[Senate Hearing 108-893]
[From the U.S. Government Publishing Office]
S. Hrg. 108-893
CEO COMPENSATION IN THE POST-ENRON ERA
=======================================================================
HEARING
before the
COMMITTEE ON COMMERCE,
SCIENCE, AND TRANSPORTATION
UNITED STATES SENATE
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
MAY 20, 2003
__________
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Transportation
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SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
JOHN McCAIN, Arizona, Chairman
TED STEVENS, Alaska ERNEST F. HOLLINGS, South Carolina
CONRAD BURNS, Montana DANIEL K. INOUYE, Hawaii
TRENT LOTT, Mississippi JOHN D. ROCKEFELLER IV, West
KAY BAILEY HUTCHISON, Texas Virginia
OLYMPIA J. SNOWE, Maine JOHN F. KERRY, Massachusetts
SAM BROWNBACK, Kansas JOHN B. BREAUX, Louisiana
GORDON SMITH, Oregon BYRON L. DORGAN, North Dakota
PETER G. FITZGERALD, Illinois RON WYDEN, Oregon
JOHN ENSIGN, Nevada BARBARA BOXER, California
GEORGE ALLEN, Virginia BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire MARIA CANTWELL, Washington
FRANK LAUTENBERG, New Jersey
Jeanne Bumpus, Republican Staff Director and General Counsel
Robert W. Chamberlin, Republican Chief Counsel
Kevin D. Kayes, Democratic Staff Director and Chief Counsel
Gregg Elias, Democratic General Counsel
C O N T E N T S
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Page
Hearing held on May 20, 2003..................................... 1
Statement of Senator Allen....................................... 3
Articles:
REVIEW & OUTLOOK--Big Labor's Enron, dated August 20, 2002,
Wall Street Journal........................................ 37
Teachers Union Scandal in the Nation's Capital, dated March
2003, Labor Watch.......................................... 39
DC Teachers' Union Plagued With Scandal, dated January 17,
2003, Fox News............................................. 45
Statement of Senator Breaux...................................... 2
Statement of Senator Lautenberg.................................. 50
Prepared statement........................................... 52
Statement of Senator McCain...................................... 1
Witnesses
Bachelder, Joseph E., Founder and Senior Partner, The Bachelder
Firm........................................................... 20
Prepared statement........................................... 22
Clapman, Peter C., Senior Vice President and Chief Counsel,
Corporate Governance, TIAA-CREF................................ 4
Prepared statement........................................... 6
Hall, Brian J., Associate Professor, Harvard Business School..... 8
Prepared statement........................................... 11
Harrigan, Sean, President, Board of Administration, California
Public
Employees' Retirement System................................... 24
Prepared statement........................................... 27
Silvers, Damon A., Associate General Counsel, American Federation
of Labor and Congress of Industrial Organizations (AFL-CIO).... 15
Prepared statement........................................... 17
CEO COMPENSATION IN THE POST-ENRON ERA
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TUESDAY, MAY 20, 2003
U.S. Senate,
Committee on Commerce, Science, and Transportation,
Washington, DC.
The Committee met, pursuant to notice, at 9:33 a.m. in room
SR-253, Russell Senate Office Building, Hon. John McCain,
Chairman of the Committee, presiding.
OPENING STATEMENT OF HON. JOHN McCAIN,
U.S. SENATOR FROM ARIZONA
The Chairman. Good morning. Thank you all for joining us
today for this hearing on CEO compensation. Over the past three
years, shareholders have lost an astonishing $7 trillion in
stock value. Meanwhile, corporate profits have plummeted
hundreds of companies have gone bankrupt, and shareholders were
devastated by these circumstances, but they were not the only
ones impacted. Since the year 2000, approximately 3 million
Americans have lost their jobs and our unemployment rate is at
the highest it has been in a decade.
Despite these dismal economic statistics, the median pay of
CEOs has continued to increase and we continue to see many
examples of enormous pay packages awarded by boards to top
executives. For example, according to media reports one CEO
last year made over $100 million in total compensation despite
the fact that his company was the subject of multiple Federal
probes. Purportedly, most of his compensation was from stock
sales made prior to the Federal investigations.
Another CEO was reportedly paid a million-dollar bonus and
granted millions of dollars worth of free stock in 2002, the
same year that his company lost over a billion dollars,
eliminated thousands of jobs, and saw its stock price collapse.
That CEO later announced that he was voluntarily reducing his
compensation significantly, but only after considerable
pressure from the public and from his company's employees.
Another CEO reportedly made hundreds of millions of dollars
from a stock option exercise and sale in 2001. Shortly
thereafter, the company made a downward revision in its
financial forecasts and the stock sank sharply.
There are many other examples of similar CEO compensation
packages and practices. There appears to be a disconnect
between CEO pay and performance at many of America's
corporations. Warren Buffett and many others have pointed to
excessive CEO compensation as a crucial problem for corporate
America. Indeed, Mr. Buffett has called executive compensation
``the acid test for corporate reform.''
So what do we do about concerns over excessive CEO
compensation and the popular perception that the corporate
system seems to have put the interests of top managers above
those of shareholders employees. My hope is that this hearing
will begin to answer these questions.
I should point out that some seem to believe that the
question of CEO pay is one best left to boards and executives
negotiating behind closed doors. We invited several CEOs to
testify at this hearing. Not one accepted the invitation to
appear today and join us in this important discussion. Private
discussions may have been appropriate at one time, but today,
with over half of American households invested in the stock
market, CEO compensation and other issues of corporate
governance have become crucial matters of public concern. They
are issues that must see the light of day to help inform
individual investors about the very companies that they count
on to fund their children's education and their retirement.
Discussing CEO compensation and other matters of corporate
reform is much more than fair game for public debate. It is an
essential step towards empowering shareholders and returning
investor confidence to our equity markets, which are a critical
component of our vibrant system of capitalism, in which I
strongly believe.
I look forward to an informative hearing this morning and
again thank the witnesses for appearing today. Senator Breaux.
STATEMENT OF HON. JOHN B. BREAUX,
U.S. SENATOR FROM LOUISIANA
Senator Breaux. Thank you very much, Mr. Chairman. It is
really an appropriate and timely hearing, really very
interesting, too, about what is the Government's responsibility
to the private sector when they decide to hire people to work
for them? Is it the Government's responsibility to say that
something is out of kilter or is it the shareholders who own
the company who are responsible for running it to wave a red
flag and say: Wait a minute, something is wrong here.
It seems to me that there is something wrong when sometimes
you see corporations which are losing money increasing the
compensation packages for the people who run the company. It is
really sort of like Congress passing a tax cut when we have a
$400 billion deficit. It does not make a lot of sense in the
private sector. We do the same thing sometimes in the Congress
with how we manage the country.
But I think that we argued last week on the floor of the
Senate about attorney fees and there was an effort for Congress
to limit privately negotiated attorney fees between plaintiffs
and defendants, and some of our colleagues said: Well, they are
getting too much. The response is that this is something that
was negotiated and approved by the courts.
The argument here is that compensation packages are
negotiated between employers and employees and sort of approved
by the shareholders. Then it is interesting to find out, what
is the role of the Congress. I am very open to trying to find
out the extent of the problem and potential solutions to it,
and I think this hearing can be very helpful.
Thank you.
The Chairman. Thank you, Senator Breaux.
Senator Allen.
STATEMENT OF HON. GEORGE ALLEN,
U.S. SENATOR FROM VIRGINIA
Senator Allen. Thank you, Mr. Chairman, and I thank our
witnesses for coming today and look forward to their testimony.
One aspect of this debate that I see that might arise has
to do with stock options and whether or not stock options ought
to be expensed. I would share with my colleagues, Senator
McCain and Senator Breaux, that on May 8th Senators Boxer and
Cantwell and I joined Senator Enzi for a two-hour roundtable
discussion with CFOs, CEOs, academics, analysts, and also Bob
Herz, who is Chairman of the Financial Accounting Standards
Board, on the issue of whether we should mandate the expensing
of stock options.
I came away from that discussion feeling, number one, that
the chairman already had made up his decision that they are
going to expense stock options. If he were a judge, I think
people would ask him to recuse himself for having already made
a determination and only wanted to get on to the sentencing
phase, already having determined what was going to happen.
I also came away from that hearing, not only with that
concern, but the reality that broad-based stock options are
good. I think it is good for employees in small businesses to
be able, in start-up companies, to be able to have stock
options. I think it is good that employees care about the
future of a company. It helps companies attract officers,
directors, and also motivate and keep employees.
So to the extent we get into that issue, I am one who
thinks that, first of all, there is no proven value that can be
assigned to, accurate value for stock options, and I will be
pleased to hear the various comments of individuals, having
read some of their testimony and some of the statements.
When you get into executive compensation, it is one thing
to be concerned about executive compensation, but in the effort
to curtail executive compensation do not harm the ability of
small start-up companies, technology companies and others to
attract officers, directors, and most importantly, do not take
away this opportunity for employees to own a part of the
company.
So I look forward to the testimony and thank you for the
hearing, Mr. Chairman.
The Chairman. Thank you, sir.
Our witnesses are: Mr. Peter Clapman, Senior Vice President
and Chief Counsel for Corporate Governance, TIAA-CREF; Brian J.
Hall, Associate Professor at the Harvard Business School; Damon
Silvers, Associate General Counsel, American Federation of
Labor and Congress of Industrial Organizations; Joseph E.
Bachelder, Founder and Senior Partner of the Bachelder Fund--is
that the proper pronunciation?
Mr. Bachelder. The Bachelder Firm.
The Chairman. Bachelder Firm. And Mr. Sean Harrigan,
President of the Board of Administration of CalPERS.
We will begin with you, Mr. Clapman, and welcome to all the
witnesses.
STATEMENT OF PETER C. CLAPMAN, SENIOR VICE PRESIDENT AND CHIEF
COUNSEL, CORPORATE GOVERNANCE,
TIAA-CREF
Mr. Clapman. Thank you very much and good morning. Mr.
Chairman and Members of the Committee: I am pleased to have
this opportunity to express TIAA-CREF's views on corporation
governance issues here today, particularly concerning executive
compensation practices in the United States. My name is Peter
Clapman. I am Senior Vice President and Chief Counsel for
Corporate Governance at TIAA-CREF, a large financial services
company with approximately $262 billion in assets under
management serving nearly 3 million education and research
employees at 15,000 institutions. TIAA-CREF is widely
recognized as a major voice for shareholder rights and improved
corporate governance.
