When accepting the Oscar for best documentary, Inside Job (which by the way I have seen and is a masterful recount of the underlying causes of the financial crisis), the director, Charles Ferguson, pointed out that “three years after a horrific financial crisis caused by massive fraud, not a single financial executive has gone to jail, and that’s wrong.” Warren Buffett recently said that CEOs of companies that needed rescuing by the government and their spouses should end up “dead broke” and the board should suffer too.
So how are we doing with holding corporate America accountable?
According to the AFL-CIO, in 2010 CEOs at 299 U.S. companies had combined compensation of $3.4 billion or enough to pay more than 102,000 workers. Put another way, the average pay for the CEOs of companies in Standard & Poor’s 500 Index is enough to cover the salaries of 28 US presidents or more than 700 minimum wage workers. (For more information, access the AFL-CIOs website “Executive Paywatch.”)
In a report entitled “Negotiating Out of the Crisis: Executive Compensation and the Economic Crisis,” the US propensity to overpay CEO’s of its financial institutions is highlighted. In 2003, the average CEO pay in the US was $2,249,080. The second highest was in Switzerland where average CEO pay was $1,190,567 or only about 50% of that paid to US CEOs. UK CEOs averaged, $830,223, French CEOs averaged $700,290, and Japanese CEOs averaged $456,957. The study concluded that part of the disparity for the much higher US CEO salaries was the “phenomenon of multi-year guaranteed annual bonuses, where executives were guaranteed bonuses irrespective of performance,…” And the difference was not due to overseeing the biggest financial institutions. In China, two banks, ICBD and CCB had the two highest rates of market capitalization (value of the company’s stock); yet in 2008 the levels of executive compensation was 50 times lower than that of executives in Western banks with considerably lower market capitalization. For example, the CEO of Chinese bank ICBC which in 2008 had a market capitalization of $250.20 Billion was paid $235,700 in compensation (in US $$) and the CEO of HSBC in the UK was paid $2,800,000 when HSBC had a market capitalization of $188.10 Billion. In contrast, Jamie Dimon of JP Morgan was paid $19,651,560, even though JP Morgan had a market capitalization of $158.60 billion or only 63% the size of ICBC and only 84% the size of HSBC.
In addition, median CEO pay jumped 27% in 2010 according to a study undertaken by USA Today. The large percentage increase is due in part to reduced compensation paid to CEOs in 2008 and 2009 and was still slightly below 2007 levels of CEO compensation. USA Today reports that profits in the S&P 500 companies rose 47% in 2010 but the increase in profits was due to cost-cutting and layoffs rather than growth and increasing business. In other words, the CEOs were paid well to lay off the rank and file.
Many experts also think CEOs are set up to significantly increase their pay in future years because of the high number of stock options granted to them in 2008 and 2009 when stock prices were very low. As the stock prices increase dramatically, the CEOs’ potential gain also increases dramatically. The increase in stock options is in part due to the push by regulators to get Wall Street to restructure its compensation packages. The idea was that, by holding more stock options, the CEOs’ interest would be more aligned with that of their shareholders and aggressive risking taking would be discouraged. However, in the same way the regulators failed to mandate the way in which companies could use their taxpayer bailouts, they also failed to protect against CEOs again gaming the system and The New York Times recently reported that many executives who received stock options in 2008 and 2009 in lieu of their typical cash bonuses used derivatives to protect them against losses in stock value. One Goldman Sachs executive reportedly avoided more than $7 million in losses by use of derivatives. In other words, the executives are using their knowledge and expertise in the derivative market to protect themselves against losses if their companies again crash and, like Goldman Sachs in the mortgage back securities debacle, might even make money from their stock options if their companies do crash. Alignment with their shareholders?
A few measures have been taken in the US to help rein in executive pay. The SEC enacted the “say on pay” rule which permits shareholders of publicly traded companies to vote on whether they approve the compensation packages being awarded to the top executives by the Board of Directors. These votes are not binding on the Board and it remains to be seen how much credibility the Board will give to shareholder votes. And since mutual funds control about 25% of publicly traded shares and are generally managed by Wall Street CEO cronies, it remains to be seen the shareholder votes will play out. To date, shareholders of only four companies have voted against proposed executive compensation.
There are a few promising actions underway that may help promote executive accountability.
One is an independent High Pay Commission recently formed in the UK which some believe will approach their review of executive pay with more credibility, creativity and integrity than typically found in “blue ribbon commissions”.
A promising course of action comes from the Obama administration. The Wall Street Journal and Bloomberg.com report that the administration is flexing its regulatory muscle and threatening to ban drug company Forest Laboratories, Inc. from doing business with the federal government, including Medicare and Medicaid, unless they dump their current CEO. The government is allowed to do this under a little-known policy in the Social Security Act and the Obama administration is reportedly invoking it because they believe that fines and penalties no longer have much deterrent effect. (A view I am sure is shared by many who have felt for years that the so-called penalties had morphed into being simply a “cost of doing business” to corporate America.) The Wall Street Journal describes this demand as “part of a larger Obama administration effort to pursue individual executives blamed for wrongdoing rather than simply punishing companies.” The pharmaceutical industry is predictably claiming that the use of this new tool will end Western civilization as we know it.
Ironically, the new model for corporate accountability may be Nigeria (yes, that Nigeria – the home of the infamous email scams). The Nigerian central bank governor identified nine banks that were in trouble and, concluding that their management acted in ways detrimental to the interest of the banks’ depositors and creditors, he fired the chief officers of eight of them. He has also implemented bailouts with stiff rules on capital and proprietary trading. A speech he gave in 2009 shortly after he was appointed to this post has become a “must-read” for financial policy wonks around the world. You can watch it here or read it here.