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August 17, 2011

How CEOs Loot their Companies: Get a Nodding Bobble Head Board of Directors

By william czander

Explores how boards of directors are constructed and how they contribute to outrageous CEO compensation.

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  Despite the recession and falling profits CEO compensation was up between 23 and 28 percent in 2010, and energy companies led the way. Wisconsin utility companies collectively paid out $44 million in bonuses to their top executives in 2010. The biggest bonus went to Gale Klappa, CEO, president and chairman of We Energies, who in addition to his $1.13 million salary, received $10.45 million bonus. Second on the list was Frederick Kuester, chief operating officer at We Energies, who collected about $5.5 million in bonuses. So how do these executives find a way to pay for these bonuses? They added a fuel surcharge to every customer's bill.

Top executives keep getting increases by using methods that have become common practice in Corporate America. They get their boards of directors to give and give and give. How do they do it?

The executive compensation committee of the board and/or the VP or Director of Executive Compensation (a fast growing occupation)   review market data of energy peers at the 25th, 50th and 75th percentile for annual cash compensation, bonuses, long-term incentive compensation, and perks. Of course these boards and compensation executives also hire outside consultants, who are paid handsomely to help out by also benchmarking and conducting competitive assessments. So as one CEO's compensation goes up, other CEO's in the same industry demand that their compensation must go up and then another and another. This is what has happened in the energy industry.

In many cases the CEO hires the compensation consultants and compensation executives who serve at the pleasure of the CEO so the deck is stacked in the CEOs favor. When the CEO also holds the title Chairman of the Board, Like Mr. Klappa of We Energies, the compensation game is completely tilted. It's a game of envy and "gimme more" that gets played out annually and Directors of Boards go along for several reasons.

Boards of Directors

Business in America has changed considerable over the years.   Fifty years ago businesses were primarily in manufacturing processes and twenty five years ago the primary business growth was in technology and now its financial services. While the nature of business has shifted the composition of boards have remained the same. Also the complexity of understanding the strategy and executive decision making has significantly changed. Now CEO's   surround themselves with CIO's, CFO's, IT Officers, Six Sigma experts, "quants", and other "numbers crunchers", who provide "bottom line" services. They also hire consultants who provide the mathematical models to assist CEO's in making their "bottom line" decisions. In addition, they hire coaches, consultants, and public relations to help them engage in the work of self-promotion and self confidence. Given the complexity of running a financial service business most board directors sit in the dark. 

While Enron executives were cooking the books Robert Jaedicke was Chairman of the Enron Audit and Compliance Committee from 1985 to 2001. Jaedicke is Dean Emeritus of the Stanford Business School and a former accounting professor. Trying to understand the inner workings of a corporation is a daunting task for a part time board director. Even an accounting professor could not get his arms around the complexities.

In addition, trying to be a responsible board director is especially problematic if one holds other positions or serves on several boards or even holds a full time position. When Bob Nardelli served as the CEO of Home Depot he also served on the Board of Directors of Pepsi.

To make matters worse board directors use their positions to feather their own bed. There is no better example of board incompetence and lack of responsibility and unethical behavior than the Enron board. CEO magazine, selected Enron's board as one of the top five corporate boards in America, this was before the collapse and discovery that Enron's board like most boards engaged in little or no oversight. A U.S. Senate investigation found that the 13 member board of directors was intertwined with conflicts of interest and engaged in off the books financial arrangements. It was not only Enron's board that was asleep at the wheel but also the boards of scandalous corporations like WorldCom, Adelphia, Refco, Lehman, Tyco, ImClone, Martha Stewart Ominmedia, and HealthSouth. The ethical transgressions ranged from individual lapses of judgment to defective corporate cultures and involved embezzlement, insider trading, and financial statement falsification (Fombrun & Foss, 2004; Smith & Walter, 2006).

