Daily Dose of Optimism

Some Friendly Advice for Jeff Skilling

To Jeff Skilling: When you appeal your guilty verdict in the Enron trial, try hiring Unfrozen Caveman Lawyer instead of Daniel Petrocelli. - Ed

 

Graef Crystal - International CEO Comp Comparison

I covered a short while back what I interpreted as Graef Crystal's guilt complex for his potential culpability in today's booming CEO-comp industry.

As I hope was clear at the time, that's now water under the bridge, and his writings to the opposite effect are useful.

An excerpt from In Search of Excess that you might find interesting is this comparison of US average CEO salaries versus Japanese average CEO salaries.

Although this information is a little dated, I would be surprise if it had changed all that much over the years; if anything, I expect the disparity would have widened.

Key excerpts:

(1) Japanese CEOs have no monetary incentives to engage in truly long term behavior, while American CEOs, at least in theory, have huge monetary incentives. It is, of course, Japan that is cleaning our clock by looking to the long term.

(2) In Japan, as I understand it, the game seems to be played for recognition or, if you will, standing in the community. The game is not being played for huge sums of money.

In fairness, I do think that the high personal income tax rates in Japan have a large part to do with low compensation, as there is little point to giving away astronomical sums to the government. What that means for the Laffer Curve is up for debate. - Ed

In Search of Excess: Perhaps one could accept the high pay levels of U.S. senior executives if one could observe the same high pay levels in other major industrialized countries. But fans of high pay are not going to find much comfort [here] …

A 1990 study showed the average CEO among 202 major company CEOs in the United States studied was earning $1.4 million per year in total current compensation – a combination of salary and annual bonus – and $2.8 million per year in total direct compensation, the combination of salary, annual bonus, and the annualized present value of such long term incentives as stock options, restricted stock, performance shares, and performance units. Excluded from this awesome $2.8 million total are the values for perquisites and for both regular and supplemental fringe benefits – such as pension and profit sharing plans, and life and medical insurance coverages.

Now let us do some sightseeing.

According to Tatsuaki Kiuchi who is Manager of Human Resources International for the Giant NEC Corporation, the typical CEO of a major Japanese company earns a combination of salary and bonus around 40 million yen. At an exchange rate of 129 yen to the dollar, which prevailed at the time this book was being written, that translates into total cash compensation of around $310,000 per year. The sum of $310,000 per year would not even fund your typical American CEO's salary for half a year, much less his annual bonus.

Graef Crystal's Guilty Conscience

I want to pull out a few interesting excerpts from Graef Crystal's 1991 book, In Search of Excess: The Overcompensation of American Executives.

Graef has some good material in there, which I have cited only once as yet (as a joke) although I admit that overall the book is a little snoozy. (I think this is because most of the executives listed have come and gone, and in any case, were exceeded 10x over in the late 1990s.) Read about 75%, and then I had to put it down.

One interesting aspect for me was his experience and motives for writing the book, which are detailed in the introduction, and which I have excerpted below. The excerpt talks about how Crystal determined compensation levels, and what he would have done differently now if he could do it all over again.

Having facilitated the overcompensation of American executives in his career as a compensation consultant, Crystal now writes columns (and a few books) about the practice.

Although we'd need a university study to tell us which was more impactful on American business, my intuition tells me Crystal's work as a trailblazing compensation consultant was probably far more impactful, and damaging for American business, due to the establishment of precedent, than his current writings could ever hope to rectify.

The reason being that history and frequency now trump what decency and rarity once prevented.

At least, of course, Crystal is trying. I gladly give the man credit, and am linking to his book above so you can too. - Ed

In helping a company to decide how much to pay its top executives, I would like to have Williams’s survey data showing the current pay levels of other companies. The trouble was, however, that all the companies were U.S. companies, and so I never saw how American CEOs paid without stripping that of CEOs abroad during a period when foreign companies captured large portions of the American markets. And I never looked back to see how much top executives pay had been growing in the United States, compared to what ordinary workers were earning.

If a company wanted to pay its top executives above market levels – presumably to assure its ability to attract top talent and to encourage greater performance on the part of the talent the company already had‑ I generally went along with the CEO’s thinking. I never focused very well on the fact that unless other companies were willing to pay their executives at below market levels, the market would simply explode. And explode it did.