Today I will focus on three key issues: TIAA-CREF's
approach to corporate governance, problems within the current
system for determining executive compensation, and suggested
improvements.
For many years now, TIAA-CREF has had a proactive corporate
governance program. We identify and focus on timely critical
issues affecting all shareholders, be they individual investors
or large institutional investors like TIAA-CREF. Quiet
diplomacy is TIAA-CREF's preferred course of action in
addressing corporate governance concerns at portfolio
companies. In dialoguing with portfolio company managements, we
discuss not only the problems but also potential remedies.
However, when the dialogue is unproductive TIAA-CREF is
prepared to file shareholder resolutions and in fact we have
received high votes in favor of our positions, often a
substantial majority of the issues voted--of the shares voted.
TIAA-CREF has been a strong advocate for increased director
independence, greater board accountability, and much higher
standards of boardroom vitality and effectiveness. This means
that directors must have the requisite courage and tough-
mindedness to challenge management and to say no when
necessary, and that brings us directly to the issue of
executive compensation and the need for reforms.
TIAA-CREF has long believed that executive compensation is
in a very real sense a window into the company's broader
corporate governance character. Executive compensation is an
important barometer of corporate conduct. Employees, especially
highly paid individuals, respond to the incentives and
motivations given or allowed by the system.
For example, the current system provides great incentives
focusing on the current short-term share price of a company. Is
it any wonder that some executives have abused the system by
cashing out short-term gains from options while at the same
time encouraging or fostering accounting aggressiveness or even
fraud to keep earnings high enough to support the high share
prices at which they cashed out? Regrettably, that is the state
of affairs today for executive compensation at too many
companies.
Currently, the typical option is fixed price and wide. Not
only do the current accounting rules not impose expensing for
such options, but, even worse, they require expensing for
better forms of equity compensation such as performance-based
options or restricted stock. All of the compensation
consultants we have heard from say this accounting discrepancy
is responsible for crowding out these better forms of
compensation.
This year TIAA-CREF has filed shareholder resolutions
calling for performance-based options with a substantial
holding period for holding stock after exercise. This would
produce a better alignment between management and shareholders.
Now I will go to our top priorities for executive
compensation reforms. First, we need better performance from
board compensation committees. Under new stock exchange rules,
only independent directors may serve on compensation
committees. This is a good first step, but not a panacea.
Directors must act in a truly independent fashion and be
sufficiently educated to understand what executive compensation
is all about and, as I said earlier, have the tough-mindedness
to say no on occasion.
Second, it is crucial for independent directors to retain
truly independent, outside consultants rather than rely on
consultants selected by management. Consultants will promote
the interests of whoever hires and pays them. Compensation
committees must take on that role rather than management.
Third, compensation committees must reverse the ratcheting
effect of seeking to position CEO compensation levels between
the 50th and 75th percentiles, a statistical impossibility if
all do it.
Fourth, we must strongly urge the system to stop rewarding
failure. The public is outraged by excessive severance payments
to failed CEOs. Individual shareholders and large institutional
investors alike have registered their anger by supporting
shareholder resolutions urging shareholder approval of
compensation payments that exceed reasonable performance-based
parameters.
Fifth, we believe that Congress must take care not to
politicize this issue and it should permit FASB to deal with
this issue on its intrinsic message--merits.
In the final analysis, shareholders have been more than
forebearing, even in the face of stock market losses and
compensation abuses. However, shareholders want future
management rewards to be based on real management performance,
not short-term share prices. Shareholders want management to
hold real stock as opposed to primarily stock options and thus
bar the down side risk that shareholders bear, and we cannot
let them down.
I have given you a brief overview of TIAA-CREF's approach
to corporate governance and discussed some of the issues at the
root of most of the executive compensation excesses. Finally, I
have suggested some remedies that we hope will lead to improved
corporate governance best practices and the restoration of
investor trust and confidence. We assure you that TIAA-CREF
will continue to press for these reforms.
Thank you for giving me the opportunity to comment on these
matters and I will be pleased to answer any questions you might
have as to my testimony, including some that have been alluded
to earlier by some of the Senators. Thank you.
[The prepared statement of Mr. Clapman follows:]
Prepared Statement of Peter C. Clapman, Senior Vice President and Chief
Counsel, Corporate Governance, TIAA-CREF
I am pleased to appear before the Senate Committee on Commerce,
Science, and Transportation to discuss issues of corporate governance,
particularly as they apply to current concerns about executive
compensation practices in the United States. I will focus on TIAA-
CREF's philosophy and approach to corporate governance; executive
compensation principles; and suggested ways to achieve ``best
practices'' for corporate governance.
TIAA-CREF Philosophy and Approach
In my capacity as Senior Vice President & Chief Counsel, Corporate
Governance, I manage a staff of 6 professionals who are dedicated to
TIAA-CREF's efforts on behalf of shareholders. TIAA-CREF has been a
leader in trying to improve corporate governance, both domestically and
globally for over 20 years. Our organization is a full-service
financial services provider with approximately $262 billion in assets
under management. Our main asset base goes to support the pensions of
nearly 3 million individuals at nearly 15,000 institutions in the
educational and research field. As such, TIAA-CREF is uniquely
independent compared with other large institutional investors because
it works solely for the benefit of its participants.
TIAA-CREF's broad focus is to seek higher favorable investment
returns for the millions of stakeholders in the same companies in which
it invests. The TIAA-CREF investment strategy is long-term buy and
hold--a significant percentage is quantitatively managed or indexed,
and for that reason TIAA-CREF does not ``vote with its feet''. In
addition to its public activities with individual portfolio companies,
TIAA-CREF works at the policy level with groups such as the Financial
Accounting Standards Board (FASB), New York Stock Exchange (NYSE),
National Association of Securities Dealers Automated Quotations
(NASDAQ), Securities and Exchange Commission (SEC) and internationally
at the International Accounting Standards Board (IASB).
Our corporate governance program seeks to enhance our investment
operations by taking on issues that further the long-term interests of
shareholders. Although TIAA-CREF is a large shareholder, the interests
it seeks to advance are those of concern to all long-term investors,
both large and small.
TIAA-CREF has an active corporate governance program that
identifies companies where we see problem areas. We enter into a
dialogue with these companies in an attempt to correct the situation.
Although ``quiet diplomacy'' is our preferred course, we are prepared
to file shareholder resolutions on a number of issues and, in fact,
have received high votes in favor of our positions, often a substantial
majority among all votes cast by shareholders.
We have been strong advocates for more director independence, board
accountability, and much higher standards of boardroom vitality. As
shareholders we cannot micromanage our portfolio companies, but must
rely instead on the directors performing in practice what is their duty
in legal theory--to be the fiduciaries for the long-term shareholders.
In actual practice, this means that the directors must be willing to
oversee and monitor the senior managements of companies, and if
necessary, be willing to say ``no'' when appropriate.
Executive Compensation Principles
This brings us directly to the current problems with executive
compensation in the United States. We have long believed that executive
compensation in a real sense is a ``window'' into broader corporate
governance issues at a company. If the directors do not get executive
compensation right, they probably will fail shareholders in other areas
as well. Disclosure rules applicable to executive compensation are not
fully adequate in many respects. For example, disclosure is obscure for
retirement benefits and executive perquisites. Nevertheless,
shareholders are able to glean through executive compensation to make
reasonable assumptions as to how the directors are doing--or not
doing--their job.
Executive compensation has its own importance in other ways.
Individuals respond to the incentives and motivations given by the
system. If those incentives and motivations are the wrong kind, we
should not be surprised to find that wrong actions are the result.
For example, if the current system provides great incentives for
focusing on the current short-term share price of a company, is it any
wonder that some executives abused the system by cashing out short term
gains from options while at the same time encouraging or fostering
accounting aggressiveness or even fraud to keep earnings high enough to
support the high share prices at which they cashed out?
Regrettably, that today is the state of affairs for executive
compensation at too many companies. The typical option today is fixed-
price, and why? The current accounting rules not only impose no cost of
compensation for such options, but even worse require expensing for
other forms of equity compensation such as performance-based options or
restricted stock. We have heard from all of the compensation
consultants that this accounting discrepancy is responsible for
crowding out those forms of compensation that would be better for
shareholders--more acceptable to shareholders--solely because of the
accounting rules.
TIAA-CREF filed shareholder resolutions this year challenging these
practices, calling for performance-based options with a substantial
holding period for holding stock after exercising the options. The main
point argued by proponents of equity compensation is that such
compensation will produce alignment between management and
shareholders. The overemphasis on options, however, and our experience
under that approach, is that the alignment for option holders is only
with other option holders.
Top Priorities for Executive Compensation Reform
So what executive compensation reforms are needed, and where will
they come from? First, we will need better performance from
compensation committees. Under the new NYSE rules only independent
directors may serve on compensation committees. This is a good first
step, but not a panacea. The fact that directors are nominally
independent does not necessarily equate to their acting independently.
Will directors become more educated as to what compensation is all
about--and abide fully by the intent of the new accounting rules?
Secondly, will directors retain truly independent consultants? In
the past, all too often directors relied on the consultants selected by
incumbent management. This has got to change since the entity that
hires and pays the consultant is the entity that will motivate the
consultant's advice. That entity has got to become the compensation
committee and not the management.
Third, what objective is being sought in executive compensation? We
see the ratcheting effect of every company seeking to position its CEO
compensation between the 50-75th percentiles, a statistical
impossibility.
Fourth, we must strongly encourage the system to stop rewarding
failure. The public has seen and is outraged by the high levels of
severance payments to failed CEOs. Such executives have also received
service credit for time not served, a semantic twist of words that
convey total cynicism for the purpose of the grant. This season we have
seen the response by shareholders as they have supported shareholder
proposals attempting to introduce some rationality into this process,
requiring shareholder approval of severance payments that exceed
reasonable formulas. The question again is how boards could have given
such contracts if they were truly representing the interests of
shareholders.
Fifth, we need to better link compensation with long-term
performance goals. There are two problem areas with the current system:
(1) reliance on fixed-price options and (2) absence of substantial
holding periods for stock after exercise of options. In analyzing the
situation recently, the Conference Board identified one of the current
barriers to proper management of these issues--the absence of
accounting neutrality regarding treatment of different forms of equity
compensation. Until the properly authorized expert independent
organization, FASB, acts to correct this problem, many companies will
hide behind differing earnings treatments and disdain performance-based
options even while recognizing that they are the better approach to
executive compensation. Congress should be careful not to politicize
this issue and should permit FASB to take on this issue on its
intrinsic merits. The recent support of the FASB by SEC Chairman
Donaldson is encouraging as to the view at the SEC.
