issue is illustrated by a story in The New York Times on April 10, 2006, “Advice on Boss’s Pay May Not Be So Independent” by Gretchen Morgenson.
Morgensen reports that, in 2005, Ivan G. Seidenberg, Chairman and Chief Executive Officer of Verizon Communications Inc. received $19.4 million in salary, stock and other bonuses, constituting a 48% rise in his overall compensation. In 2005, however, the stock price fell 26 percent, bondholders’ value dropped, and the pensions of 50,000 managers were frozen. Verizon’s earnings declined by 5.5 percent in 2005.
Conflicts of Interest
According to the article, however, this consultant is Hewitt Associates, an employee benefits management and consulting firm, which has a substantial array of consulting contracts with Verizon which, according to the report, have amounted to over half a billion dollars since 1997. The reporter suggests that the consultants, which secure their contracts from management, had a conflict of interest on advising the board on the CEO’s remuneration.
Executive pay consultants are increasingly being used by the compensation committees of boards of directors. The reporter writes that the procedures behind, and justifications for, the conclusions reached by the consultants and the full reasoning behind board compensation decisions rarely come to light and have received little to no public analysis.
While compensation committees of board of directors should consist solely of independent directors without ties to management, according to the latest U.S. corporate governance standards, the New York Times report provides details on Verizon’s board that raise questions about just how independent the compensation committee members are. Morgensen reports that boards of directors are frequently composed of executives from other companies that have a strong incentive to keep average executive pay high. While SEC regulations require compensation committees members to be unconnected to the executives whose pay they control, the links between the two are often said to be subtle and hard to control, frequently stemming from years of running in the same social circles or sitting on the same boards. A number of key members of the Verizon compensation committee sit on the same boards as does Verizon’s CEO, for example.
The Securities and Exchange Commission is currently considering suggestions for a new set of executive compensation disclosure rules, which it aims to introduce before the 2007 proxy season (see Landmark US SEC Regulations and SEC Chairman Speech lower on this same page). It has suggested regulations that would require companies to publicly name pay consultants, as well as provide far more detail on all aspects of executive remuneration, including perks and retirement packages. It would also oblige companies to divulge more about how compensation committees operate and establish pay. The rules, however, would not compel businesses to reveal information on any other contracts consulting firms have with the company. Moreover, critics have argued that they would not increase the role that shareholders have in setting pay.
Many NGO’s and experts have joined the SEC in proposing solutions to the compensation issue. The Committee for Economic Development, for instance, in its recent report, “The State of Corporate America After Sarbanes-Oxley” (See Corporate Governance, Views and Analysis) stressed that the issue of excessive compensation must be considered in terms of both “process and disclosure.” It underlined its belief in the validity of market forces and individual performance in setting executive salaries as well as its opposition to “specific rules, laws, or regulations that place artificial limits on compensation.” The report suggested, among other things, that compensation committees should fully disclose not only compensation decisions but also the reasonings behind them. It further suggested that determinations of pay relative to performance should be based on long-term increases in corporate value. Finally, it recommended that companies maintain the right to recall executive bonuses should targets not be met.
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Wachovia Corporation, a major U.S. banking group with headquarters in Charlotte, North Carolina, reported on January 30, 2006 that Wallace Malone, a vice chairman and director, will retire with a severance package valued at $135 million.
Mr. Malone had headed South Trust Corporation which was acquired by Wachovia in November, 2004. In a filing with the Securities and Exchange Commission the retirement payment, according to The New York Times.
The Securities and Exchange Commission is reviewing current corporate compensation practices. Numerous shareholder and investor groups, as well as public interest groups, are also reviewing the degree to which top executive compensation is fully disclosed by companies and the scale of key awards.
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Two Reports: SEC Action Pl,an on Executive Compensation and SEC Chairman's first major statement explaining his goals on compensation transparency.
The U.S. Securities and Exchange Commission Makes Landmark Decision to Increase Transparency in Corporate Compensation
(January 17, 2006)
The Securities and Exchange Commission today voted to publish for comment proposed rules that would amend disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters, and security ownership of officers and directors. The proposed rules would affect disclosure in proxy statements, annual reports and registration statements. The proposals would require most of this disclosure to be provided in plain English. The proposals also would modify the current reporting requirements of Form 8-K regarding compensation arrangements.1. Executive and Director Compensation
The proposals would refine the currently required tabular disclosure and combine it with improved narrative disclosure to elicit clearer and more complete disclosure of compensation of the principal executive officer, principal financial officer, the three other highest paid executive officers and the directors.
