George W. Bush recently weighed in on the subject of excessive CEO pay, which we discussed here. The other day, Federal Reserve chairman Ben Bernanke mentioned that issue in the context of a growing income gap. An interesting piece by Albert R. Hunt in Sunday’s International Herald Tribune reinforces the view that CEO pay abuse is becoming a cause for more than just shareholder activists. Here is an excerpt:
There is hand-wringing in America over growing income inequality and excessive executive compensation.
The complaints are not emanating from populists on the left or ivory-tower academics. The Federal Reserve chairman, Ben Bernanke, devoted an entire speech this month to income inequality, worrying that it threatened “the dynamism” of capitalism. And President George W. Bush has been a critic of greedy executives.
Since most American households are invested in the stock market, directly or indirectly, and all Americans are affected by what major corporations do or fail to do, and especially how they are led, they have a stake in the subject of CEO pay.
Abuse in executive remuneration has become a symbol —a litmus test, if you like— for what is wrong with American business. It doesn’t take a Sherlock Holmes to detect that excessive top pay has been present in nearly every corporate scandal in the past quarter-century and has become the signature affliction of directors who do not direct. When it is present, you are almost sure to find misdirected boards oblivious to the ethical minefield over which they are stumbling, frequent corporate underperformance and CEOs whose Pharaonic paydays so well insulate them that many have lost touch with the realities that shape corporate success.
Several years ago, at the height of the scandals involving Tyco and Enron (WorldCom was still to come), President Bush gave a landmark speech extolling the importance of corporate responsibility and sound governance. Having been one of the relatively few voices in the business world for those concerns going back some three decades, I was astonished and frankly delighted at the time to see a president of the United States tackle these issues. Much more needed to be done than he proposed, and the final Sarbanes-Oxley Act was more hard-hitting than the administration first wanted. But at least George W. Bush voiced concerns on a subject that had not been heard from a president since FDR, when a previous crisis rocked confidence in American capitalism.
Yesterday, Mr. Bush sounded a reminder of corporate responsibilities on another contentious issue: CEO pay. Most of you will know this is a long-standing concern of mine. It is ten years since I gave a speech in which I called excessive CEO pay “the mad cow disease of the North American boardroom.” The President did not refer to the pay issue in exactly these terms, but at least his speech is another sign that this is a growing flashpoint among investors, employees and customers. It needs to be among boards of directors, too. Here is an excerpt of what Mr. Bush said in New York:
America’s businesses have responsibilities here in America. I know you know that. A free and vibrant economy depends on public trust. Shareholders should know what executive compensation packages look like. I appreciate the fact that the SEC has issued new rules to ensure that there is transparency when it comes to executive pay packages. The print ought to be big and understandable. When people analyze their investment, they ought to see loud and clear — they ought to be able to see with certainty the nature of the compensation packages for the people entrusted to run the companies in which they’ve got an investment.
Government should not decide the compensation for America’s corporate executives, but the salaries and bonuses of CEOs should be based on their success at improving their companies and bringing value to their shareholders. America’s corporate boardrooms must step up to their responsibilities. You need to pay attention to the executive compensation packages that you approve. You need to show the world that American businesses are a model of transparency and good corporate governance.
Like his initial foray into corporate governance a few years ago, Mr. Bush’s moral exhortations are unlikely to be sufficient as a force for change. But it was the beginning of a new debate at the highest level of American policy-making, and once again, a most welcome surprise.
This highly valued company enjoys a global reputation for technological innovation. The chair of its board helped to found a think tank to examine issues of global governance, and heads that board. Yet the company’s own governance falls well below best practices, with three members of management sitting on its small board of seven, a stock options plan for directors, and its insistence on having its co-CEO also head the board to which he reports.
When the company launched its internal investigation into possible stock option irregularities last September, it established a committee of four outside directors who are also members of its audit committee to conduct the review. The company assured shareholders at the time that no material restatements would be required –despite not having completed the investigation. During the course of the review, with no explanation to investors and a stunning disregard for the optics of such a move, the co-CEOs exercised more than 750,000 stock options even while the company was in default of its statutory financial filings for the second quarter. Shortly after, the company advised the Ontario Securities Commission that it had found hundreds of thousands of additional documents as part of its investigation and that the restatement anticipated would be “substantially larger” than previously projected.
Late last Friday, in yet another surprising twist, the company announced that two directors would be stepping down from the probe over matters involving the “perception” of objectivity in the investigation, leaving only two others to complete the review that has already produced too many surprises. The board itself continues to be headed by a co-CEO who is a central figure in its stock options investigation. These matters have been the subject of continuing attention at Finlay On Governance.
It would be hard to imagine a more clumsy approach to an important issue from a board and a company that should have done much better. All of this reflects a persistent undervaluing of both principles of sound governance and common sense that have compromised the integrity of the internal investigation and the reputation of the company in ways that were entirely avoidable, which makes this latest episode in Research In Motion’s mishandling of its stock options fiasco the Outrage of the Week.