In the final analysis, shareholders have been more than reasonable
on this issue. Despite large stock losses, despite revelations about
executive compensation excess, despite reasonable concerns about board
performance, shareholders have been patient and understanding.
Shareholders are willing to support improvements in the process of
determining executive compensation, believing that the excesses will be
squeezed out if the process improves.
The need now is to make the expectations of the new stock exchange
rules work. The culture in the boardroom must undergo change so that
the directors are truly accountable to the shareholders and not the
management. With that change in board culture, the right accounting
changes, and the generally improved corporate governance practices,
hopefully the excesses in the system can be corrected. Congress needs
to strongly support these reforms to restore investor and public
confidence in the system.
The Chairman. Thank you very much.
Mr. Hall, welcome.
STATEMENT OF BRIAN J. HALL, ASSOCIATE PROFESSOR, HARVARD
BUSINESS SCHOOL
Mr. Hall. Thank you. Chairman McCain and distinguished
members of the Committee: Thank you for inviting me to provide
testimony on this important topic.
In the recent two decades we have seen dramatic changes in
the way that American CEOs are paid. There has been about a
sevenfold increase in the inflation-adjusted median level of
CEO pay since 1980, which far outstrips the increases seen by
rank and file workers.
As important, there has been a dramatic shift in the
composition of CEO pay. As recently as 1984, the median option
grant to CEOs of large American companies was zero, which
implies that fewer than half of the CEOs received any option
grants at all. In recent years, option grants have represented
about two-thirds of total CEO pay. Options became the icing on
the cake for CEOs in the mid-1980s. Today the icing has become
the cake.
The option explosion is clearly the central and most
controversial development in CEO compensation. I will therefore
focus most of my testimony on what is good and bad about the
CEO option explosion for the American public. Let us start with
what is good. In the 1970s and early 1980s, American CEOs
received very little equity-based pay and as a result had very
weak ownership stakes in the companies they managed. Although I
am simplifying a bit, their main financial incentive was to
increase the size of their companies in terms of revenues,
assets, and employees, while virtually ignoring the company's
owners.
American CEOs were largely protected from shareholders and
had financial incentives to do something they already enjoyed
doing, making their companies bigger and expanding their
empires. They responded in kind. CEO companies became larger,
but, absent meaningful incentives for top executives to make
decisions consistent with raising shareholder value, there were
essentially zero returns to shareholders on an inflation-
adjusted basis for more than a decade.
The financial incentives facing U.S. executives changed
dramatically following the shareholder rebellion that began in
the 1980s. The increase in takeovers removed the inappropriate
way in which CEOs were insulated from the wishes of company
owners, while appropriately lessening their job security.
Moreover, management buyouts, which virtually always led to
large increases in the ownership stakes for top managers,
increased dramatically and were typically quite successful in
raising efficiency, productivity, and profits.
The use of equity-based pay then began to spread throughout
corporate America and became mainstream following the rise of
institutional investor influence and the subsequent
entrepreneurial wave of the 1990s. Although the move towards
equity-based pay created new problems and abuse, it had many
benefits, the most notable being that top executives, who now
owned significant amounts of stock and options, began to focus
more on creating value for shareholders and society. Many top
executives began to think and act like owners, at least
relative to the period before the option explosion. The
incentives created by ownership are at the core of a well-
functioning market economy and are fundamental to long-run
economic prosperity.
In my view, one of the risks of the recent corporate
scandals is that they may create an excessive backlash against
equity-based pay, even though well-designed equity-based
compensation is the central tool for aligning the incentives of
owners and managers.
Now to what is bad. The problem with the option explosion
is that it has too often led to excess and abuse. In specific
cases, option plans have been poorly designed, leading to
perverse incentives and huge payouts to top executives. But
even for the typical or average CEO, the option explosion may
have indirectly caused total compensation to become excessive.
Now, some argue that, even though there are clearly
specific instances where CEOs seem to have been overpaid, CEO
is not excessive in general. This argument is based on the
logic of efficiency of markets: CEOs are simply getting what
the market will bear. If companies are willing to pay a price
for CEOs, who is to say that the market price is wrong?
Unfortunately, a close examination of the pay process for
CEOs reveals some serious doubts that the CEO labor market is
particularly well-functioning, one which in my view gives
weight to the argument that the overall level of top executive
pay is excessive. The most crucial problem is that boards are
often too weak and too cozy with top executives. CEOs are quite
powerful in most American boardrooms. They typically chair the
board and have a large influence over who is selected on the
board. In such circumstances most directors feel pressure to
please the CEO and one of the ways that they do this is by
providing generous compensation.
Second, the compensation determination process has become
dominated by the use of surveys whereby pay is determined by
benchmarking against other CEOs of comparable size and in
similar industries. The key problem here is that very few
boards want to pay their CEOs below the median of this
distribution, while a very large percentage of boards believe
that their above-average executive should be paid above-average
compensation.
But when boards consistently pay above median levels while
using peer benchmarking to determine the median, the
uncompromising laws of mathematics imply pay ratcheting over
time, and this is precisely what we have observed.
Finally, the dramatic increase in the use of options led to
an upward bias in CEO pay, since many boards perceive options
to be much cheaper than their true economic cost to
shareholders. Indeed, many boards incorrectly view options to
be free or costless.
The false view that options are inexpensive is the result
of three reinforcing factors: First, the current accounting
rules allow companies to treat options as free from an
accounting perspective; second, options require no cash expense
up front; and third, option valuation is inherently complex,
leading many people to refer to option costs in terms of the
number of options, which often seems much smaller than the
expected dollar cost of options. In my view, these three
factors have led to upward biases in CEO pay.
Thus, CEO pay is probably significantly higher than what we
would see in a well-functioning labor market where well-
informed owners spend their own money to attract, retain, and
motivate high-quality executives.
For similar reasons, I have serious doubts that the
specific design of most CEO pay packages is the optimal result
of a well-functioning market. The way in which some top
executives have been able to get huge payouts preceding huge
declines in stock prices represents the most egregious example
of poorly designed equity pay plans.
The solutions to the executive pay problem involve
strengthening shareholder rights and corporate governance while
also requiring companies to appropriately account for all
compensation expenses, including stock options, on their
accounting statements. More generally, solutions that take the
form of improving the underlying problem are much preferable to
trying to micromanage the pay process or pay outcomes through
Federal legislation. Such legislative micromanagement is likely
to be ineffective in solving the problem and may well have
harmful and unintended consequences.
The best example of this is the 1993 rule aimed at curbing
executive pay. The so-called million-dollar rule disallowed
companies from deducting non-performance-related pay above $1
million for corporate tax purposes. At best, these changes were
ineffective. At worst, they distorted pay towards options while
contributing to CEO pay excesses. Indeed, a quick glance at the
pay trend makes it look as if the 1992-93 changes were passed
with the intention of accelerating, not curbing, CEO pay
increases.
There are many specific ways in which boards can better
design packages. For example, in my view aligning CEO
incentives with long-run shareholder value creation would
require longer vesting periods, stronger and more widespread
ownership requirements, and automatic clawback of payouts
following accounting restatements. But such specific changes
are not easily legislated and if these are good ideas and
boards become stronger and more empowered they will happen
naturally.
Finally, one of the important ways in which Congress can
act to curb excesses and distortions to executive pay is to
encourage, rather than to discourage FASB to begin expensing
options. Much of the current debate regarding the expensing of
stock options is about whether expensing will help investors
value companies more accurately. While I agree with many
opponents of option expensing that this will not improve
information flows, this largely misses the key point. The main
problem with the current accounting treatment is that it
distorts the compensation decisions made by boards and
executives. Very few boards are willing to design or even
consider equity pay packages that create an expense on the
income statement when they can give out free options instead.
As a result, boards grant options even though options may not
be the most beneficial form of compensation.
An example that likely illustrates the distortion created
by the current accounting rules involves the infrequent use of
restricted stock. As noted earlier, the main rationale for
paying executives in the form of equity is to create ownership
incentives. But since shareholders hold stock, why do boards
primarily pay executives in options instead of stock? There are
many good reasons to pay in stock instead, but they are rarely
considered.
Despite these advantages, many boards rarely consider stock
because of the current accounting rules. Requiring an expense
for options will level the accounting playing field, leading to
fewer distortions in the way that executives are paid. Combined
with rules that give shareholders more influence in boardrooms
will also curb many of the excesses in pay levels, especially
with regard to many of the large outliers that we have seen.
To summarize, although we must not forget the large
benefits of the option explosion, there are good reasons to
believe that there is an executive pay problem. But the
executive pay problem is best solved by addressing its
underlying causes, governance, and accounting, rather than by
attempting to regulate pay directly.
In addition to improving the accounting, making managers
and boards more accountable to shareholders will make the
executive pay process sounder and less prone to abuse and
excess. Currently, there are a host of mechanisms that
disempower shareholders. Poison pills, staggered boards, and
proxy voting rules serve to weaken the ways in which boards and
managers are held accountable to the company's owners. Although
appropriate changes to governance and accounting rules are best
accomplished through the exchanges, the Delaware courts and
other courts, and regulatory bodies such as the SEC and FASB,
Congressional support of these changes would well serve the
interests of the American public.
I thank you for this opportunity to provide testimony.
[The prepared statement of Mr. Hall follows:]
Prepared Statement of Brian J. Hall, Associate Professor,
Harvard Business School
Chairman McCain, and distinguished Members of the Committee, thank
you for inviting me to provide testimony on the topic of CEO
compensation.
In the recent two decades, we have seen dramatic changes in the way
that American CEOs are paid. Although the press and media have often
sensationalized the issue in ways that misinform the public, there has
been about a 7-fold increase in the inflation-adjusted median level of
CEO pay since 1980, which far outstrips the increases seen by rank-and-
file workers. As important, there has been a dramatic shift in the
composition of CEO pay. As recently as 1984, the median option grant
(valued at the time of grant by standard option pricing models \1\ ) to
CEOs of large American companies was zero--which implies that fewer
than half of the CEOs received any option grant at all. In recent
years, option grants have been (on average) about twice as large as
cash-based pay, representing about two-thirds of total CEO pay. Options
became ``icing on the cake'' for CEOs in the mid 1980s. Today, the
icing has become the cake. \2\
---------------------------------------------------------------------------
\1\ Such as Black-Scholes or binomial models.