I succumbed more than I should have to the two favorite siren songs of American CEOs. First, if your company has performed brilliantly, then you should pay your top people brilliantly. However, if your company has performed poorly, you can not afford to make people suffer very much, because they will simply leave and go elsewhere; in other words, you have to keep the good people. Simple logic, of course, mandates that there can be very few effective people at the top of a lousy performing organization. But simple logic was apparently not my forte. As a result, I helped create the phenomenon we see today: huge and surging pay for good performance and huge and surging pay for bad performance, too. After all, if you are going to pay people highly in good times, because they deserve it, and if you are going to pay people highly in bad times, because you need to keep them with the company, just when is it that you are ever going to cut their pay? There are, so far as I know, only two types of times: good times and bad times.

I also succumbed to the argument that the reason CEOs earn so much today is that there is a scarcity of talent. Most of today’s CEOs were so-called depression babies, people born in the 1930s. That particular cohort, as the demographers term a ten-year span of birth, had far fewer births than the cohorts before or after it. Consequently, the supply of potential CEO labor was unnaturally low. Moreover, it was rendered even lower by the fact that until the 1970s, women were systematically excluded from the executive labor force. Hence, so the argument goes, if there is a scarcity of labor, there is naturally going to be an increase in the price of that labor, as company after company fights to obtain and keep scarce talent. The argument seems to hold water, until one thinks about the fact that our major trading partners ‑ Japan, Germany, France, and the United Kingdom – also experienced the depression of the 1930s and its consequent effects on birth rates. Yet they seem to be able to field more than an adequate supply of CEO talent without paying the moon for it. For my part, I did not think about executive pay in other countries, because I saw it as being irrelevant to the U.S. executive labor market. Technically, it is irrelevant, but the fact that other countries can do the job - and frequently do it better – with lower priced talent points up that there is something wrong with the U.S. executive compensation. (Page 10)

Thoughts On Professional Managers

Old, but good:

WSJ: A survey commissioned last year by the Concours Group ... found that only 62% of managers strongly or moderately agree that "I really care about the fate of this organization," and only half were glad they chose to work at their company over another. Moreover, only 35% of managers said their organization inspired the best in them. Tammy Erickson, an executive officer of the Concours Group, calls the results "enough to make you cry." She says she's dismayed "that the very people you're counting on to engage other people are themselves feeling so disenchanted with what they're doing." Link

That would probably also explain this gem:

“Ninety percent of what we call ‘management’ consists of making it difficult for people to get things done.”

– Peter Drucker

TSE Executives Fined for Computer Glitch

Good datapoint on how Japanese executives respond to a crisis in their business. In addition to Japan having a lower ratio of CEO comp to average employee comp, such punitive measures are interesting:

Executives at the Tokyo Stock Exchange will take temporary pay cuts after a computer breakdown shut down trading on the exchange for three hours earlier this month, frustrating investors and shaking confidence in Asia's biggest bourse.

TSE President Takuo Tsurushima's monthly pay will be slashed by 50 percent for six months from November as a punitive measure, while systems chief Tomio Amano will receive a 30 percent cut over the same period, the exchange said in a statement Thursday.

All seven other TSE operating officers will also take cuts in their monthly salary of between 10-20 percent, while Chairman Taizo Nishimuro will voluntarily impose a 50 percent cut in his pay for half a year.

On Nov. 1, trading in most stocks and bonds on the exchange, where over 2,000 issues are listed, was suspended for all but the final 90 minutes of the trading session due to a glitch in the transactions system. (Link: Yahoo Finance)

American Management Style: Systems fail, business as usual. Systems work in a crisis (NYSE), we deserve a multi-million dollar bonus.

"The thing that really surprised me was that he was paid a [$5 million] bonus for [restarting the exchange after] 9-11,"   said Muriel Siebert, an NYSE seatholder since 1967 who heads up her own brokerage.   "Now, I think Dick did a superb job that day. ... But a lot of people in   this country would have paid for the privilege of having that responsibility.   And they would have done it without a bonus."  Link

Japan: Systems fail, you pay.

I wonder which system will produce better results over time? America, for "not scaring off risk takers", or Japan's, for "holding people accountable"?

Let's apply this idea to another industry:

America: car sales unprofitable, liabilities greater than ability to fund them, design of cars is boring - pay executives millions!

