Diane Urquhart, an independent financial analyst and shareholder advocate based in Mississauga, Ont., says that CEOs such as D’Alessandro are genuinely surprised at the outrage they provoke, because they truly believe they deserve their windfalls. “An intense greed has seeped into the upper echelons for corporate society, and these CEOs have lost touch with reality,” she says. “They do think they’re entitled, and all the people that they surround themselves with are of a similar mindset. So there’s no one there to put the brakes on that psychology.” Still, she adds, “There are now some slivers of hope that people are beginning to push back.”
The question is whether the impulse for change will last. Investors have grumbled about fat executive paycheques for years, even as the payouts have accelerated. But these are not typical times, and thanks to outrageous bonuses given to executives at AIG, Fannie Mae, and other large American firms, executive pay is now a political issue on the international stage. In the U.S., President Barack Obama is talking of placing caps on executive pay, while some economists are even blaming executive greed for fuelling the worldwide economic meltdown. A few scattered Don Quixotes may have triggered a global reform movement, aimed at turning back the clock on executive pay by decades.
Executives have always been well-compensated, but the era of celebrity CEOs and obscene wealth is a relatively new phenomenon. Ironically, the explosive inflation in executive pay can be traced to two regulatory changes introduced almost 15 years ago, with the aim of protecting investors, says Christopher Chen, a compensation consultant with the Hay Group.
The first change was to begin publicly disclosing executive pay. It used to be that CEO pay rates were kept under wraps, so consultants like Chen would make educated guesses on what other CEOs were making, then advise their clients on an appropriate rate. “It was a black-box art,” he says. But in the mid ’90s, as stock prices started to balloon, so did CEO pay. In an effort to keep it under control, regulators in the U.S. and Canada began demanding that companies disclose how much top executives were pocketing. Soon after that, the U.S. also removed the tax-exempt status of executive pay over US$1 million. Both moves were intended to curb skyrocketing pay, but they achieved precisely the opposite effect.
Making CEO pay public led to the “Lake Wobegon effect,” says David Lynn, a U.S. partner at international law firm Morrison & Foerster. Named after the fictitious town of Lake Wobegon from the American radio series A Prairie Home Companion, where “all the women are strong, all the men are good-looking, and all the children are above average,” this effect describes the natural human tendency to rate ourselves above the pack. Since the boards of directors at most companies like to think that their CEO is “above average,” it only seemed fitting that their CEO’s pay should be above average too. Unfortunately, when every company pays its CEO an above-average salary, that average starts to move up in a hurry. In other words, says Chen, “the rising tide lifted all boats.” According to the International Institute for Labour Studies, in just the four years between 2003 and 2007, CEO pay in the U.S. shot up by 45 per cent.
A huge amount of that inflation was rooted in the rise of stock options. When the government removed the tax-exempt status of cash payouts over US$1 million, corporate boards shifted the majority of executive pay from cash to options. This was initially seen as a good thing. If a company did well, then its stock price would go up and the options would be worth more. But while it sounded good in theory, Lynn says that in practice it led to CEOs pumping the next quarter’s results at all costs, even if it meant fudging the numbers. “It had the unfortunate effect of causing scandals like WorldCom and Enron and all these major meltdowns that resulted from executives being focused on trying to boost their stock price,” he says.
As companies moved from cash compensation to increasingly elaborate pay structures, the true level of pay became ever more difficult to grasp. Today’s packages generally include base pay, stock options, restricted shares, annual bonuses, special bonuses, golden handshakes, golden parachutes and accelerated supplemental pensions. Lynn says that sometimes not even the boards of directors who set the pay levels know what they’re on the hook for. “Compensation decisions are typically made piecemeal,” he says. “At one meeting they might make the decisions as to equity grants, and then six months later they might make the decisions on performance goals for an incentive plan, and then at another meeting, they’ll discuss salary.” At every one of those meetings, the total pay package tends to get fatter.
The shareholders are supposed to act as the safety valve on all of this. If executive pay gets out of hand, then as the ultimate owners of the company, shareholders have the power to vote out the board of directors. However, Stephen Griggs, executive director of the Canadian Coalition for Good Governance (CCGG), which represents institutional investors controlling about $1.3 trillion, says the system for electing those boards doesn’t resemble anything most people would call democracy—unless you happen to be Kim Jong Il. “The main problem is that the vast majority of boards will have a nominating committee that sets a slate of directors,” he says. “And shareholders then either vote for that slate in its entirety, or their only other legal option is to withhold their vote. So you can have a scenario where a nominating committee puts whoever they want onto that slate, and as long as a single shareholder votes for that slate—even if you have 99.9 per cent of shareholders withholding their votes—then that slate is still elected.” It would be like introducing new rules for our next federal election that state you can either vote for Stephen Harper, or not at all. And as long as one person votes for him, he wins.
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