\2\ See Figure 1 for details.
---------------------------------------------------------------------------
The option explosion is clearly the central and most controversial
development in CEO compensation. It has dramatically affected the level
of pay, the composition of that pay and, crucially, the incentives that
top executives face to create or destroy value. As a result, I will
focus most of the remainder of my testimony on what is good and bad
about the CEO option explosion for the American public.
Let's start with what is good. In the 1970s and early 1980s,
American CEOs received very little equity-based pay and, as a result,
had a very weak ownership stake in the companies they managed. Although
I am simplifying a bit, their main financial incentive was to increase
the size of their companies (in terms of revenues, assets and
employees) while virtually ignoring the company's owners. American CEOs
were largely protected from shareholders and had financial incentives
to do something they already enjoyed doing--making their companies
bigger and expanding their empires. They responded in kind. U.S.
companies became larger, but absent meaningful incentives for top
executives to make decisions consistent with raising shareholder value,
there were essentially zero returns to shareholders on an inflation-
adjusted basis for more than a decade. \3\
---------------------------------------------------------------------------
\3\ Of course, macroeconomic and other factors also contributed to
the poor performance of U.S. companies at this time. But lack of
meaningful ownership stakes for U.S. executives was likely a major
factor.
---------------------------------------------------------------------------
The financial incentives facing U.S. executives changed
dramatically following the shareholder rebellion that began in the
1980s. The increase in takeovers (and takeover threats) removed the
inappropriate way in which CEOs were insulated from the wishes of
company owners, while appropriately lessening their job security.
Moreover, management buyouts \4\--which virtually always led to large
increases in the ownership stakes for top managers--increased
dramatically and were typically quite successful in raising efficiency,
productivity and company profits. \5\ The use of equity-based pay then
began to spread throughout corporate America, and became mainstream
following the rise of institutional investor influence and the
subsequent entrepreneurial wave of the 1990s. Although the move toward
equity-based pay created new problems and abuse, it has had many
benefits, the most notable being that top executives--who now hold
significant amounts of stock and options in the companies they manage--
began to focus more on creating value for shareholders and society.
Many top executives began to think and act like owners, at least
relative to the period before the option explosion. The incentives
created by ownership are at the core of well-functioning market
economies and are fundamental to long-run economic prosperity and
dynamism. In my view, one of the risks of the recent corporate scandals
is that they may create an excessive backlash against equity-based pay,
even though well-designed equity-based compensation is the central tool
for aligning the incentives of managers and owners.
---------------------------------------------------------------------------
\4\ These are also called leveraged buyouts, since the transactions
are often done with high levels of bank and other debt financing.
\5\ See Palepu (1990) and Kaplan (1989).
---------------------------------------------------------------------------
The problem with the option explosion is that it has too often led
to excess and abuse. In specific cases, option plans have been poorly
designed, leading to perverse incentives and huge payouts to top
executives following (or preceding) poor performance. But even for the
typical (or the median) CEO, the option explosion may have indirectly
caused total compensation to become excessive.
Some argue that CEO pay is not excessive in general, even though
there are clearly specific instances where CEOs seem to have been
overpaid. This view is generally based on the logic of the efficiency
of markets--CEOs are simply getting what the market will bear. If
companies are willing to pay a price for CEOs, who is to say that the
market price is ``wrong''?
Unfortunately, a close examination of the pay process for CEOs
reveals some serious doubts that the CEO labor market is not a
particularly well-functioning one, which, in my view, gives weight to
the argument that the overall level of top executive pay is excessive.
\6\ The most crucial problem is that boards are often too weak and too
cozy with top executives, and as a result, fail to adequately represent
shareholders when negotiating CEO pay packages. CEOs are quite powerful
in most American boardrooms. They typically chair the board and have a
large influence over who is selected to be on the board. In such
circumstances, most directors (and the compensation consultants
advising them, who desire to please their client) feel pressure to
please the CEO and one of the ways that they do this is by providing
generous compensation, even in relatively well-functioning boardrooms.
---------------------------------------------------------------------------
\6\ See Bebchuk, et al. (2002).
---------------------------------------------------------------------------
Second, the compensation determination process has become dominated
by the use of surveys, whereby pay is determined by benchmarking
against other CEOs of comparable size and in similar industries. The
key problem is that very few boards want to pay their CEO below the
median of this distribution while a very large percentage of boards
believe that their ``above average'' executive should be paid ``above
average'' compensation. But when boards consistently pay at above
median levels while using peer benchmarking to determine the median,
the uncompromising laws of mathematics imply pay ratcheting over time.
And this is precisely what we have observed.
Finally, the dramatic increase in the use of options has led to an
upward bias in CEO pay since many boards perceive options to be much
cheaper than their true economic cost to shareholders. \7\ Indeed, many
boards incorrectly view options to be ``free'' or ``costless.'' The
false view that options are inexpensive is the result of three
reinforcing factors. First, the current accounting rules allow
companies to treat standard options as free from an accounting
perspective since there is no required expense on the income statement.
Second, options require no cash expense up-front, even though the
dilution cost is economically equivalent. Third, option valuation is
inherently complex, leading many people to refer to option costs in
terms of the number of options, which often seems much smaller than the
expected economic dollar cost of options. In my view, these three
factors--especially in combination--have led to upward biases in CEO
pay. Thus, CEO pay is probably significantly higher than what we would
see in a well-functioning labor market where well-informed owners spent
their own money to attract, retain and motivate high-quality
executives. For similar reasons, I have serious doubts that the
specific design of most CEO pay (as opposed to the level of pay)
packages is the ``optimal'' result of a well-functioning market. The
way in which some top executives have been able to get huge payouts
(from selling equity and/or exercising options for a profit) preceding
huge declines in stock prices represent perhaps the most egregious
example of poorly designed equity-pay plans.
---------------------------------------------------------------------------
\7\ Hall and Murphy (2002, 2003).
---------------------------------------------------------------------------
The ``solutions'' to the executive pay problem involve
strengthening shareholder rights and corporate governance while also
requiring companies to appropriately account for all compensation
expenses (including stock options) on their accounting statements. More
generally, solutions that take the form of improving the underlying
problem (involving the incentives of the involved parties and the
information they have) are much preferable to trying to micromanage the
pay process or pay outcomes through federal legislation. Such
legislative micromanagement is likely to be ineffective in solving the
problem and may well have harmful and unintended consequences. The best
example of this is the 1993 rule aimed at curbing executive pay. \8\
This so-called ``million dollar rule'' disallowed companies from
deducting non-performance-related-pay above $1 million for corporate
tax purposes. Around the same time, the SEC passed new regulations
creating greater executive pay disclosure on company proxy statements.
At best, these changes were ineffective. At worst, they distorted pay
towards options (which automatically count as performance-based pay)
while contributing to CEO pay excesses. Indeed, a quick glance at the
pay trend in Figure 1 makes it look as if the 1992/1993 changes were
passed with the intention of accelerating, not curbing, CEO pay
increases.
---------------------------------------------------------------------------
\8\ This is section 162 (m) of the Internal Revenue Code.
---------------------------------------------------------------------------
There are many specific ways in which boards can better design CEO
pay packages. For example, in my view, aligning CEO incentives with
long-run shareholder value creation would require longer vesting
periods, stronger and more widespread ownership requirements (which
require executives to hold specific amounts of stock) and automatic
clawback of payouts following accounting restatements (that is,
executives would be required to pay back any payouts that preceded
accounting restatements combined with stock price declines). But such
specific changes are not easily legislated and would happen anyway (if
they are good ideas) if boards became stronger and more empowered
representatives of shareholders.
One of the important ways in which Congress can act to curb
excesses in, and distortions to, executive pay is to encourage rather
than discourage FASB to begin expensing options. Much of the current
debate regarding the expensing of stock options is about whether or not
expensing will help investors value companies more accurately. While I
agree with many opponents of option expensing that requiring expensing
will not significantly improve the information flows to investors, this
largely misses the key point. The main problem with the current
accounting treatment is that it distorts the compensation decisions
made by boards and executives. Very few boards are willing to design
(or even consider) equity-pay packages that create an expense on the
income statement when they can give out ``free'' options instead. As a
result, boards (and managers) grant options, even though options may
not be the most cost-effective and beneficial form of compensation.
An example that likely illustrates the distortion created by the
current accounting rules involves the infrequent use of restricted
stock (stock that vests slowly) relative to options. As noted earlier,
the main rationale for paying top executives in the form of equity is
to create ownership incentives. But since shareholders hold stock, why
do boards primarily pay executives in options instead of stock? The
likely answer is the distorted accounting treatment of equity (which
requires an expense for restricted stock but not options), not the
inherent superiority of options as a compensation and incentive tool.
Indeed, there are many advantages to stock relative to options. Stock
is simpler and easier to value, which helps incentives while also
curbing abuses. Stock does not have the huge underwater problem that
plagues options (underwater options undermine ownership incentives,
create retention problems and lead to perverse pressures to reprice
options or grant large ``refresher'' grants following stock price
declines) \9\ since stock cannot fall underwater. Stock also better
aligns shareholder and executive decisions regarding dividends (and
sometimes risk-taking \10\).
---------------------------------------------------------------------------
\9\ See Hall and Knox (2002) for evidence on the significance of
the underwater options problem.
\10\ Especially when options fall underwater.
---------------------------------------------------------------------------
But despite these advantages, many boards rarely consider stock--or
other types of pay that create an accounting expense--because of the
current accounting rules. Requiring an expense for options will level
the accounting playing field, leading to fewer distortions in the way
that executives are paid. Especially combined with rules that give
shareholders more influence in board rooms, this will also curb many of
the excesses in pay levels--especially with regard to many of the large
outliers paid to CEOs, virtually all of which involved abuses of
``inexpensive'' and ``hard-to-value'' option grants.
To summarize, although we must not forget the large benefits of the
option explosion, there are good reasons to believe that there is an
executive pay problem. But the executive pay problem is best solved by
improving governance and accounting, rather than by attempting to solve
the problem directly without addressing its underlying causes. In
addition to improving the accounting, making managers and boards more
accountable to shareholders will make the executive pay process sounder
and less prone to abuse and excess. Currently, there are a host of
mechanisms that disempower shareholders including poison pills,
staggered boards and proxy voting rules that serve to weaken the ways
in which boards and managers are held accountable to the company's
owners and other stakeholders. Although appropriate changes to the
governance and accounting rules are best accomplished through the
exchanges, the courts (especially the Delaware courts) and regulatory
bodies such as the SEC and FASB, congressional support of these changes
would well serve the interests of American public.
