The Best Defence

The Best Defence

Last week, I argued that shareholders are deluded if they think that boards, company auditors, company lawyers and regulators can collectively stop ill-intentioned executives from getting unjustifiably high compensation. There are no laws or audit rules against greed, even naked greed. Boards could in theory curtail greed, but any wily CEO who puts his or her mind to it can make sure that the board doesn’t resist the value extraction. And clever, greedy executives can come up with all sorts of clever value-extraction mechanisms, like personal non-compete payments, to facilitate their wealth accumulation.

My argument begs the question, What, if anything, can or should be done to protect shareholders from genuinely ill-intentioned public company executives? Should we enact stronger laws that would protect against executive greed? I don’t think so. Not because I am against securities regulation; I just think an attempt to legislate against greed would produce a cure that is worse than the disease. Consider two recent attempts and their results. First, in 1993, the U.S. Congress passed a bill making any CEO compensation over $1 million non-deductible for corporate income tax purposes. The result: the virtual explosion of alternative compensation methods, including the massive ramp-up of stock option grants that helped CEOs earn more than ever before. Then, in both the U.S. and then Canada, securities regulators forced the disclosure of the total compensation of each corporation’s five highest paid employees, in order to shine light on and create embarrassment around excess. The result: compensation consultants suddenly had perfect information pertaining to executive salaries at other corporations, and used the data to argue for higher compensation levels for their clients’ executives. At the corporate Lake Wobegon, everybody needed to be above average, so the 50th percentile in executive compensation kept going up and up.

Basically, I can’t think of a single regulatory change that would have a net beneficial effect on the challenge of executive greed, and I can come up with lots that would be decidedly negative—like Sarbanes-Oxley, but don’t get me started. The only people who can protect shareholders are shareholders themselves. The first step they need to take is to internalize the reality that they are not going to be protected from such executives; the delusion of protection is their enemy.

The second step: shareholders need to band together to fight excessive executive compensation. Ten million dollars in excess compensation to a CEO might well cost an individual shareholder a couple of bucks, so the wily CEO will invest more in extraction than the individual shareholder will in prevention. This is why I am so excited about the Canadian Coalition for Good Governance (C2G2). It’s North America’s first effort at shareholder solidarity. Principal founders Claude Lamoureux of the Ontario Teachers’ Pension Plan and Stephen Jarislowsky of investment manager Jarislowsky Fraser Limited, plus C2G2 managing director David Beatty are to be lauded for recognizing that shareholders need to tackle the job themselves rather than ask the government to do their job for them, and have amassed 47 institutions with more than $1 trillion in investments behind their efforts. I have high hopes that the C2G2 will be copied elsewhere around the world.

The third thing shareholders need to do is be more discerning about CEOs when choosing to invest. This is probably the trickiest and most subtle task, because shareholders want positive returns on their investments; telling them to look for nice, pleasant CEOs without regard for their performance capacity would be silly indeed. However, they won’t be served well in the long run by CEOs who put their own interests in front of those of shareholders. Shareholders need to look more closely at whether CEO behaviour is oriented toward alignment or misalignment. When a CEO is lured to the company, like Carly Fiorina by Hewlett-Packard and Bob Nardelli by Home Depot, by way of a huge package that pays him or her simply for making the shift—regardless of whether good performance follows—shareholders can infer that the CEO cares much more about personal compensation than the fate of the shareholders. Same goes for when CEOs have compensation formulas that pay handsome rewards even if the company languishes, and the CEOs take the compensation with a shrug of the shoulders, claiming that was their deal. Or when CEOs sell their company stock if they have doubts about the future of the enterprise—i.e., betting against your own team. The same thing done by a professional athlete would get the player thrown out of the sport for life.

In the end, shaking off the delusion that someone is going to take care of them, banding together for leverage and showing vigilance in judging the behaviour of CEOs are far better bets for shareholders than looking to boards, lawyers, auditors and regulators—even if it entails a little more work.