On Feb. 17, President Obama signed into law a $787 billion stimulus package that includes limits on the pay and bonuses of the 20 top-earning executives at companies receiving federal bailout money. The provisions, inserted by Senate Banking Committee Chairman Chris Dodd of Connecticut, are even tougher than the President proposed and are raising concerns on Wall Street about an exodus of talent. The view is different on Main Street, where executive pay is under attack as more Americans lose their jobs and as billions in taxpayer money props up teetering banks. But is there really change afoot in the way executives are compensated? I talked with Nell Minow, editor and co-founder of The Corporate Library, an independent firm respected for its research on corporate governance and compensation.
Anger over enormous executive compensation has been rising for years. Are we at a watershed moment?
Yes, I think so. All the scandals I have lived through going back to the savings and loan crisis, insider trading, Enron, and WorldCom seemed very localized—they were about something that everyone could understand. There were people who behaved unethically, and we got to see some very satisfying perp walks. But in this case, because the problem seems so systemic and there has been no indication that anyone has done anything illegal, that has fueled a level of rage I have never seen before. I used to compare some of these executives to Marie Antoinette, but a better comparison is Nero. When the stories came out about [former Merrill CEO John] Thain and his $1,400 wastebasket and the corporate jets and the bonuses, that makes people feel that not only did the business community create this problem, but they don't care how bad it gets. I will tell you that the biggest disappointment I've had in this mess has been the absolute vacuum of leadership on the part of the business community.
The public may be angry, but don't stockholders have to get angry, too, for there to be any dramatic changes?I'm so glad that you brought that up because all the reforms going back to Enron and before always focus on what they call the supply side of corporate governance, which is what the boards must do, what the corporations must do, what the accountants and lawyers must do. And we have completely failed to address the demand side of corporate governance, which is what shareholders must do. Shareholders have reelected these directors, have approved these pay plans, and have been enablers for the addictive behavior of the corporate community.
The stimulus bill reins in compensation for executives of banks or companies receiving bailout money. Is that fair?I think there are two important points to make about it. The most important is that this is not the government regulating CEO pay. This is capitalism. This is the provider of capital insisting on some improvement in CEO pay. And whether you are a distressed company that goes to a private equity firm for help or to your Uncle Max for help, those people are going to insist on some kind of a giveback with regard to pay. So this is a business partner negotiating. Caps don't really have much of an impact, but they send a powerful message. To me, the interesting part is the restricted stock. The fact that there's no limit on the restricted stock means that you can earn a zillion dollars under this program as long as you earn it. And the fact that it cannot vest until the government gets [paid back] is very, very good. It really does the best job possible of aligning the interests of the managers with the interests of investors and taxpayers.
Can you explain how compensation contributed to the mess we are in now?Certainly. With regard to the subprime mess, compensation was structured so that people were paid based on the number of transactions rather than the quality of transaction. And it doesn't take a rocket scientist to figure out that that is going to lead to disaster.
How has executive pay ratcheted up to such a level?In part, the answer is that the last time the government tried to fix [outsized executive compensation], there was no limit on stock options. At the time you didn't have to expense stock options, and they just mushroomed. So we want to have some humility going forward about efforts to correct this problem we helped to create the last time we tried to correct it. And there was a cultural element that led to this as well. I always say that investment bankers are the geishas of the financial world because they sit next to the CEO and laugh at his jokes and talk about what a big strong man he is and wouldn't it be fun to buy something together. And so CEOs looked at the investment bankers and said to themselves, "This guy's making more than I am. I am a titan. I'm the CEO of a great big company. I'm responsible for all these employees and customers, and all this guy does is move numbers around. I should be paid as much as he is." And then we have what we call the virus directors—directors who move from company to company and bring bad pay plans with them. So you have people like [Home Depot (HD) founder] Ken Langone, and you find him on the compensation committees of GE (GE), approving Jack Welch's retirement plan, Dick Grasso's at the NYSE (NYX), and [Bob] Nardelli's at Home Depot (HD). He personally was involved in three of these outrageous plans.
So compensation committees are at fault?Yes. I absolutely blame them 100%. I've given up on any other reform other than the ability to replace directors who do a bad job. Without that, as long as you still have this very cozy interlocked system of having CEOs control who is on their boards, you're going to have no incentive for directors to say no to bad pay. I mean, when Warren Buffett says that he has knowingly voted for excessive compensation because collegiality trumps independence, you know that there's something really wrong with the system.