I thank you for this opportunity to provide testimony on this
important issue.
References
Bebchuk, Lucian, Jesse Fried, and David Walker. 2002. ``Managerial
Power and Executive Compensation,'' University of Chicago Law
Review 69.
Hall, Brian J. and Thomas A. Knox. 2002. ``Managing Option Fragility,''
NBER Working Paper 9059 (July).
Hall, Brian J. and Jeffrey B. Liebman. 1998. ``Are CEOs Really Paid
Like Bureaucrats?'' Quarterly Journal of Economics 113 (3).
Hall, Brian J. and Kevin J. Murphy. 2003. ``The Trouble with Stock
Options,'' Journal of Economic Perspectives (forthcoming).
Hall, Brian J. and Kevin J. Murphy. 2002. ``Stock Options for
Undiversified Executives,'' Journal of Accounting and Economics.
33, pp 3-42.
Kaplan, Steven N. 1989. ``The Effects of Management Buyouts on
Operating Performance and Value,'' Journal of Financial Economics
24 (October), 217-254.
Palepu, Krishna G. 1990. ``Consequences of Leveraged Buyouts,'' Journal
of Financial Economics 27:1-2 (October), 247-262.
The Chairman. Thank you very much.
Mr. Silvers.
STATEMENT OF DAMON A. SILVERS, ASSOCIATE GENERAL COUNSEL,
AMERICAN FEDERATION OF LABOR AND
CONGRESS OF INDUSTRIAL ORGANIZATIONS (AFL-CIO)
Mr. Silvers. Thank you, Mr. Chairman, and good morning. My
name is Damon Silvers and I am an Associate General Counsel of
the American Federation of Labor and Congress of Industrial
Organizations. On behalf of the AFL-CIO, we would like to thank
you for your leadership on the issue of executive compensation
and for the opportunity to appear before you today.
The AFL-CIO is the federation of America's unions,
representing more than 66 national and international unions and
their membership of more than 13 million working men and women.
Of the 1,000 shareholder proposals filed in the 2003 proxy
season, more than 380 were filed by union members and their
benefit funds. 75 percent of those 380 proposals dealt with the
issue of executive compensation. So far, at last 15 of these
proposals have won majority support from shareholders at major
companies and at seven additional companies, including GE and
Verizon, worker funds' shareholder proposals have led to
agreements to phase out extraordinary executive retirement
plans.
Since 1997, the AFL-CIO has sponsored the PayWatch web
site, www.paywatch.org, where workers and investors can track
CEO pay at the companies they care about, compare it to their
own compensation, and take action to reform executive pay
practices. Over 2 million people have visited PayWatch since
its launch.
There are companies where executive pay matters in the
simplest possible way. It has grown to a level where it is
materially and directly affecting companies' economic
performance. But the more common problems involving runaway
executive pay are that: one, it is structured to create
perverse incentives; two, it corrodes organizational cultures;
and three, it is a symptom of an unaccountable CEO and a weak
board. A couple of examples of each problem.
First, perverse incentives. As several of my colleagues on
this panel have mentioned, stock options that can be exercised
after three years give the CEO an interest in both increased
share price and increased volatility. If the stock price is
falling, the CEO begins to develop a rational interest in
taking risky decisions that shareholders, particularly long-
term shareholders such as our pension funds, do not share. In
addition, short-term equity-based compensation, whether options
or stock, creates a strong incentive to manipulate companies'
stock prices through massaging accounting statements or other
disclosure manipulations.
Second, organizational culture. Consider recent events at
American Airlines. That company was seeking concessions from
its employees in the name of business survival, including
cutbacks in retirement benefits. The employees had narrowly
voted to accept these cutbacks when it was revealed that the
CEO was secretly increasing his retirement benefits at the same
time.
Not only was this grossly unfair, it jeopardized the
approval of the agreements the company had said were necessary
to avoid a bankruptcy filing. It shows that treating people
unfairly has consequences.
Finally, executive compensation as a symptom. I hope that
you have seen the previous witness Professor Hall's list of the
top paid CEOs of 1999 and noticed the overlap with the
corporate villain list of 2001 and 2002. This strongly suggests
that when pay is out of control other things are likely to be
as well.
But scandalous levels of executive pay are neither a
permanent feature of the American economy nor a necessary
byproduct of prosperity. In 1964, at the end of the greatest
period of economic performance in this country's history, CEO
pay stood at roughly 25 times that of the average employee, a
level comparable to that of the other major industrialized
countries of the time and the other major industrialized
countries' CEO pay levels today. Of course, in the United
States today CEO pay stands at over 500 times the pay level of
the average worker, and the pay of the median CEO continues to
rise even though by most measures corporate performance is
falling.
We believe real change requires the enactment of two
reforms, reforms that are under discussion at the agencies that
have the power to enact them, but which face serious political
opposition. These reforms are the expensing of stock options
and the democratization of corporate board elections, a
democratization which is central and really the only way to
achieve what Professor Hall was talking about in terms of
strengthening the board's hand in dealing with the CEO.
I address stock options first. Frankly, the only reason why
option expensing is an issue at all today is because in the
mid-1990s, FASB's efforts to require expensing, as the
professionals at FASB have been urging for as long as they have
been around, were thwarted by political pressure. Similar
pressures are now being brought to bear as FASB once again
tries to do its job.
The AFL-CIO strongly supports FASB Chairman Bob Herz'
efforts to restore credibility to GAAP in this area and
commends the Chairman and Senator Levin for their leadership in
supporting FASB's independence.
In our opinion, there is more at stake here than just
option accounting or executive compensation, if that was not
enough. Our markets will be damaged if after the events of the
last two years it appears that our accounting standards are
still being held hostage to the very political dynamics that
prevented effective regulation in the 1990s.
Part of the reason the AFL-CIO supports option expensing is
that we believe with a level playing field companies will, in
part due to investor pressure, choose better forms of executive
compensation such as restricted stock. However, we are
skeptical of mechanical approaches to executive compensation in
general. Any mechanism, any one metric, can be gamed. I think
the history of the 1992 attempts at reform shows that this is
true in spades.
A model executive compensation program in our opinion would
include a thorough evaluation by the board of both quantitative
and qualitative performance measures aimed at assessment the
executive's contribution to the long-term health of the
business. But such a multi-factor approach requires boards that
are genuinely independent from the CEO and accountable to long-
term investors.
That is why last week the AFL-CIO filed a rulemaking
petition with the Securities and Exchange Commission asking the
commission to democratize the director election process. The
petition asks the commission to adopt rules giving long-term
significant investors in public companies the right to have
short slates of directors they nominate listed on management's
proxy along with management board candidates and thereby create
a possibility of moving board of director elections away from
the North Korean model.
We suspect that access to the proxy as an option, while it
will be rarely used, will make dialogue between boards and
investors much more substantive. In particular, it is only
through this type of reform that boards will become independent
enough to really negotiate CEO pay packages.
The SEC has announced a review of the issue of shareholder
access to the proxy and in particular shareholder involvement
in director selection. The staff of the SEC has been asked to
report to the commission on this issue by July 15th. But the
reality is that CEOs will oppose this reform as strongly as
they are opposing option expensing, but without it, it would be
impossible to prevent further abuses of executive compensation.
FASB and the SEC have the power and the tools to do
something about runaway executive pay, to foster precisely the
kind of private sector fixes that Senator Breaux alluded to in
his opening remarks. However, both bodies need the support of
Congress. The AFL-CIO is grateful to this Committee for its
commitment to this task and we would be pleased to assist the
Committee in any way as you continue your work in this area.
Thank you.
[The prepared statement of Mr. Silvers follows:]
Prepared Statement of Damon A. Silvers, Associate General Counsel,
American Federation of Labor and Congress of Industrial Organizations
(AFL-CIO)
Good morning Chairman McCain and Senator Hollings. My name is Damon
Silvers, and I am an Associate General Counsel of the American
Federation of Labor and Congress of Industrial Organizations. Thank you
for your leadership on the issue of executive compensation and for the
opportunity to appear before you today.
The AFL-CIO is the federation of America's labor unions,
representing more than 66 national and international unions and their
membership of more than 13 million working women and men. Union members
participate in the capital markets as individual investors and through
a variety of benefit plans. Union members' benefit plans have over $5
trillion in assets. Union-sponsored pension plans account for over $400
billion of that amount. Worker-owners and their benefit funds have
become increasingly active participants in corporate governance in the
last fifteen years. Of the 1000 shareholder proposals filed in the 2003
shareholder season, more than 380 were filed by unions. Seventy-five
percent of these union-sponsored proposals dealt with the issue of
executive compensation.
So far, worker fund proposals on executive compensation have won
majority votes at companies like Alcoa, Apple, Delta (2), Hewlett
Packard, International Paper, PPG, Raytheon, Sprint, Tyco, Union
Pacific, U.S. Bancorp (2), Weyerhaeuser, and Whole Foods. At Adobe,
Airborne, Coca-Cola, Exelon, General Electric (2) and Verizon the AFL-
CIO or an affiliate union recently negotiated agreements to phase out
extraordinary executive pensions. Of particular note, building trades
unions' funds have led the fight to get companies to expense stock
options at dozens of public companies, following up on their success
last year in winning auditor independence proposals.
The AFL-CIO has been involved in the effort to reform executive
compensation since well before the corporate scandals of the last
several years. Since 1997, the AFL-CIO has sponsored the PayWatch
website (www.paywatch.org), where workers and investors can track CEO
pay at the companies they care about, compare it to their own
compensation, and take action to reform executive pay practices.
PayWatch is a very popular web site, with over 2 million people
visiting since its launch and over 400,000 visits in 2002.
Executive compensation should be a key part of the web of
relationships that make up the corporate governance process. It should
contribute toward getting companies to make smart, long term focused
decisions that lead to sustainable benefits for all who participate in
the company. Unfortunately, executive compensation has become the best-
known symptom of the breakdown of that process. This year 277 of the
approximately 1000 proposals filed at companies pertained to reining-in
executive compensation.
We believe executive pay matters. Amazingly, there are companies
where executive pay matters in the simplest possible way--it has grown
to a level where it is materially and directly affecting companies'
economic performance. But the more common problems involving runaway
executive pay are that (1) it is structured to create perverse
incentives, (2) it corrodes organizational cultures, and (3) it is a
symptom of an unaccountable CEO and a weak board.