People who serve on boards are supposed to be held responsible for overseeing their companies, but they are rarely accountable. Even if the company fails board directors jump from board to board. The Senate Commission to investigate the collapse of Enron concluded: "Board membership is no longer just a reward for "making it' in corporate America; being a director today requires the appropriate attitude and capabilities, and it demands time and attention." This statement made in 2002 has not been heeded and boards are run the way they have always been and directors are selected they way they have always been selected, from an interlocking corporate community of power elites. Take for example Thomas Gerrity the former Dean of Wharton Business School. He was a board director at Fannie Mae the loan giant when it took on enormous risks and accounting irregularities and was seized by the government in September 2009 and contributed to the financial crisis of 2008. But nothing has changed for Gerrity he serves on several boards. According to Forbes (2011)   Gerrity has served on the following boards: ICG since December 1998;   PharMerica Corporation since 2007; Sunoco, from 1990 to 2010;   Hercules, from 2003 to 2008; CVS Corporation from 1995 to 2007; Federal National Mortgage Association from 1991 to 2006; Knight-Ridder from 1998 to 2006.

Many Corporate Board Directors see their job as an easy way to makes lots of money.   This is certainly true for Gerrity, from 2006 to 2010 his total compensation for serving on boards was over $2 million. Directors may be given upwards of $100,000 to attend a board meeting and can receive in excess of a $1 million in pay and stocks for serving. The median salary for these directors of corporate boards is $200,000 for a few hours of work per week. If one sits in several boards one can easily earn between $500,000 to over a $1 million. Many call it the world's best part time gig and retired CEOs and professors from elite MBA programs can live a comfortable life style serving on a few boards.

In addition, many board directors are: members of the founder's family, some are senior citizens who rarely attend meetings.

Gross mismanagement on the part of the board occurs when the board allows a CEO to be the chair of the board. This has the potential of putting the fox in the hen house. Often this is done to allow board directors to do business with the company creating massive conflicts of interests. When a board engages in questionable practices to enrich themselves they contribute to creating a culture where greed is permissible and even encouraged. This creates a culture where executives see their main activity as the attainment of personal wealth.

Celebrity board members

Retired wealthy executives who have attained celebrity status in the business world are in hot demand to serve on boards. So are highly visible Africa-Americans: Vernon Jordan sat on six boards, and if you're an African-American ex-football player you are really in demand; Willie Davis sat on nine (Domhoff, 2005). CEO's love people like Ken Langone or Jack Welch on their boards, they are publicly stated believers that CEO's should be paid very well. Having a celebrity CEO on the board not only increases the likelihood the CEO will be well compensation, but also the CEO will become a celebrity themselves. CEOs also love to have deans from their alma maters on their board especially business school deans. Boards have been known to have executive recruiters on their boards. 

These head hunters not only recruit executives but also board members.   

CEOs want friends, colleagues and those who will be agreeable especially when it comes to compensation matters. Consider what Kathy Noland says, she is the vice president of the board of directors and CEO at B.E. Smith, a head hunter firm for hospital executives. She wants hospitals to guarantee high pay and large severance packages to let executives know they can make necessarily risky decisions without being penalized. She says: "The principle behind (high pay) is the board of directors wants the CEO to make prudent decisions for the mission and values of the organization," she goes on. "[The severance] package gives the CEO a confidence level to make those decisions. If for any reason they are terminated without cause, there is that extension of salary until they are engaged in their next employment" (Fields, 2011). What is she saying- use big pay to encourage risk with no penalty, and big pay packages with big severance packages will encourage confidence and if the CEO is fired and terminated the CEO will be taken care of. Health care CEOs love this even though her comments can clearly be considered self serving. It is people like Noland who are responsible for excessive health care CEO salaries but also their Senior VPs', VPs', and board members. For example, in 2007, the top 6 health plan boards paid themselves a whopping $277,998,793 (Jodell, 2009).