2. Related Person Transactions, Director Independence and Other Corporate Governance Matters
The proposals would update, clarify, and slightly expand the disclosure provisions regarding related person transactions. Principal changes would include a disclosure requirement regarding policies and procedures for approving related party transactions, a slight expansion of the categories of related persons and a change in the threshold for disclosure from $60,000 to $120,000. The requirement to disclose these transactions would also be made more principles-based, and would require disclosure if the company is a participant in a transaction in which a related person has a direct or indirect material interest.
Proposed Item 407 also would consolidate corporate governance related disclosure requirements currently set forth in a number of places in the proxy rules and Regulations S-K or S-B. This would include disclosure regarding board meetings and committees, and specific disclosure about nominating and audit committees. Proposed Item 407 would also require similar disclosure regarding compensation committees and a narrative description of their procedures for determining executive and director compensation.3. Security Ownership of Officers and Directors
The proposals would require disclosure of the number of shares pledged by management.4. Form 8-K
The proposals would modify the disclosure requirements in Form 8-K to capture some employment arrangements and material amendments thereto only for named executive officers. The proposals would also consolidate all Form 8-K disclosure regarding employment arrangements under a single item.5. Plain English Disclosure
The proposals would require companies to prepare most of this information using plain English principles in organization, language and design.
Comments on the proposed rules should be received by the Commission within 60 days of publication in the Federal Register.
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In January 2006, the SEC Chairman provided the detail of broad approaches towards executive compensation that he highlighted in a major speech on December 12, 2005. That presentation by Chairman Christopher Cox at the New York Economic Club provides thew basic context for the work that is unfolding at the SEC in 2006 that may well lead to major increases in transparency of Board actions at major corporations on corporate compensation.
Mr. Co0x started by stressing that the SEC will strengthen rules to ensure that shareholders have clearer information on executive pay, while also moving to radically simplify reporting requirements by corporations in order to enhance the clarity of public information.
Chairman Cox asserted that, “When it comes to giving investors the protection they need, information is the single most powerful tool we have. It's what separates investing from roulette. If the SEC is truly to succeed in helping investors and in ensuring compliance with the law in the securities industry, we'll need nothing less than an all-out war on complexity.”
He said that the complexities of SEC rules often impede compliance. “When it comes to disclosure documents intended for investors, nothing is more complicated than the description of executive compensation. We aim to simplify it, and make it more meaningful,” he noted.
He pointed out that today the SEC has over 800 different forms and “the SEC might have need of no more than a dozen. The key to making this happen is looking at the data on the forms independently from the forms themselves. That's what we mean by interactive data. Computer codes can tag each separate piece of information on a report, and tell us what it is: operating income, interest expense, and so forth. That way, every number in a report or financial statement is individually identified, both qualitatively and quantitatively. For individual investors, this means they'll be able to use more sophisticated software tools to analyze the information from SEC filings in real time. For the SEC, it means we could organize our database not around individual reports, but instead around the companies who file them.”
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On December 21, 2005, the Germany Federal Supreme Court ruled in favor of public prosecutors who appealed the acquittal earlier in the year of top corporate executives in a case involving Mannesmann. The case brings to the fore stark differences in compensation for successful business executives. Over the last year, for example, several top executives of major U.S. corporations whose firms were acquired went home with vast multi-million dollar payments. A perspective on this major German case was provided on December 22, 2005 in an editorial (fully reproduced below) in The Financial Times.
Mr Ackermann has said he will not resign - no doubt to the relief of Deutsche Bank shareholders. Yet they too have been penalised by this continuing show trial that has provided a lengthy and unnecessary distraction for Germany's largest bank. It is not surprising that Deutsche Bank - like several others among the country's most successful enterprises - considered moving its corporate base abroad. Nor is an environment where rewards for exceptional performance produce such consequences an attractive place for ambitious managers to work.
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