Who to Blame for the Financial Mess? The Boards of Directors.

By Nell Minow
Special to CNN

Nell Minow is editor and chair of The Corporate Library, an independent research company specializing in corporate governance. Minow was named one of the 20 most influential people in corporate governance by Directorship magazine in 2007 and “the queen of good corporate governance” by BusinessWeek Online in 2003. She has written more than 200 articles and co-written three books. Since 1995, Minow has also written “Movie Mom,” an online parents’ guide to “media, culture and values.”

As big Wall Street firms topple like dominoes, there is plenty of blame to go around.

Failure this broad and deep takes a village, and regulators, lawyers, compensation consultants, auditors, executives, shareholders, and the press all played a part. But the people who are most responsible for the massive meltdowns of these institutions are the boards of directors.

Their sole responsibility is to act as fiduciaries for the shareholders in managing risk. They not only failed to perform this task but indeed, in their approval of outrageous pay plans with perverse incentives, they all but guaranteed the current disaster.

I am a capitalist. I love it when executives earn boatloads of money. But it infuriates me when they get it without earning it.

If the executives’ compensation is tied to the volume of business rather than the quality of business, we should expect dealmakers to be more attentive to the number of transactions than the value they create. This is the basis for much of the sub-prime mess, whose collateral damage is taking down the biggest firms on Wall Street.

At Merrill Lynch, former CEO Stanley O’Neal received total compensation of more than $91 million for 2006, according to The Corporate Library’s calculations. He was given that package based on performance numbers that came out before nearly $23 billion in write-downs by the company.

O’Neal received more than $160 million in stock and retirement benefits while shareholders lost more than 41 percent of their investment value over the year. Three executives brought in to Merrill less than a year ago will share a $200 million payment as they turn over the company to Bank of America in a last-minute deal to help it survive.

American International Group (AIG) replaced CEO Martin Sullivan after the company posted losses for two consecutive quarters totaling $13 billion. Sullivan’s contract entitled him to about $68 million. His replacement, a board member who served as CEO for three months before the company was taken over by the government, will get as much as $7 million.

The boards of directors approved pay that was completely disconnected to performance. This, after all, is the world of the ultimate oxymoron: the “guaranteed bonus.” So we should not be surprised that executives took the money and ran.

Fewer than 13 percent of public companies have claw-back policies requiring executives to return bonuses based on inflated numbers. All of the incentives are for them to inflate the numbers, take the money, and run.

And that is why companies whose names used to be synonymous with stability and trustworthiness will live on through history and business school case studies as discredited, greedy and corrupt.

The people who insisted that government regulation interfered with the perfect efficiency of the markets are now getting bailed out by taxpayers with some walloping welfare checks.

I just hope that this time the government does a better job of protecting itself than it did with its bail-out of Chrysler almost 30 years ago and this time insists on a piece of the upside rather than a fixed repayment. If the government is going to run a business, it has to act like a business and make sure its interests are aligned with the executives.

Despite the post-Enron adoption of the most extensive protections since the New Deal, a survey released this week by Kroll and the Economist Intelligence Unit found that corporate fraud rose 22 percent since last year.

The option back-dating and sub-prime messes show that even the post-Enron Sarbanes-Oxley reform law and expanded enforcement and oversight cannot eliminate the severest threats to our markets and our economy.

This proves that there are limits to structural solutions. Ultimately, markets are smarter and more efficient than regulation. What the government needs to do now is insist on removing obstacles to the efficient operation of market oversight.

Shareholders must be able to replace directors who make bad decisions and they should have a non-binding “say on pay” vote on executive compensation as they do in the UK and several other countries.

Our current system of executive compensation does not tie pay to performance, it does not provide an effective incentive to create long-term shareholder value, and it does not meet any possible market test.

Executive compensation must be looked at as any other asset allocation. The return on investment for the expenditures on CEO pay is by any measure inadequate.

Some have argued that the amounts at issue are so small in proportion to the assets being managed that they do not have any material impact. On the contrary, the CEO compensation in America’s public companies is a leading indicator of serious problems — and one reason my firm has consistently given most financial services companies “high-risk” ratings.

And it is more than a symptom of the pervasive problem that is toppling our most respected financial services companies. It is a perversion of the market that imposes enormous and growing costs on America’s working families — as shareholders, customers, employees, and members of the community.

These outrageous pay packages juxtaposed with losses in share value and jobs diminishes our credibility and increases our cost of capital. In today’s global economy this is an expense we clearly can no longer afford.

The opinions expressed in this commentary are solely those of the writer.

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