A couple of examples of each problem. First, perverse incentives.
Stock options that can be exercised after three years give the CEO an
interest in both increased share price and increased volatility. If the
stock price is falling, the CEO begins to develop an interest in taking
risky decisions that shareholders, particularly long-term shareholders,
do not share. In addition, equity based compensation, whether options
or stock, that can be converted to cash during the executive's tenure
creates a strong incentive to manipulate company stock prices through
massaging accounting statements or other disclosure manipulations.
Second, organizational culture. Consider recent events at American
Airlines. The company was seeking concessions from its employees in the
name of business survival, including cutbacks in retirement benefits.
The employees had narrowly voted to accept these cutbacks when it was
revealed that the CEO was secretly increasing his retirement benefits
at the same time. Not only was this grossly unfair, it jeopardized the
approval of the agreements the company had said were necessary to avoid
a bankruptcy filing. Treating people unfairly has consequences.
Finally, executive compensation as a symptom. You have seen
Professor Brian Hall's list of the top paid CEOs of 1999, and noticed
the overlap with the corporate villain list of 2001-2002. This suggests
that when pay is out of control, other things are likely to be as well.
But scandalous levels of executive pay are neither a permanent
feature of the American economy nor a necessary byproduct of
prosperity. In 1964, at the end of the greatest period of economic
performance in this country's history, CEO pay stood at roughly 25
times that of the average worker, a level comparable to that of the
other major industrialized countries. Today of course it stands at over
500 times the pay level of the average worker, and the pay of the
median CEO continues to rise even though by every measure corporate
performance is falling.
Yet, solutions to runaway executive pay have been elusive in more
recent American history. CEO pay increased throughout the 1980's, to
the point where in 1992 Congress felt it had to take action to tie pay
to performance. Then pay really took off. We should learn from these
experiences that in the absence of effective corporate governance,
mechanical measures to rein in pay are unlikely to be successful--CEOs
and their consultants can and will game these rules if they control the
processes by which their pay is set. For example, today we are seeing
executives shift from stock options to SERPs and other retirement plans
as stock options become both controversial and relatively unprofitable.
So we believe that solutions to the problem of executive pay
require at a minimum good disclosure to investors and the public and
real accountability on the part of corporate boards, accountability
that will result in real bargaining between boards and CEOs.
Specifically, this requires the enactment of two reforms--reforms
that are under discussion at the agencies that have the power to enact
them but which face serious political opposition. These reforms are the
expensing of stock options and the democratization of corporate board
elections.
Stock options need to be expensed so they can be managed and so
they can be on a level playing field with other types of executive
compensation that are better suited to aligning executive interests
with the long-term interests of their companies. There is no good
reason not to expense options. But there are a number of bad reasons.
These bad reasons include the spurious assertion that options cannot be
valued, that options turn up in earnings per share calculations, and
that options vary in value after they are granted.
Options can be valued using Black-Scholes and a variety of other
pricing methods related to Black-Scholes. Though these values are
estimates, so are the values used for numerous other line items on
corporate financial statements, including depreciation, amortization,
and inventory-related adjustments. Options do vary in value after they
are granted--but so do a variety of payments and agreements made by
companies--for example payments made in foreign currencies or long-term
commodity contracts. No one would suggest they should be left off the
companies' financial statements. Finally, the inclusion of options in
the creation of the fully diluted earnings per share figure does not
treat options as a cost, which in fact they clearly are.
Frankly, the only reason why option expensing is an issue at all is
because FASB's efforts to require expensing have been thwarted in the
past by political pressure. Similar pressures are now being brought to
bear as FASB tries once again to do its job. The AFL-CIO strongly
supports Bob Herz's efforts to restore credibility to GAAP in this
area, and commends the Chairman and Senator Levin for their leadership
in supporting FASB's independence. In our opinion, more is at stake
here than just option accounting or executive compensation. Our markets
will be damaged if after the events of the last two years it appears
that our accounting standards are still being held hostage to the very
political dynamics that prevented effective regulation in the 1990's.
Part of the reason the AFL-CIO supports option expensing is that we
believe that with a level playing field companies will, in part due to
investor pressure, choose better forms of executive compensation such
as restricted stock. But we are skeptical frankly of mechanical
approaches to executive compensation in general. Any mechanism, any one
metric, can be gamed. A model executive compensation program, in our
opinion, would include a thorough evaluation by the board of both
quantitative and qualitative performance measures aimed at assessing
the executive's contribution to the long term health of the business.
This kind of process can only work though when the board is
genuinely independent from the CEO and accountable to long-term
investors. That is not the reality of today's corporate boards. That is
why worker pension funds and other institutional investors are looking
to make long-term investors a real counterbalance to management power
in the board room. Last week the AFL-CIO filed a rulemaking petition
with the Securities and Exchange Commission asking the Commission to
democratize the director election process. The petition asks the
Commission to adopt rules giving long-term significant investors in
public companies the right to have short slates of directors they
nominate listed on management's proxy along with management board
candidates. This proposal for access to the proxy is designed to give
long-term institutional investors voice, not to facilitate takeovers.
We suspect that access to the proxy, while rarely used, by its very
availability as an option will make dialogue between boards and
investors much more substantive. In particular, it is only through this
type of reform that boards will become independent enough to really
negotiate CEO pay packages.
The SEC has announced a review of the issue of shareholder access
to the proxy, and in particular shareholder involvement in director
selection. The SEC staff has been asked to report to the Commission on
the issue by July 15. But the reality is that CEOs will oppose this
reform as strongly as they are opposing option expensing, and that
without it, it will be impossible to prevent further abuses of
executive compensation.
FASB and the SEC have the power and the tools to do something about
runaway CEO pay. But not if they succumb to Congressional and company
pressure to continue business as usual. One would think that after the
last couple of years it would not be necessary to say this.
Ultimately, the crisis in executive compensation is a microcosm of
the crisis in corporate governance that brought us Enron and WorldCom
and HealthSouth and so many others. Only by getting disclosure right
and giving institutional investors the power to act on what they know
can we get executive pay under control. But the long term health of our
economy and the basic principles of fairness demand we do so. The AFL-
CIO is grateful to this Committee for its commitment to this task and
we would be pleased to assist the Committee in any way as you continue
your work in this area. Thank you.
The Chairman. Thank you, Mr. Silvers.
Mr. Bachelder.
STATEMENT OF JOSEPH E. BACHELDER, FOUNDER AND
SENIOR PARTNER, THE BACHELDER FIRM
Mr. Bachelder. Mr. Chairman and distinguished Members of
the Committee: I very much appreciate the opportunity to speak
with you this morning on the subject of executive compensation
and in particular the focus of today, CEO pay. I am a founder
and senior partner of the Bachelder Law Firm in New York City.
I have concentrated in matters associated with executive
compensation for over two decades. I have represented many
prominent chief executive officers and other senior level
executives of United States corporations. I have also
represented boards of directors and compensation particulars. I
write a regular column, ``Executive Compensation,'' which
provides current commentary on the subject of executive pay for
the New York Law Journal.
By way of introduction, I would like to note that a
recently completed study of 437 companies out of the S&P 500
shows that, taking into account salary, bonus, and long-term
incentives, including stock options, the average CEO pay is
down approximately 24 percent in 2002 from 2001. This same
survey, based on these 437 companies out of the S&P 500, is
down by about 10 percent. I think that what goes up does indeed
come down, and other surveys do indicate that CEO pay in 2002
is down from 2001.
I would like to make some observations on CEO pay today.
First of all, I believe that the market of CEO pay is a free
market, much in the way that the stock market is a free market
or the real estate market is a free market. None of these
markets are perfect, but it is basically that. In order to get
a CEO to move from company A to company B, for example, company
B must do what it takes to get him or her to move. If company A
wants to keep that CEO from accepting the offer from company B,
it must pay what it takes. It is a bargaining process, much of
which goes on in other free markets.
If asked, the vast majority of directors of the
approximately 15,000 public companies in the United States
would likely say that the single most important factor to a
company's success over the next several years is the CEO. This
is one reason why CEOs have the leverage they command in
negotiations over their pay.
For major U.S. corporations, CEO pay represents a very
small portion of the value of the companies they run. If for
example Jack Welch received over his career a billion dollars
of value--and the publicly available information that I have
reviewed indicates it to be significantly less than that--this
would be approximately one-quarter of 1 percent of the
company's total market capitalization as of September 2001 when
he retired. You will pay more than that as a percentage of most
transactions to your stockbroker. If you sell your house, you
will pay something like 6 percent to your real estate broker.
From a different perspective, Jack Welch's pay for his
entire career would probably equal less than 10 cents per share
of GE stock, currently priced at approximately $28 per share,
with approximately 10 billion shares outstanding.
CEO salaries and bonuses have increased, but not to an
egregious degree, over the past 50 years, averaging between 5
and 6 percent. Adjusted for inflation, this rate is about 2
percent. In fact, the rate of increase in CEO salaries and
bonuses trailed the rate of increase in pay of production
workers during the 1950s, 1960s, and 1970s.
So why the extra fuss over CEO pay today? To a very
significant degree, it is due to stock options, and this in
turn is due in large part to the way we report stock options as
compensation. For the moment I am addressing the issue of
reporting CEO pay and not the issue of whether options should
be expensed for accounting purposes, a very important and
separate issue, but not the subject of this testimony that I am
giving.
Much of the reporting of the huge CEO pay gains in the
1990s was based on values attributable to the awards of stock
options using the financial model called Black-Scholes. Black-
Scholes' initial applications were to freely tradable short-
term options, meaning options for periods of less than a year,
frequently in the range of only three to six months. Applied to
ten-year executive stock options, Black-Scholes is like
planning a long drive through traffic by taking a one-time look
in the rear view mirror.
Let us compare an executive stock option to one of those
short-term options traded on the Chicago Board Options
Exchange. An executive stock option cannot be sold. It usually
cannot be exercised for a significant period of time. If the
option is exercised, the sale of the stock may be subject to
SEC insider restrictions. If the executive quits, the option is
probably forfeited.
Even if the executive continues on during the full option
term, how does one forecast the consequences of wars,
recessions, and the growth or collapse of particular employers
over that period?
To report one dollar of such highly speculative value as
the equivalent of one dollar of salary paid today is debatable,
to say the least. Notwithstanding the foregoing, many U.S.
surveys report side by side dollars of theoretical option value
with dollars of salary paid as if they were equivalent. These
surveys then compound the sin by adding the two together.
