Brad DeLong's Semi-Daily Journal: A Weblog

I fully believe its because corporate officers have near complete control over board of directors. Given they nominate board members and control enough shares via non-comitted proxies CEOs pretty much get any board that they want.

Many in the market orginally bought the thesis that one reason for poor stock returns in the 1970s was disconect between exec compensation and stock price. So was big push among fund managers about 20 years ago to tie exec comp to stock prices. By considence the big 20 year bull market started at about same time as shift in exec comp. Consequently, many in markets believed they were getting just what they asked for -- make exec comp function of stocks and stocks go up. Because of very wide belief in this cause-effect rational portfolio mangers are
keeping quite on exec comp.

How long we have to have poor stocks and great exec comp before fund managers change their beliefs is an open question.

There seem to be things happening not visible to the rest of us. Take for example the ouster of Sean Harrigan as president of the CalPERS Board because of his activism. The lesson one might take from this situation is that pension funds are not supposed to interfere in the internal affairs in corporations the fund managers have invested in. One would think that pension fund managers have a fiduciary responsibility to protect the investments they make on behalf of their pension fund contributors. Alas, such appears not to be the case.

Instead of working to simplify taxes maybe Bush should take on simplifying CEO compensation. Hows about tying it to performance for starters, along with the elimination of golden parachutes, especially for poor performers who end up being jettisoned. Better yet, maybe this is one job description that is ripe for outsourcing. I'm sure there are plenty of qualified individuals overseas who can get the job done for a small fraction of today's bloated executive compensation packages.

One problem may be that too much power and information are centralized in the upper reaches of American management. Should one try to get really tough with top management's compensation, they threaten to leave together, in which case the company is in such trouble that it will lose more value than paying the extra 10% or so.

http://www.nytimes.com/2004/12/12/business/yourmoney/12watch.html

GRETCHEN MORGENSON
Are Options Seducing Directors, Too?

TRYING to extricate company directors from their chief executives' pockets has been at the heart of many changes in corporate governance during these dizzying scandal years. Indeed, the most commonly cited cure-all for what ails corporate America is director independence.

But all the independent directors in the world cannot seem to fix perhaps the biggest problem facing shareholders: egregiously high and ever-rising executive pay. Even though members of companies' compensation committees now must be independent, executive pay just keeps on rocketing.

A new study by academics at Baruch College, part of the City University of New York, offers a possible explanation of why this may be. You may not be shocked to learn that - once again - it's about money.

Donal Byard and Ying Li, both assistant professors of accountancy at Baruch, analyzed stock option grants given to chief executives at United States companies from 1992 to 2002. The sample was large - almost 18,000 grants - and the study confirmed other academic research showing that options are very often granted to executives just before good news about the company is disclosed or directly after bad news. No companies were identified in the study.

The study also found that the practice of bestowing well-timed option grants - which the professors called 'timing opportunism' - has become more prevalent in recent years. Puzzled by this, the professors said they decided to dig further. So they looked at how directors were paid and found that timing opportunism was more pronounced when directors on the compensation committee received a larger proportion of stock options in their pay package.

As a result, the professors said, a heavier reliance on stock options in the pay of independent directors more effectively aligns their interests not with the shareholders to whom they have a duty, but with top management.

'Since outside directors frequently receive options at the same time as C.E.O.s,' the study noted, 'these directors also benefit from any timing opportunism. We argue that when outside directors receive a lower proportion of their compensation from stock options, they are more likely to limit C.E.O.s' timing opportunism.'

It is another aspect of the current corporate morality play. Just as no one argues for sensible boardroom pay, no one argues for accountibility when disaster strikes the firm and the golden parachutes are deployed.
As a layman when I hear "This *insert high-sounding fraudulent issue here* is being done for the benifit of the shareholders", I tend to substitute for shareholders the phrase "a restricted sub-set of shareholders that include myself and my cronies".

Same music, different words.

You ask why fund managers don't step up to discipline executive compensation. Not such a difficult question to answer.

The largest shareholder in a typical large publically traded company holds just a tiny fraction of the equity in the company. A 5% stake in Ford or IBM is worth billions of dollars, but isn't even close to a position of institutional power. So even the biggest institutional investors typically have very little control over the companies they invest in. The are two alternatives to this: 1) Institutional investors could concentrate their holdings in just a few companies, thereby gaining real leverage over those companies; 2) Groups of institutional investors could pool their resources and coordinate their shareholder activism. Altenerate #1 would be disasterous for most investors. What's worse: having the CEO of a company that represents .2% of your retirement pay himself .001% of that company's value in exec comp (500 times over), or having your retirement invested in 10 companies rather than 500? The former results in a slow drain on your assets. The latter a potentially catastrophic increase in your risk exposure.

Alternative #2 seems slightly more attractive, but has at least two problems. First, the typical company holding accounts for a tiny percentage of a typical institutional investor's total assets (sort of the flipside of the phenomenon above). It is costly for institutional investors to try to discipline their holdings. Nagging 500 (or more) companies about their compensation policies would result in huge administrative costs to shareholders. Second, the different institutional investors holding stock in a typical public company are themselves competitors in the marketplace. Fidelty competes with T. Rowe competes with Janus, etc. Its generally a bad idea to ask competitors to "cooperate" for the "public good." I myself can't think of any way for big institutional investors to line their own pockets in the name of "good corporate governance," but then again, I don't have years to think about it a a potential payout of hundreds of millions of dollars if I can find a way.

The LBO is of course an excellent vehicle for disciplining public companies. An LBO typically creates a company where the executives get wildly rich if they indeed deliver outstanding value for the shareholders, but where they get nothing, and in many cases lose a significant chunk of their own net worth, if they fail to deliver such value. Of course, there are tremendously onerous restrictions on the LBO form of corporate governance, thanks largely to laws passed in the wake of the late 1980s LBO boom.

Those laws were of course originally conceived of by corporate executives who didn't much like the idea of being forced to perform for their daily bread, but were pushed through on a wave of mis-guided lefty populist rage over "corporate raiders." This does not make me especially optimistic about the ability of the current round of lefty populist rage over executive comp to improve things for small investors.

Given that a company only has one CEO, if the company is making tens of billions of dollars per year, the compensation to the CEO, even if it is quite lavish, is only going to soak up a small proportion of that revenue. If the CEO is doing a good job, it's hard to say that reducing his or her salary will allow for a substantially greater dividend to stockholders or better long-term prospects for the company. If the CEO is doing a bad job, he or she should be replaced, not docked in salary.

As a citizen and taxpayer, I am all for getting the eight-figure-income crowd to pony up a fair proportion of their income to the government. As a stockholder, I'm not sure I should care very much about CEO compensation as a Bad Thing in and of itself.

Another angle is that the people who manage funds are often directors themselves (and get paid mighty handsomely for it), and/or they want to move in the same circles as the corporate chieftains.

An example I never understood was John Biggs at TIAA-CREF. Their top officials during Biggs's tenure beat back repeated votes to get them to open up their own internal processes and to get them to be more publicly active about the internal processes of companies they invest in. They always said they could be much more effective if there was no requirement to report any of what they were doing.

If corporate management and directors are a closed circle, we'd have to include fund managers within it. They surely seem to have a strong sense of their own membership in it.

Isn't there a bit of a free rider problem, or something, here? A fund manager raises hell, and if it does any good, all managers invested in the company, and all other shareholders, benefit. No advantage gained relative to other managers. But only the hell-raiser pays the price in terms of alienating management and the board, possibly becoming unwelcome elsewhere, etc.