Infectious Greed: Restoring Confidence in Americas Companies - page 25


Summary

The corporate form of business allows businesses that need capital to get it and expand, thereby helping the economy. It also allows people with money to provide those funds to a business and profit from having ownership in that business. The disadvantage of public corporations is the separation of ownership and control. Managers who control a firm can take advantage of investors who own the firm. To inhibit poor managerial behavior, shareholders try to align the executives' interests with their own through incentive programs involving stock and stock options. In addition, the corporate system has several different groups that monitor managers. Unfortunately, both alignment incentives and monitors have failed recently. The system has interrelated incentives that combine to create an environment in which people might act unethically. We believe that the best solutions are ones that fully recognize the integrated nature of corporate America and alter the present incentives. In the following chapters, this book documents the extent of the failure. Later, we examine solutions to the problem.


Endnotes

  1. William J. Megginson, Corporate Finance Theory (Reading, MA: Addison-Wesley, 1997), p. 40.

  1. Ibid.

  1. See, for example, Stuart Gillan and Laura Starks, "A Survey of Shareholder Activism: Motivation and Empirical Evidence," Contemporary Finance Digest 2, no. 3 (1998): 10 “34; Cynthia Campbell, Stuart Gillan, and Cathy Niden, "Current Perspectives on Shareholder Proposals: Lessons from the 1997 Proxy Season," Financial Management 28, no. 1 (1999): 89 “98; and Lilli Gordon and John Pound, "Information, Ownership Structure, and Shareholder Voting: Evidence from Shareholder-Sponsored Corporate Governance Proposals," Journal of Finance 47, no. 2 (1993): 697 “718.

  1. Mike Elgan and Susan B. Shor, "Gloves Are Off in Merger Fight," HP World , February 2002, www.interex.org/hpworldnews/hpw202/01news.html.

  1. Almar Latour and Kevin Delaney, "Outside the U.S., Executives Face Little Legal Peril," Wall Street Journal , August 16, 2002, p. A1.


Part 1: The Failure of Executives

Chapter  3.   Executive Compensation and Incentives

Chapter  4.   Executive Behavior


Chapter 3. Executive Compensation and Incentives

Corporate executive behavior is the result of many factors. These factors include the relationship between the board and the CEO and between auditors and the firm, regulators, and executive pay structures. Boards, auditors , accountants , analysts, regulators, investors, and others in the corporate system are discussed in other chapters. Here, we focus on the incentives induced by modern executive compensation.

The SEC requires that the pay of the CEO in public firms be disclosed. Therefore, anyone can obtain and know the pay of the top executives of a firm. Many people take an interest ”particularly stockholders , employees , labor unions, the media, and even Congress. However, executive pay did not really come into the public debate until the early 1990s. Stories about CEO pay aired on 60 Minutes and Nightline in 1991. Then, Graef Crystal's book In Search of Excess was published in October 1991. Time came out against the excess pay to executives in 1992. [1] Congress also heard the beat of the drum and (in an election year) proposed bills that limited the tax deductibility of excessive pay. These bills never become law, but the SEC and the IRS enacted policies with similar spirit.

However, this attention did not seem to change the trend of increasing executive pay. The pay of CEOs escalated in the mid-1990s while firms were downsizing. That is, the CEOs were paid more while the rank-and-file employees were laid off. The base pay of CEOs was nearly 100 times greater than that of the average production worker. If incentive awards like stock options were included, CEO pay was more than 200 times higher. Again, the media clamored about the injustice.

In the late 1990s, the bull market increased the value of executive stock and stock options further. The gap between realized CEO pay and the income of average employees grew even more. While the controversy continued , it also seemed to lose some strength. Employees were finding that they, too, could profit by owning the company stock. Instead of anger at CEOs who made millions, the media reported more stories about secretaries at dot-com firms who received stock options and became rich. However, by late 2000 and 2001, the stock market fell and employees no longer felt rich. Instead, it appeared that the executives had cashed in their stocks and options before the stock prices fell. The impression is that the CEOs are still rich, while the employees lost significant portions of their pension money and are now making plans to retire later than previously anticipated. Through the good times and bad times, the pay of executives has continued to increase.

We now examine executive compensation and illustrate how the structure of the compensation provides incentives for specific CEO behavior. Unfortunately, the behavior induced by some compensation plans is not the kind valued by shareholders or society.