Making CEOs Pay for Bogus Books

Boards must find the backbone to end the cronyism that lets corporate chieftains retain compensation based on fictional earnings

By Louis Lavelle

Let's say you hit the big time and take a $1 million signing bonus for a senior position at a top company. But after two months on the job, you up and leave. Oops. Sorry. Got to go now. Bye.

Most employers would demand that you give back the signing bonus, right? After all, you didn't perform as expected. So why is it that when CEOs routinely walk away with a multimillion dollar pay package for financial performance that often turns out to be pure fiction, few boards ever ask for a refund?

A flood of financial restatements in recent years has thrown this issue into stark relief. Since January, 2002, CEOs of more than 100 companies -- including Kmart (KM ), WorldCom, and Bristol-Myers Squibb (BMY ) -- received lavish bonuses, stock awards, and options grants based on earnings that later had to be restated. Give the inflated bonuses back? Fat chance.

RESTATEMENTS FOR ALL.

  Never mind that dramatic restatements can cost companies plenty in regulatory actions, shareholder lawsuits, and sometimes even criminal proceedings. If investors are ever again going to place their trust in Corporate America, this blind-eye behavior must change. CEOs need to start restating their pay when they restate profits, and if they don't, boards need to do it for them.

"Board members have that responsibility," says William George, former chairman of Medtronic (MDT ) and a long-time corporate-governance advocate. "With restatements, there ought to be some restatement of compensation as well," he adds.

Take Computer Associates (CA ). An internal probe found the outfit was booking revenues before software contracts were signed in 2000, a year when CEO B. Sanjay Kumar received $14.6 million in pay and 750,000 options. A spokesman says Kumar hasn't had a bonus for three years. Still, he hasn't returned his 2000 bonus -- compensation designed to reward his performance for the period in which this accounting error occurred.

A RARE FEW.

  Bristol-Myers Squibb wiped away $900 million in profits and $2.5 billion in sales reported from 1999 to the first half of 2002, when Peter Dolan received $12.4 million and 765,000 options as senior vice-president, president, and later, as CEO. A Bristol-Myers spokesman says Dolan ran the company for only a portion of the restatement period. Dolan hasn't said whether he intends to return a prorated amount.

In fact, executives who have returned bonuses in underperforming circumstances are hard to come by, if you don't count those who have been forced to cough up ill-gotten gains by prosecutors or regulators. There have been a few. Back in 1996, Green Tree Financial's Lawrence Coss, who earned $108.8 million that year, returned more than 760,000 shares and $2.5 million in cash following a profit restatement -- a pay cut of nearly $40 million. More recently, Dollar General's (DG ) former CEO Cal Turner Jr., who was paid $23.2 million plus 620,000 options from 1998 to 2000, returned $6.8 million after the company restated net income for those years to reflect errors in accounting for expenses, leases, and taxes.

Sometimes CEOs get special dispensation, even after they're forced to return pay based on inflated financial results. At Xerox (XRX ), following an Securities & Exchange Commission complaint alleging that it overstated pretax earnings by $1.4 billion from 1997 to 2000, six current and former executives agreed to pay $22 million in penalties, including bonuses and stock profits based on those profits. But two executives, former CEO Paul Allaire and former CFO Barry Romeril, paid just $1 million each -- Xerox picked up the balance of their penalties, nearly $12 million.

RETURN TO GIVER.

  The Sarbanes-Oxley law enacted last year in the wake of Enron and other corporate accounting scandals requires CEOs and CFOs to forfeit pay following restatements that were the result of misconduct. Yet, most boards seem loath to enforce it. One exception is HealthSouth (HLSH ), where the board has informed former Chairman Richard Scrushy that it plans to demand a return of his bonuses and equity-based pay if the company restates earnings.

Scrushy, the target of several investigations into allegations that HealthSouth overstated profits by $2.5 billion over several years, earned nearly $36 million (including options) from 1999-2001, the most recent three-year period for which information is available.

The solution to this problem isn't just enforcing Sarbanes-Oxley, however. Corporate boards must do a better job of outlining the performance measures used to set CEO pay so accurate adjustments can be made later, if necessary.

FUTURE DEDUCTIONS.

  Just as important: Compensation committees must view pay as contingent on real results. If recouping previously awarded pay isn't practical, boards should make adjustments for future pay. "The board is responsible," says Roger Raber, CEO of the National Association of Corporate Directors. "Something has to be done when somebody's compensation is based on something that didn't happen."

Even in this era of post-Enron reform, decades of cronyism make it difficult for many boards to stand up to a CEO and demand restitution on behalf of shareholders. As compensation committees become more independent, that will change, but only if directors make pay reform a priority.

Lavelle covers management for BusinessWeek in New York

Edited by Douglas Harbrecht

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