The Scandal of America's Top Executive Pay

Financial Times
Michael Skapinkler
February 7, 2005

In 1997, Delta Air Lines awarded Ronald Allen, its retiring chief executive, a $3.5m seven-year consulting contract. What did Delta expect from Mr. Allen in return? That he "perform his consulting services at such times, and in such places, and for such periods as will result in the least inconvenience to him".

What if he became too ill to do even those convenient pieces of consulting? He would still get the money. And if he died? His heirs would get the money.

By contrast, the conditions AOL Time Warner imposed on Gerald Levin when he stepped down as chief executive were draconian. In return for an annual fee of $1m, Mr. Levin had to provide the company with five days of consulting a month.

There are several such nuggets in this comprehensive account of the scandal that is US executive pay. Yet what astonishes are not the big perks that companies give their departing bosses - it is the small ones. When Jacques Nasser was sacked from Ford in 2001, the company gave him one free car a year, as well as the option of buying more at a discount. All that for someone with a pension of $1.27m of year.

The authors - both US law professors - are not outraged by the levels of chief executive remuneration. Indeed, they would not mind chief executives earning even more. What they object to is the way companies camouflage their top executives' pay - by, for example, providing absurdly inflated post-retirement perks, as in the examples above.

Their second objection is that executive pay is often unrelated to performance. This is particularly true when it comes to share options, which allow senior executives to benefit from rising share prices that owe more to market movements than to anything they have done for their companies. The authors are unimpressed by the move away from share options to restricted stock. A restricted stock, they say, is simply a share option with an exercise price of zero.

The third objection, and the one that underlies their carefully constructed case, is that chief executives' remuneration is decided by outside directors with no real interest in safeguarding shareholders' interests.

Many argue that recent US corporate governance reforms will change all that. Compensation committees, for example, now have to be composed of independent directors. The authors welcome the reforms. They accept they will make some difference to remuneration practices, but not much.

Whatever the committee set-up, independent directors will continue to do chief executives' bidding when it comes to pay, they predict. The social pressures to conform are strong on any board. No one likes to be the perpetual dissenter; strong bonds of collegiality develop in any group.

Also, outside directors' pay is now sufficiently high that they will not want to lose it. Nor will they want to undermine their chances of being appointed to other boards. Which board will want to appoint a trouble-maker, one who is going to start objecting to the structure and level of the chief executive's pay?

Most of the corporate governance reforms have concentrated on making directors more independent. What is really needed, the authors say, is to make directors more dependent - on shareholders. They propose various reforms, including making it easier for shareholders to dismiss directors and elect their own representatives. They point out, however, that companies' furious objections to the tepid board election reforms proposed so far do not inspire optimism.

For anyone looking for a guide to the debate over American top pay, this book will be indispensable. It is clear, well-argued, fully researched and deeply felt. But it is a guide to American pay, and this is also its principal weakness.

Looking beyond the US might have helped the authors deal with the question of how to mobilise shareholders who may see little reason to engage with a particular board over the company's remuneration policy. They would have benefited, for example, from looking at how, in the UK, the Association of British Insurers and the National Association of Pension Funds have forced the pace of reform. Given that shareholders are often temporary residents of company share registers, it often takes the bigger players or representative organisations to have an effect.