DRUM BEAT OF REFORM GROWS LOUDER

The Conference Board Commission on Public Trust and Private Enterprise, as part of a wide-ranging corporate reform effort, released its initial recommendations last week for dealing with the abuse and overall unfairness of American executive compensation practices.

The 12-member commission includes Paul Volcker, former Federal Reserve Chairman; Warren Rudman, former U.S. Senator; Arthur Levitt Jr., former Chairman of the Securities and Exchange Commission; and Andrew Grove, chairman of Intel. It delivered a broadly defined yet damning first installment of what will be a three-part study on “the widespread abuses which led to recent corporate scandals and declining public trust in companies, their leaders and the American capital markets.” Reports on corporate governance as well as auditing and accounting will follow soon.

“Of the three [topics], there was a real sense that compensation very much had tipped the balance in the long-term decline of some companies,” said Carolyn Kay Brancato, director of the commission. “We were extremely concerned — enough to attack this first.”

The committee recommendations included the establishment and strengthening of independent compensation committees, more performance-based compensation, the expensing of fixed-price stock options, more transparent and conspicuous disclosure of the effects options have on earnings per share, and advanced notice by senior executives of their intent to sell stock. The commission also recommended that key executives should hold a significant amount of their corporations' stock.

“These are the types of changes that will help create a system that is more market-driven and isn't hidden,” said John Challenger, CEO of Challenger, Gray and Christmas, an international outplacement firm.

However, change could take time and unfortunately may depend on the emergence of a strong corporate conscience.

“You can't legislate this,” Brancato said. “We're hoping that through ‘moral-suasion’ we can get companies to voluntarily adopt them so they get embedded in corporate culture.”

While the recommendations apply to the entire business community, telecom has provided more than its fair share of what Brancato calls egregious abusers.

So far, there is a distinction between the likes of WorldCom's Bernard Ebbers and other telecom executives whose compensation may seem excessive to some people but does not constitute egregious abuse (see figure).

COMPENSATION FOR TOP TELECOM CEOs IN 2001
Salary/bonus	Long-term incentive compensation	Options, stock appreciation rights (SARs)*	Number of options and SARs granted
Ivan Seidenberg, Verizon
$3.9 million	$6.2 million	$8.7 million	784,900
Ed Whitacre, SBC
$5.9 million	$4.2 million	$25.9 million	142,000
Joe Nacchio, Qwest**
$2.7 million	$24.4 million	$114.6 million	7.3 million
Duane Ackerman, BellSouth
$3 million	$0	$27.2 million	631,083
William Esrey, Sprint ***
$1.3 million	0	$54 million	4.8 million
C. Michael Armstrong, AT&T
$4 million	$4.8 million	$0	1.1 million
Bernard Ebbers, WorldCom**
$1 million	0	$12.2 million	1.2 million
*Combined value of exercised and unexercised in-the-money options; may include options granted prior to 2001. **Data not available for current CEO. ***Sprint FON and PCS combined.
Source: SEC documents

“I don't think companies that somehow ‘accidentally misstated’ billions of dollars as profit should be compared to the thousands of companies that are trying to do a good job within a crazy, stock-based system,” said Bob Otis, managing director of Atlantic Research Technologies, an executive recruitment firm.

But even for the good guys, in a capital-constrained environment where layoffs and bankruptcy are accepted, perception is everything and compensation packages provide a big target for those seeking justice.

“Companies are driven by shareholders looking to keep their costs down in every area. There is just no reason executive compensation should be exempted from that,” Challenger said.

The primary source of executive compensation over the last decade has been stock options. Ten years ago, options accounted for only 27% of median CEO compensation. Today, they account for 60%, according to S&P data cited by the commission. The issuance of large numbers of undervalued stock options entice chief executives to manage their businesses for short-term stock price gains without considering the long-term health of a company, according to compensation experts.

One recommendation supported by most of the commission is that fixed-price options should be expensed in order to create a level playing field. Although telecom execs have not publicly committed to expensing options, Verizon said in a statement last week, “[We] would have no problem expensing options if the Accounting Standards Board created a method for expensing options that applied to all companies.”

The recommendation on stock options reform was not unanimous within the commission, though. Like many in the high-tech community, Grove dissented, saying shareholders should be responsible for preventing the excess dilution of value that can occur with the use of options. Volcker discouraged the use of fixed-price stock options altogether.

Analysts also argue that compensation based too much on short-term stock performance is detrimental to telecom's biggest issues: stifled competition and lackluster infrastructure investment.

However, “for what's left of the competitive telecom sector, [expensing options] is going to have a [negative] impact,” said Vic Grover, senior analyst for Kaufman Bros. Namely, the practice could affect smaller companies' ability to attract good talent.

“It will be harder for companies to compete,” said Phil Simshauser, vice president of the Center for Executive Options at Drake Beam Morin, specialists in executive transition. “One of the costs of expensing options is that they are visible, so there will be a lot of people who won't do that anymore.”

That is especially true for technology start-ups that have historically used options in lieu of cash, said Tavis McCourt, senior telecom analyst with Morgan Keegan & Co.

Otis said expensing options is a double-edged sword for start-ups. “It will have an effect on the formation of thousands of start-ups, but it will [also] put a brake on the formation of insubstantial gimmicky companies that should not be taking capital away from companies that actually have something to contribute.” he said.

In addition to stifling competition, the short-term strategies of some executives who opt to maximize their options could affect innovation and investment.

“If we want to continue to see growth and innovation in this country, we have to provide incentives for people who take chances or create new products and new ideas,” Challenger said. According to The Conference Board, short-term strategies prohibit that.

But can CEOs be blamed for shortsightedness when, according to DBM, the average tenure for an American CEO is about three years? Can we blame CEOs for demanding contracts that guarantee a payout when they are three times more likely to get fired than their counterparts in 1985? Perhaps not, but we can blame a system in which, according to DBM, “CEOs can expect a diminishing likelihood that they will be able to institute meaningful changes during their brief stay at the top.”

And we can blame a system that doesn't provide clear and transparent benchmarks on incentive targets for CEOs.

“Ultimately, the board has to evaluate the CEO,” said Shumanta Ray, analyst with the Communications Workers of America.