Harvard’s Lucian Bebchuk, who is doing some of the most interesting research on executive compensation in decades (and was nominated in the Finlay On Governance 2006 Annual Year End Awards as one of the people we would like to hear more from in 2007) had an interesting op-ed piece in last weekend’s Wall Street Journal concerning Apple’s stock options probe. For those without a subscription to the Journal, Professor Bebchuk posted the piece on the university’s corporate governance blog. It very much accords with some of the views expressed here on the subject recently, which are collected together at this site.
As Professor Bebchuk observes:
Steve Jobs’s great accomplishments have well earned him a place in the pantheon of high-tech leaders and visionaries. And Apple’s senior management has undoubtedly done very well for shareholders during the past several years. All of this, however, clearly does not compel the conclusion that Apple’s governance has performed adequately with respect to option grants. And the company’s report falls far short of providing a basis for accepting such a conclusion.
I posted the following comments on the piece:
I, too, am of the view that the company’s independent directors took an overly narrow approach to their mandate. They should have probed further into what was done, why it was done and the implications for the company’s reputation and culture. It is not enough to say that CEO Steve Jobs did not make unlawful or improper gains from options manipulation. Improprieties occurred on his watch. He permitted or encouraged backdating in his capacity as the most senior executive of the organization. He is the one who sets the moral tone for the rest of the company.
I am unaware in either the pre or post Enron era where it was acceptable that there could be the slightest doubt in the word or integrity of the company’s CEO. Concerns must, therefore, also focus on specifically how Jobs assisted in the backdating, what his precise role was and whether he misled investors as to the disclosures that were made at the time and have subsequently been proven false to the tune of $84 million.
The report also asserts that Mr. Jobs was unaware of the “accounting” implications involved. He has been CEO of the company for a considerable period and is widely reputed to be a “hands-on” manager. A Ken Lay type excuse that Mr. Jobs was not aware of what was happening around him or did not understand even the ethical implications of what he was doing, and was not bright enough even to seek counsel about any uncertainty, not only is not plausible, but even if it were would still raise serious questions about the standards of competency in the company’s top management.
Inasmuch as CEOs have been recently fired for making false statements on their resumes and have had their bonuses reduced because of plagiarism, it appears that Apple’s board has not adequately considered the full implications, including far-reaching ethical implications, of what has occurred. What failures in governance oversight, along with the size and functioning of the board, that may have contributed to the fiasco, and what needs to be done to address these shortcomings, also appear to have escaped the board’s gaze.
It’s clear from the actions of all the players involved that there should be more fallout from Apple’s revelations. The failure of the board to probe deeper and give Jobs a pass for this kind of conduct is bad enough. I have already talked with a number of CEOs and directors who are astonished at the board’s obvious and ill-advised attempts to sweep Jobs’ role under the carpet. But the failure of the SEC and the media to prevent that from occurring carries profound implications for the governance and leadership of corporate America and the confidence of the investors who rely upon it.
There is a growing consensus from a number of thoughtful and highly respected sources –many of whom I suspect, like me, are enthusiastic owners of Ipods and Macs, and perhaps even Apple shares– that the board’s investigation fell considerably short of the standards expected in voluntary reviews and that there may well be more fallout from both what was revealed –and what was not.
In light of the comprehensive nature of the Company’s management-initiated, voluntary internal review of stock options, including the past and future role of the Compensation Committee of the Board of Directors in respect of stock option grants, the audit committee believes it is important that the internal review not only be objective in fact, but also be perceived by RIM’s stakeholders as being objective.
–RIM press release, January 5, 2007
The board probe into possible irregularities in the handling of stock options at Waterloo-based Research In Motion takes yet another surprising turn, and one of several we continue to follow at Finlay ON Governance. The latest involves the announcement that Douglas Wright and Kendall Cork, two directors on the audit committee who also serve on RIM’s compensation committee, have recused themselves from the company’s internal stock options investigation. This was done, the company claims, to avoid even the appearance of conflict. Such a decision so late in the review raises the inevitable question: Was something more troubling discovered?
The two directors who have stepped down from the probe because they were also members of the compensation committee were members of that committee when the investigation began in September of last year. They have been part of the investigating committee all through October, November and December. They have sat on the compensation committee for several years. Yet, if we are to believe the company, no potential conflict was even considered until January of 2007.
The fact that only now, months after the investigation began, the company has come to realize that it is important that the review also be “perceived by RIM’s stakeholders as being objective” is a staggering admission, to say the least. The issue of “appearance” in connection with RIM’s board and the makeup of the committee heading the options probe was raised on these pages here in early December, when we said:
…the fact that RIM’s independent directors share an options deal with its management directors raises serious questions about how independent they really are and suggests at least the appearance that they may be unduly beholden to the founders of the company for a substantial part of their own (the independent directors’) wealth.