You see where I'm going. Just bear in mind this executive retribution example as something to propose when you're on the board of a company or a 5-10% holder and company performance goes south for some reason. - Ed

Sexual Consultants

This anecdote is an excerpt from the 1991 book  In Search of Excess: The Overcompensation of American Executives by Graef Crystal (pgs. 83-84):

Some years ago, I found myself hitching a ride on the corporate jet of one of my clients. A board meeting had just been held, and the jet was flying to Chicago with a group of outside directors. I was busily reading the Wall Street Journal and trying not to eavesdrop on the conversations that were taking place, but I couldn’t help overhearing the following exchange.

Director 1 to Director 2:  “Hey, Don, I just read in the paper that you retired as CEO of the XYZ Company. So what are you going to do to keep busy?”

Director 2: “Well, I’m going to be a consultant to my former company.”

Director 1 (with a trace of sarcasm): “What exactly does that mean?”

Director 2: “If you must know, I’m going to be a sexual consultant.”

Director 1: “A sexual consultant! What’s that?”

Director 2: “Well, when my former company signed me up as a consultant, they told me: ‘If we want any of your fucking advice, we’ll call you!’”

O Canada - CIBC, Enron and CEO Refunds

For those who care about signs that managerial misdeeds are being addressed by those who are really responsible - the shareholders - this one should bring tears of joy, an example to be repeated the world over. Too bad this sort of response only came about because of an egregious fine, but we've got to start somewhere.

I should state that I am much more in favor of these issues being settled outside the courts as a matter of good corporate governance by shareholders smart enough to realize that it is in their interest to make sure the companies they OWN are keeping house correctly. - Ed

Key quote:

"Investors have to ask: 'What did you get compensated for? You just whacked us for $2.5-billion [Canadian]. Like, how does that justify a big fat bonus?'"

    - Lex Kerkovius, PM, McLean & Partners (Calgary)

Investors want Hunkin to share CIBC pain  Link  8/3/05

CIBC shareholders are asking that former chief executive officer John Hunkin and other departed officials be forced to give up some of their past compensation in light of an unprecedented $2.4-billion (US) legal settlement the bank struck with Enron investors this week.

Mr. Hunkin officially retired on Friday, taking with him about $52-million (Canadian) in stock and other securities. In addition, he pocketed nearly $15-million in salary and bonuses since he took over as CEO in 1999.

Virtually no one forecast the severity of the CIBC settlement, which will force the bank to take $2.5-billion in charges: the largest one-time hit in Canadian banking history. The charge accounts for about 25 per cent of the bank's entire book value.

Lex Kerkovius, a portfolio manager with Calgary-based McLean & Partners Wealth Management Ltd., said investors were “ambushed” by the news, and questioned whether Mr. Hunkin would accept “more than token responsibility” for the bank's costly entanglement with Enron.

CIBC has already paid U.S. regulators an additional $80-million (U.S.) for allegedly aiding and abetting the accounting fraud at the infamous energy trader, and is expected to announce a third settlement with the company itself, valued in the hundreds of millions of dollars, within days, according to sources. A spokesman for the bank declined to comment on this latter potential agreement over what has been dubbed the “MegaClaims” litigation.

“We all know that Mr. Hunkin made some rather large bonuses in the past few years, and I don't know how investors can sit still here,” Mr. Kerkovius said in an interview, adding that other investors have made similar complaints to the bank. He said investors have to ask: “What did you get compensated for? You just whacked us for $2.5-billion [Canadian]. Like, how does that justify a big fat bonus?”

Tyco ("TYC") - Ah, the Irony...

Well, I suppose it takes one crook to know another, and that crooks know how other crooks should be punished. There are absolutely priceless quotes from Mr. Kozlowski in his letter, particularly the one extolling his "firsthand knowledge" (original here: TYCO_Letter.pdf). Enjoy! - Ed

Koz' Letter: "I view Mr. Shah's crime as particularly egregious, and as one which cannot be condoned in any manner.  ... Not only did he steal from the stock holders of this Fortune 500 company, but he breached the fiduciary duty placed in him by the company... (new paragraph) ... I write from firsthand knowledge..." 

"I urge you to impress upon Mr. Shah and those others who commit similar crimes that wrongdoing of this nature against society is considered a grave matter ... and will not be condoned. 

Mr. Sharh should be sentenced to incarceration for the maximum term ... and no less than that."

WSJ Article: An executive caught stealing money from a company is guilty of a "particularly egregious crime" and "should be sentenced to incarceration for a maximum term," said the 1995 letter to a sentencing official in Houston.