Another problem with larger than life celebrities on the board is they tend to dominate not only discussions but the direction the company will move in including the choice of a CEO. Ken Langone dominated the Home Depot board and there is even a question as to whether he talked to the board before he offered the top spot to the problematic Bob Nardelli. The board allowed Dennis Donovan a lawyer to negotiate Nardelli's outlandish compensation package and then let Nardelli reward Donovan by making him the highest paid HR executive in history at $21 million a year. In February 2007 Donovan resigned. Under the terms of his 2001 employee agreement, Donovan was entitled to a multimillion-dollar severance package, which was triggered by the departure of   

Nardelli who received a $210 million exit package. Donovan structured a most unusual employment contract and Langone's board approved it. According to Home Depot's April 15, 2006 proxy filing, "cessation of a direct reporting relationship with Mr. Nardelli" entitles Donovan to leave the company "for good reason" and receive "all cash compensation accrued but not paid as of the termination date and certain additional benefits, including salary and target bonus continuation for 24 months and immediate vesting of all unvested equity-based awards."   Including Donovan's past compensation, it is estimated that Donovan may have received $15 million to $20 million, plus retirement benefits, stock options and compensation already earned.

Short Stay at the Top

The studies of the length of stay in the CEO position vary but they do offer a startling trend.   According to Thompson (2010) 40 percent of CEOs last no more than two years at the top. The average CEO tenure dropped from 11.4 years in 1980 to 9.7 years in 1999 to 8.3 years in 2006, the most recent year for which statistics were compiled by consultants Challenger Gray & Christmas, Crist Associates, and SpencerStuart. However the New Your Times (2008) put the trend at 8.6 years in 2000 and 3.2 years in 2007. Lubin (2010) found only 28 CEOs of companies in the Standard & Poor's 500 have held office more than 15 years and she maintains that the average for S&P 500 CEO was about 6.6 years. While we see the length of stay drop significantly, so has the age. The CEO "class of 2004 was the youngest on record, with an average age of 57.8 years. With a young age and short stay these CEO's have been called "The most prominent young temp workers" who retire at an early age. Where do they go after their term has ended?   

 It is difficult to retread a CEO. The most difficult to retread are those with high compensation, bad press coming from either a scandal or grossly unhappy stockholders and of course those who attained celebrity status, not necessarily because no board wants to hire a celebrity CEO, it's because once one attains such lofty status they do not want to return to the trenches. They prefer to write books or give after dinner speeches and appear on talk shows telling all who will listen "how they did it" and they also become instant experts giving advice and criticism on a wide variety of subjects.   If one did research on "What are they doing now?"   After a few years in the catbird seat one would find that they join venture capital or some hedge fund firms and manage their money and/or sit on corporate or nonprofit boards or find some university post. Very few return to the corporate ranks and most retire to the corporate CEO "graveyard", the golf course.

Some of the reasons for such a short stay at the top are attributed to burnout, retirements, resignations and forced terminations. With the average length of stay at 3.2 years these CEO's barely have time to impact the corporation before they leave. What we have is instability at the top caused by this revolving door. The brief length of stay strongly suggests we have weakly committed CEO's, preoccupied with "filling their personal coffers," with little concern for their employees who they do not know or care about. Long gone are the days when a beloved CEO personally knew all their employees and symbolically "bled" when his company "bled"

Boards are clearly aware of this and they know that in 3 or 4 years at $10 million plus a year and several thousand shares of vested stock, their "golden boy" will be gone. They typically set up a cue where the conga line of executives will grab the golden ring as they pass through. Does this encourage long term planning? Not a chance. It does encourage pumping up the stock even if it means terminating thousands, outsourcing, off shoring and of course getting handsomely rewarded. While boards try to get a good CEO to stay by offering large retention bonuses, most CEOs have "golden parachutes" or "golden boots" written into their contracts, they are called severance agreements.

Group Dynamics in the Board Room

One needs to remember what it takes to make it to the top of a corporation, one needs to be: fiercely determined, relentlessly competitive, and have a demanding personality. These CEOs show up at compensation meetings with their expert compensation entourage, including attorneys, and scare the hell out of a group of board members who are old, retired and don't want the aggravation. All they want is to get to the golf course.

Pushing back against a demanding and aggressive CEO will often shorten a directors tenure. This creates an intimidating situation where the board becomes more aligned with the CEO than the corporation they are ultimately responsible to govern. Board dynamics can precipitate covert conflicts that can lead to one-off meetings and phone calls outside the conference room where a CEO can gather the support of board directors seen as trusting, protective, and on their side. The CEO wants to discover the board's vulnerabilities that can be tapped as he/she maneuvers to obtain greater compensation. The issue of who is for and who is against the CEOs compensation package is information the CEO and his confederates will ferret out. 