Many billions of dollars of supposed option value
evaporated during and after the 1990s. There are cases of
executives reported to have received hundreds of millions of
dollars of option compensation during the past ten years whose
options are now underwater.
In a study of CEO pay over an approximately ten-year period
ending in 2001, the Bachelder Firm found 210 CEOs, out of a
much larger group of CEOs, who were employed as CEOs by the
same company for the entire period of approximately ten years.
The ratio of stock option gains to salary and bonuses for these
210 executives over the approximately ten years was a little
over one to one. By option gains, I mean both realized and
unrealized gains.
To the vast majority of CEOs in the United States, the
1990s were a rewarding period, with rewarding results to
shareholders, but not the bonanza of extravagance suggested by
the media.
I have a few suggestions. Let us adopt a consistent
yardstick for valuing stock options in reporting CEO pay. I am
speaking of surveys and reports on options, not at this moment
accounting for options, which, as I said, is a different issue.
I suggest using gains both realized and unrealized, rather than
the theoretical Black-Scholes value at the time of option
grant.
Second, let us stop focusing on the outliers who attract
headlines and distort the overall picture of CEO pay and
instead focus on the average or median CEO pay when discussing
that subject.
Third, it would be very helpful if there was at least one
common database of companies that we all could refer to, like
the S&P 500. Throughout each proxy season we go from surveys
that in some cases cover 50 or fewer companies in a limited
number of industries to surveys concerning much larger numbers
of companies in many industries. When that is combined with
differences in valuation methods and differences in the use of
terminology, it becomes very difficult for the public to get an
accurate picture of what really is happening to CEO pay.
Finally, when CEOs and other executives exercise stock
options it would be reasonable to require that a specified
percentage of the stock attributable to the spread at time of
exercise, net of shares needed to pay taxes incurred as a
result of the exercise, be held for a minimum period of time.
Thank you very much, Mr. Chairman and members of the
Committee, for the opportunity to testify today.
[The prepared statement of Mr. Bachelder follows:]
Prepared Statement of Joseph E. Bachelder, Founder and Senior Partner,
The Bachelder Firm
A. Introduction
A recently completed study (reported by Equilar, Inc.) of 437
companies out of the S&P 500 shows that, taking into account salary,
bonus and long-term incentives including stock options, the average CEO
pay is down 23.6 percent in 2002 from 2001.
Looking farther back, over the past fifty years, CEO pay (salary
and bonus) has grown an average of approximately 5.8 percent a year.
That compares to the S&P 500 total shareholder return (stock price
growth plus dividends deemed reinvested) of approximately 12 percent a
year over the same fifty-year period. It is noteworthy that during the
1950s, the 1960s and into the 1970s, the rate of increase in CEO pay
(salary and bonus) trailed the rate of increase in production workers'
pay.
Another way of looking at CEO pay is to compare it as a percentage
of employer revenues over a period of time. Looking at over 230 U.S.
corporations that are in the current S&P 500 and that were in the same
index a decade ago, salary and bonus paid to the CEOs of those
companies represented approximately 0.035 percent of their revenues a
decade ago and represents approximately 0.029 percent today.
What about stock options? In the early 1980s, after approximately
15 years of almost no growth in the stock markets, stock options were
encouraged as a favored form of long-term incentive award. Consultants,
investors and academics looked favorably on stock options. Why? Because
they wanted to tie CEO pay to increase in shareholder wealth. What
better way to do that than with stock options? If the markets went up,
the CEO shared in the growth. If the markets went nowhere, the CEO made
nothing.
What happened? The stock markets exploded! From the early 1980s to
the end of the 1990s, the stock markets rose 1400 percent. In a
September 2002 report, the Conference Board indicated that
approximately 80 percent of the increase in CEO pay over the period
1992 to 2000 was attributable to gains in stock options. The stock
market had its remarkable success in the 1980s and 1990s and so did
stock options for many CEOs in that same period. In a sense we got what
we asked for: we tied CEO pay to increasing shareholder wealth and
shareholder wealth overall increased dramatically.
B. Some Observations on CEO Pay Today
1. Free Market
First, let's recognize that the market of CEO pay is a free market,
much in the way the stock market is a free market, or the real estate
market is a free market. In order to get a CEO to move from Company A
to Company B, Company B must pay what it takes. If Company A wants to
keep that CEO from accepting the offer from Company B it must pay what
it takes. It is a bargaining process, much as goes on in other free
markets.
2. The Market Value of CEOs
If asked, the vast majority of directors of the approximately
15,000 public companies in the United States likely would say that the
single most important factor in a company's success over the next
several years is the CEO. This is one reason why CEOs have the leverage
they command in negotiations over their pay.
There are not a lot of people who possesses the qualities necessary
to be a successful CEO. To succeed, they must:
Master the business operations--most frequently global in
scope--of companies with hundred of millions, and in some cases
hundreds of billions, of dollars of revenues and market
capitalization.
Have the vision and leadership to keep their companies ahead
in developing and marketing new products and services,
improving existing products and services, and in marketing
those products and services.
Understand and oversee increasingly complex financial
structures (and we all know the tragedies associated with
leadership that either, willfully or neglectfully, fails to do
this).
Attract, motivate and retain talented people--frequently
tens of thousands and, in some cases, hundreds of thousands.
Work effectively and productively with multiple
constituencies including employees, shareholders, directors,
Wall Street analysts, the media, Federal, state and local
governments and, frequently, foreign governments as well, and
the citizens of the communities of which they are a part.
Individuals who effectively combine these skills, with the energy,
commitment and personal sacrifices required, do indeed command a
premium in today's market.
Ironically, institutional shareholders criticize CEO pay and yet
many of them have been a force in increasing CEO pay. Representing some
of the greatest concentrations of stock wealth in the history of our
country, institutional shareholders have provided constant pressure for
increasing stock prices. CEOs respond to this pressure. With or without
stock options, the pressure would have been there. Did the 1990s
produce too much in the way of institutional shareholder gains? Where
were many of the institutional shareholders just a few years ago on the
subject of Enron? On the subject of Worldcom? I am not sure I would
look to institutional shareholders as the oracle on CEO pay.
3. CEO Pay Versus the Value of the Companies They Run
For major U.S. corporations, CEO pay represents a very small
portion of the value of the companies they run. If, for example, Jack
Welch received over his career a billion dollars of value, and the
publicly available information that I have reviewed indicates it to be
significantly less than that, this would be approximately 0.25 percent
of the Company's market value as of September 2001 when he retired. You
will pay more than that as a percentage of most transactions to your
stockbroker. If you sell your house, you will pay something like 6
percent to your real estate broker. From a different perspective, Jack
Welch's pay for his entire career would probably equal less than ten
cents per share of GE stock currently priced at approximately $28 per
share, with approximately 10 billion shares outstanding.
C. Stock Option Gains and the Black-Scholes Bugaboo
As already noted, CEO salaries and bonuses have increased--but not
to an egregious degree--over the past 50 years. As also already noted,
the rate of increase in CEO salary and bonus trailed the rate of
increase in pay of production workers during the 1950s, the 1960s and
into the 1970s. So why the extra fuss over CEO pay? To a very
significant degree, it is due to stock options. And this, in turn, is
due in large part to the way we report stock options as compensation.
(I am addressing the issue of reporting CEO pay and not the issue of
whether options should be expensed for accounting purposes, a separate
issue that is not the subject of this testimony.)
Much of the reporting of huge CEO pay gains in the 1990s was based
on values attributed to the awards of stock options using the financial
model called Black-Scholes. Black-Scholes seeks to value an option
based on a number of factors, including the current stock price, the
option exercise price and the historic volatility of the stock to which
the option applies. Other elements of the model include the term of the
option, the dividend yield and the risk-free interest rate. Black-
Scholes' initial applications were to freely tradable short-term
options--meaning options for periods of less than a year, frequently in
the range of only three to six months. Applied to ten-year executive
stock options, Black-Scholes is like planning a long drive through
traffic by taking a one-time look in the rear view mirror.
Let's compare an executive stock option to one of those short-term
options traded on the Chicago Board Options Exchange. An executive
stock option cannot be sold. It usually cannot be exercised for a
significant period of time (typically it becomes exercisable in
tranches over several years). If the option is exercised, the sale of
the stock may be subject to SEC insider restrictions on sale or to
employer-imposed blackout periods. If the executive quits, the option
is probably forfeited. If the executive is fired, the option is
generally forfeited unless it is vested. If the executive dies, the
post-termination exercise period is generally limited to one year. Even
if the executive continues on during the full option term, how does one
forecast the consequences of wars, recessions and the growth or
collapse of particular employers over that period? To report one
``dollar'' of such highly speculative value as the equivalent of one
dollar of salary paid today is debatable, to say the least.
Notwithstanding the foregoing, many U.S. surveys report--side-by-
side--dollars of theoretical option value with dollars of salary paid
as if they were equivalent. These surveys then compound their sin by
adding the two together. Many billions of dollars of supposed option
value evaporated in the 1990s. There are cases of executives reported
to have received hundreds of millions of dollars of option compensation
during the past ten years whose options are now underwater.
In a study of CEO pay over an approximately ten-year period ending
in 2001, the Bachelder Firm found 210 CEOs (out of a much larger group
of CEOs of major public companies) who were employed as CEOs by the
same company for the entire period of approximately ten years. The
ratio of stock option gains to salary and annual bonuses for these 210
executives over the approximately ten years was a little over 1 to 1!
(By option gains I mean both realized and unrealized gains, the latter
being represented by the spread in options held at the end of the
period less the spread at the beginning of the period.) Over half of
the gains of this group of 210 CEOs was attributable to just 11
executives (some of whom are founders or co-founders at companies like
Oracle, Dell and Sun Microsystems). To the vast majority of CEOs in the
United States, the 1990s were a rewarding period (with rewarding
results to shareholders) but not the bonanza of extravagance suggested
by the media.
D. Some Suggestions
1. Let's adopt a consistent yardstick for valuing stock options in
reporting CEO pay. (I am speaking of surveys and reports on options,
not accounting for options, which is a different issue.) I suggest
using gains, both realized and unrealized, rather than the theoretical
Black-Scholes value at the time of grant. In this connection, we should
recognize that when a long-term award pays out or a stock option grant
is exercised, it normally represents compensation attributable to a
number of years of service, not compensation for just that one year.