This is not the first surprise RIM has presented to investors. In December, it advised the Ontario Securities Commission that it had uncovered hundreds of thousands of new documents it needed to review. It also hinted that many had been destroyed in computer systems and had to be reconstructed. Before that, RIM’s co-chairs applied to the OSC to have the ban on insider stock trades lifted so that Jim Balsillie and Mike Lazaridis could exercise the purchase of more than 750,000 RIM options. This struck us at the time, and still does, as an odd thing for the OSC to permit given that it was the awarding of stock options to top management that was the subject of the investigation in the first place and the reason why RIM had failed to make its statutory financial filings.
This most recent announcement raises a number of additional points that trouble more than they reassure. By RIM’s own admission, there are only two directors out of the company’s board of seven, who are capable of overseeing the investigation. But there may well be additional problems for those members as well. James Estill has been on RIM’s board since 1997, during which time RIM’s securities filings confirm the board’s role in overseeing compensation and stock option decisions:
The Stock Option Plan is administered by the Board of Directors and the Compensation Committee. Each of the Board of Directors and the Compensation Committee has full and complete authority to interpret the Stock Option Plan, to prescribe such rules and regulations as it deems necessary for the proper administration of the Stock Option Plan and to make such determinations and to take such actions in connection therewith as it deems necessary or advisable.
Additionally, the board as a whole played a key role in setting dates and terms for stock option decisions, according to RIM’s statements:
Options granted under the Stock Option Plan have an exercise price of not less than the closing price of the Common Shares on the Toronto Stock Exchange (“TSX”) or Nasdaq National Market (“Nasdaq”) on the business day immediately preceding the date on which the option is granted and are exercisable for a period not to exceed ten years. The term and vesting of stock options is at the discretion of the Board of Directors and Compensation Committee.
So there are some legitimate questions as to whether board members are still in the position of investigating their own decisions and oversight conduct. In these kinds of high profile situations, it is often advisable to appoint new directors, who have had no previous involvement in decisions, to supervise investigations. To make a change in an internal probe so late in the process, following on the heals of a previous announcement in which the company said its anticipated restatement would be “significantly higher” than previously revealed, does not further investor confidence and should send up some large red flags to both the SEC and the OSC. Since RIM’s legal counsel has been before the OSC on several occasions in this matter, it is rather disturbing that neither the Commission’s hearing panel nor staff evidenced the slightest concerns about any potential conflict involving RIM’s independent directors and the probe they were heading.
In my view, these most recent developments at RIM are part of a larger problem involving its corporate governance practices, the structure of its board, the practice of awarding stock options to directors, the over-presence of management on a small board, the lack of an independent director as chair or even a lead director, among other concerns. I explored these in detail previously at Finlay ON Governance.
I said in an earlier posting that we have not seen the last of surprises at RIM over its stock options probe. This is one to add to the list. There will be more to follow.
Floyd Norris has added a heretofore unexplored slant on Home Depot’s bungling of its expensive parting with former CEO Robert Nardelli by suggesting it was Lowe’s, HD’s chief competitor, and not Home Depot’s investors (and certainly not its employees), who benefited most from Nardelli’s tenure. And for that privilege, they will now pay out $210 million more, on top of the tens of millions paid to this icon of CEO excess over the past five years. It is a strange commentary on the quality of corporate governance in America, and the directors of Home Depot in particular, when you consider that the board has done more for its rival than for its own stakeholders. And, as I revealed in my posting here, this is a board that pays itself very well indeed with other people’s money.I added the following comment to the posting on Floyd’s New York Times blog.
Home Depot’s board offered a compensation package of more than $245 million to CEO Bob Nardelli over five years, according to the Times, during which period the company’s share value continued to plummet. His $210 million severance comes on top of this. It was a failed strategy one presumes from the changes announced this week. Is it just me or does that seem like a lot of money for the privilege of failing? I say this fully acknowledging that the Home Depot pay fiasco is symptomatic of the wider disease of excessive CEO pay abuse, which I long ago dubbed the “mad cow disease of the North American boardroom”.
Nardelli’s autocratic domination of the company’s annual general meeting, where he routinely cut off shareholders’ questions after one minute and ended the meeting after half an hour, and which not a single member of the board bothered to attend, was an event that would bring a smile to Kim Jong-il.
This was the clearest illustration of a CEO and a board who forgot to whom and for what they are accountable. Add to this the low marks the company receives for customer service and recent revelations that it routinely backdated stock option dates for the past 19 years, and the only reasonable conclusion is that Home Depot and its board are indeed in need of serious renovation. Nardelli’s exit is only part of the solution.
The second shoe in the form of board resignations is what investors need to hear next.