Above all, the CEO wants members who are selected to serve on the compensation committee to be his best friends. In many cases the CEO, CFO and their compensation consultants, lawyers and others outnumber the board members on this committee. Meetings tend to be disorganized and board members are swamped with data. The consultants and other experts present the compensation packages for each officer of the company making certain "red flags" are not apparent especially when "activist" stockholders are lurking. Most companies have a team consisting of several senior company officers including the CFO, general counsel, the director of investor relations and outside consultants who are experts responding to these pests.

Another issue that contributes to favorable compensation packages is the boards desire to create a chubby "good old boy" climate. Couple this desire for friendship with the prestige of the position and there is a tendency to believe that they are more competent than they actually are and their support of the CEO's strategy, decisions, and compensation is beyond reproach. They may actually collude in offering greater compensation to increase the climate of friendship and feelings of omnipotence. The rush to agreement and avoidance of conflict promotes the feelings of cohesiveness and power. This type of group behavior is most apparent when board members are selected on the basis of personal friendships and networking.

These former executives possess a high degree of agreeableness in social situations and this most likely is due to their dependency on something that is foreign to them. They are out of the role of authority.   The need for equality in social relationships and in the board room was not apparent when they were in the catbird seat. Observing these executives in the board room and at the country club the behavior was the same. They enjoy casual friendly talk and avoid discussions that hint of controversy. Keep it light and easy going and above all be agreeable.  

What happens when you get a group of old and tired ex-CEOs in a room? Sounds like it could be a good question for a series of jokes. Working as a member of a team and facilitating discussions is something they rarely did when they were top executives. They are use to making the decisions and in a group they are not familiar with equal give-and-take required for thorough discussion. Also, in thorough discussions group conflict is bound to occur and as mention before, this type of discussion is avoided because it may rupture the friendly atmosphere.

Professors serving on the boards also present an issue. They are not trusted and struggle to fit in primarily because they are viewed by ex-CEOs as intellectual eggheads writing books and cases about the company, who never worked in the trenches and do not play golf.

References

Domhoff, G.W. (2005) Interlocking Directorates in the Corporate Community. Retrieved from: click here

Fields, R. (2011) 5 Common Hospital Executive Compensation Practices.   Retrieved 1/19/11 from: http://www.beckershospitalreview.com/compensation-issues/5-common-hospital-executive-compensation-practices.html

Forbes (2011) Profile of Thomas Gerrity. Retrieved from: http://people.forbes.com/profile/thomas-p-gerrity/44869

Jodell, J. (2009). Why American Health Care Costs So Much.   January 14, 2009. Retireved from: http://jackjodell.blogspot.com/2009/01/why-american-health-care-costs-so-much.html

Lubin, J. (2010). CEO Tenure, Stock Gains Often Go Hand in Hand. Wall Street Journal, July 6, 2010. Retrieved from: http://online.wsj.com/article/SB10001424052748703900004575325172681419254.html?mod=googlenews_wsj

New York Times (2008b) For Executives Pay is Good But Time is Short., Sunday Business, Page 2, 8/10/2008.

Thomas, R. (2010) So Long and Farewell, Lon -- You're Simply Part of the CEO Trend. Retrieved from: http://www.tlnt.com/2010/07/28/so-long-and-farewell-lon-youre-simply-part-of-the-ceo-trend/



Authors Bio:
He has taught in MBA programs for almost 35 years in 2002 he left academe to work for Home Depot where he witnessed the absurdity of corporate life. He is now semiretired and serves on the faculty as an adjunct professor at several institutions. He holds a doctorate in psychology from NYU and completed two postdoc's: The Institute for Social and Policy Studies at Yale, and the Post Graduate Center for Mental Health in psychoanalysis. He is a member of a unique group of scholars and consultants who apply psychoanalytic thinking to organizations. He has written two books and is writing his third, an attempt to understand executive greed and self-destruction.

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