The subject: an employee of Tyco International Ltd. who admitted embezzling just under $1 million from the company. The writer: L. Dennis Kozlowski, then Tyco's chief executive. ... Prosecutors may use the 1995 letter to help argue for a lengthy sentence for him, according to a person familiar with the situation. 

Reached at his home, Mr. Shah said the letter "probably played a major part" in his sentence. He said he was aware of Mr. Kozlowski's recent conviction but declined further comment. Colin Amann, an attorney who represented Mr. Shah in seeking a new trial, said the 20-year sentence for someone with no prior record "shocked everyone."

Good News for rational CEO compensation

Tyco verdit came in - apparently the fact that the executives were so highly paid means that they did not have plausible deniability of the problems that ran amuck at their companies. Kurt Eichenwald (Autor of the Enron book "A Conspiracy of Fools") handles this one well below. (If you're interested in Enron, I recommend "Smartest Guys in the Room" by Bethany McLean, and if you're interested AND short on time, then see the excellent documentary by the same name. Less detail, but gets the gist, and in a way that words never quite can.) - Ed

Big Paycheck Is Exhibit A  Link
By KURT EICHENWALD
Published: June 19, 2005

In the 1990's, they were held up as corporate supermen, executives whose skills and brainpower made them so indispensable to their companies that they were paid on a scale virtually unseen in human history. But in the new millennium, as the story has moved from the boardrooms to the courtrooms, they have portrayed themselves as having been fumblers, sloppy with their paperwork and unaware of crimes in their midst - yet still deserving of their gargantuan paychecks.

And, for the most part, juries are not buying it.

The conviction on Friday of L. Dennis Kozlowski, the former chief executive of Tyco, on charges of grand larceny and conspiracy is underscoring what legal analysts say is perhaps the most surprising consequence of the explosion in corporate pay during the 1990's: a heightened expectation that executives know how to do their jobs and understand what is happening at their companies.

Indeed, coming after the convictions of other top executives - including Bernard J. Ebbers, the former chief executive of WorldCom, on charges of accounting fraud, and John J. Rigas, the former chief of Adelphia Communications, on charges of conspiring to loot the company - the Kozlowski verdict demonstrates that, at a criminal trial, high pay scales can serve as the government's Exhibit A of the defendant's potential knowledge of wrongdoing.

"One of the perils of being paid an enormous amount of money is that people will ultimately conclude that you're worth it," said Robert A. Mintz, a former federal prosecutor who is now a partner at McCarter & English in Newark. "The assumption jurors will reach is that somebody who receives large compensation is playing a critical role at the company, and a defense that you were more cheerleader than ringleader is going to be very difficult for a jury to buy."

Wisdom on GM and CFO-CEOs (Update)

Tom Peters, management guru extraordinaire, had this to say today about GM and Rick Wagoner.  Coming from Tom Peters, this sort of off-the-cuff comment is revealing. I sit here and ramble into my blog never having been to Michigan or met any of the players involved.  Tom Peters, on the otherhand, has met the executives, and apparently given lectures to the employees there. So, having him say "insane bureaucracy" gets the wheels turning - while the press sits here and says GM is being killed by high labor costs and legacy benefits, I have to wonder whether Gordon Gekko's priceles Wall Street quote doesn't also apply:

"Teldar Paper has 33 different vice presidents each earning over $200,000 a year. I spent two months analyzing what these guys did and I still can't figure it out. ...  One thing I do know is this paper company lost $110 million last year, and I'd bet half of that is in the paperwork going back and forth between all the vice presidents."

Finally, even coming from a finance career now, I don't really identify as a pure finance type, and hence the comment about CFOs making poor CEOs rings true. Most of the finance types I've ever met are short on charisma and vision.  Running a corporation isn't about financing and cash management - it's about strategy, and sales. The former is critical, but its sort of like a heartbeat is to being an athlete - yes, it's critical, but it is your practice and performance that make you a winner. - Ed

Tom Peters: I've only worked with GM a few times, years ago. My memory is "decent people, insane bureaucracy." I guess nothing changed.

As to Rick Wagoner, doubtless a very bright fellow; still, he gives credence to my long held belief that Chief Financial Officers rarely make great CEOs. The last big Detroit turnaround was crafted by Master Marketer Lee Iacocca. He was an incredible salesman—to employees, to Washington, to the consumer. (Remember, his breakout was the first Mustang while at Ford.)

In fact GM has been saddled with three of the least inspiring chiefs in recent big-corporate history: Roger Smith, Bob Stemple, and now Wagoner.

Link