2. Let's stop focusing on the outliers who attract headlines and
distort the overall picture of CEO pay and instead focus on the average
CEO when discussing CEO pay.
3. It would be very helpful if there was at least one common
database of companies that we all could refer to--like the S&P 500.
Standard and Poor's and Equilar, Inc., for example, provide such
databases. Throughout each proxy season we go from surveys that in some
cases cover 50 or fewer companies in a limited number of industries to
surveys concerning much larger numbers of companies in many industries.
When that is combined with differences in valuation methods and
differences in the use of terminology, it becomes very difficult for
the public to get an accurate picture of what really is happening to
CEO pay.
4. When CEOs and other executives exercise stock options, it would
be reasonable to require that a specified percentage of the stock
attributable to the spread at time of exercise, net of shares needed to
pay taxes incurred as a result of the exercise, be held for a minimum
period of time.
The Chairman. Thank you, Mr. Bachelder.
Mr. Harrigan, welcome.
STATEMENT OF SEAN HARRIGAN, PRESIDENT, BOARD OF
ADMINISTRATION, CALIFORNIA PUBLIC EMPLOYEES'
RETIREMENT SYSTEM
Mr. Harrigan. Good morning. Mr. Chairman and Members of the
Committee: It is my pleasure to be here and provide the
perspective of an institutional investor in regards to
executive compensation. I also have some suggestions where
Congress could take action to help support reform on executive
compensation.
I am Sean Harrigan. I am the President of the Board of
Administration of the California Public Employees' Retirement
System. CalPERS is the largest public pension fund in the
United States, with approximately $125 billion in assets. We
have long been a leading voice in corporate governance and an
advocate for better alignment of interests between
shareholders, the owners of companies, and management.
Executive compensation is a critical issue to investors.
Compensation is truly a powerful tool that will drive behavior.
Unfortunately, it can drive the wrong kind of behavior, if
proper checks and balances are not in place or if the
compensation schemes are just poorly constructed.
CalPERS and I believe most investors are not anti-
compensation. In fact, we believe in paying competitive
salaries for managerial talent and we believe it is an
important tool to motivate that management. But we feel
strongly that pay should be linked to long-term sustainable
performance in a very, very significant manner.
Something has gone wrong with executive compensation in the
United States. It is absolutely unconscionable to see that CEO
pay has swollen to 400 times that of the average production
worker. If I had to identify one issue that is at the heart of
the problem with compensation in the United States, I would
point to accountability, more appropriately perhaps lack of
accountability. This is an area where we can make reform with
the support of Congress.
As public market investors, we rely upon boards of
directors to represent us, the owners. In the case of
compensation, the compensation committee is charged with
representing the shareholders. It is clear to me that a major
contributing factor to this problem with executive compensation
is that compensation committees are not accountable to
shareholders. They obviously do not feel that approving abusive
compensation packages will cost them their jobs. Rather, it
appears that not approving what the CEO wants will in fact cost
them their jobs. This represents the central conflict of
interests inherent in the problem of executive compensation
today.
Unless this fundamental issue is solved, we will continue
to have widespread abuse in compensation practices. However,
while the absolute levels of pay are a concern, perhaps the
most troubling element of executive compensation is the ``heads
you win--I win, tails you lose'' attitude of corporate
executives. CalPERS is deeply concerned over what appears to be
an attitude of entitlement in the executive suite of corporate
America. Perhaps some of the more offensive entitlements are
the so-called forms of stealth compensation: lavish severance
packages complete with perks for life that are absolutely fit
for a king. The message is that we do not have to respect you
as owners and we do not feel accountable to you as owners.
We do, however, feel that there are concrete steps that can
be taken to help rein in the abuse in executive compensation.
Shareholders must take a more active role in overseeing
directors of companies in which we invest, with the goal of
increasing the absolute level of accountability of the
directors to the shareholders.
Executive compensation packages. CalPERS amended its U.S.
corporate governance core principles and guidelines recently to
call on companies to formulate executive compensation
policies--and I repeat, executive compensation policies--and
seek shareholder approval for those policies. Currently
compensation particulars issue a statement in the proxy to
briefly describe the company's compensation philosophy. The
shareholder's role in this process is relegated to a distant
back seat.
We believe it is a completely appropriate role for owners
of corporations to approve broad policies in relation to
executive compensation. Perhaps most importantly, it would
force compensation committees to face shareholders with a plan
and how they will use it, use it in all forms of compensation
in terms of managing the corporation. This will help to shift
the accountability back to where it belongs, to the owners.
Action item 1: Congress should support these
recommendations and call upon the SEC and the exchanges to
consider requirements that shareholders approve executive
compensation policies. We believe that executive compensation
policies should provide the following at a minimum: the
company's desire to a mix of base, bonus, and long-term
incentive compensation; the company's intended forms of
incentives and bonus compensation, including what types of
measures will be used to drive incentive compensation. Again,
we believe companies should construct incentive plans with a
significant portion of performance-based components. The
parameters by which the company will use severance packages, if
at all, should also be included.
Quantitative model, web site application as a research
tool. CalPERS is also dedicating a portion of its web site to
executive compensation issues. In the near future we will post
a catalogue of extensive research available in the executive
compensation arena.
Greater performance-based metrics is another major effort.
We are pushing for greater use of performance-based metrics in
the executive compensation plans. CalPERS recently co-sponsored
a shareholders' proposal at General Electric calling for the
company to make a significant portion of their option grants to
top executives performance-based. The company adamantly opposed
that resolution. One can only suspect that it was really
because they do not want to be held to the true measure of
outperformance to obtain the highest level of incentive
compensation.
The Chairman. Did the measure fail?
Mr. Harrigan. Yes, it did.
Shareholder approval of executive compensation. CalPERS is
also lobbying hard to help ensure that shareholders have the
right to approve any executive-based compensation plan. While
shareholders have fought the New York Stock Exchange and NASDAQ
for years over this issue, it has finally come to pass that a
proposed change to the listing standards includes greater
shareholder approval of equity-based compensation plans.
But the fight is not over. Despite the fact that the
proposed changes to the listing standard were developed last
summer, the SEC has yet to implement this change. We believe
this can be the shortest rule the SEC will ever be able to
issue and it can be stated in a single sentence: Any new
equity-based compensation plan or material change to the
existing plan must be shareholder approved.
Action item 2: Congress could join shareholders in
supporting shareholder approval of all equity-based
compensation plans without exception.
Finally, I would like to mention one remaining reform we
are advocating and that is shareholder access to the proxy.
This would provide that shareholders who meet minimum ownership
thresholds could nominate directors to corporate boards through
the management's proxy. While this may not appear to be
particularly relevant to executive compensation at first
glance, it has everything to do with accountability.
Action item 3: Congress could join shareholders in seeking
fair access to the proxy.
Thank you and I would be glad to answer any of your
questions.
[The prepared statement of Mr. Harrigan follows:]
Prepared Statement of Sean Harrigan, President, Board of
Administration, California Public Employees' Retirement System
Mr. Chairman, Senator Hollings and Members of the Committee, it is
my pleasure to be here today and to provide the perspective of an
institutional investor in regards to executive compensation. I also
have some suggestions where Congress could take action to help support
reform in executive compensation.
I am Sean Harrigan, President of the California Public Employees'
Retirement System (CalPERS) Board of Administration. CalPERS is the
largest public pension system in the U.S., with approximately $125
billion in assets. We have long been a leading voice in Corporate
Governance, and an advocate for better alignment of interests between
shareholders and management.
Executive compensation is a critical issue to investors.
Compensation is a truly powerful tool that will drive behavior.
Unfortunately, it can drive the wrong behavior if the proper checks and
balances are not in place, or if the compensation schemes are just
poorly constructed. CalPERS and I believe most investors are not anti-
compensation. In fact, we believe paying competitive salaries for
managerial talent is an important motivational tool. But, we feel
strongly that pay should be linked to long-term sustainable performance
in a very significant manner.
Something has gone wrong with executive compensation in the United
States. It is unconscionable to see that CEO pay has swollen to 400
times that of the average production worker. It is shocking to see
example after example of top executives insulating themselves from any
risk in their own compensation, and ensuring their own financial
security at the same time employees are being asked to shoulder the
burden of cuts, and shareholders are losing value.
At American Airlines shareholders and employees were shocked to
find out that the company made a $41 million dollar payment to a fund
designed to protect the pensions of executives if the company filed
bankruptcy. This fact was not disclosed during negotiations to secure
$1.8 billion in wage concessions despite the fact that the payment was
made months before.
If I had to identify one issue that is at the heart of the problem
with compensation in the United States, I would point to
accountability. More appropriately perhaps to a lack of accountability.
This is an area where we can make reform with the support of Congress.
As public markets investors we rely upon boards of directors to
represent us. In the case of compensation, the Compensation Committee
is charged with representing shareholders. It is clear to me that a
major contributing factor to the problem with executive compensation is
that Compensation Committees are not accountable to shareholders. They
obviously do not feel that approving abusive compensation packages will
cost them their job. Rather, it appears that not approving what the CEO
wants is what they feel will cost them their job. This represents the
central conflict of interest inherent in the problem of executive
compensation today. Until this fundamental issue is solved, we will
continue to have widespread abuse in compensation practices.
In the last five years alone, CEO compensation has doubled
according to compensation consultants Pearl Meyer & Partners. In 1996,
the average CEO at the largest 200 companies made about $5.8 million.
By 2001, that figure jumped to $11.7 million.
The following table compares the trends in specific components of CEO
pay to the performance of the S&P 500 for 2001 and 2002.
------------------------------------------------------------------------
2001 2002
------------------------------------------------------------------------
Median base salary Up 10.1 Up 4.2
Median cash bonus Down 17.6 Up 8.8
Median stock option Up 43.6 Down 18.6
grant
Average restricted stock Down 21 Up 1.3
Median overall Up 26.7 Down 10.9
compensation
Total return S&P 500 Down 11.88 Down 22.09 percent
------------------------------------------------------------------------
Source: compensation data--calculated for CalPERS by Equilar (includes
only CEOs that were in the position for the entire three year period);
S&P 500 returns--Bloomberg
We think this shows a disconnect between compensation and
performance on a broad scale. Part of our concern is that it appears
companies shifted compensation from cash to options in 2001, then from
options to cash in 2002--most likely due to the bear market. It is also
important to note that the value of the option grants declined at least
in part due to lower overall stock prices. It appears that a similar
number of options are still being granted (median number of options
declined only 9 percent in 2002). This was the only factor driving the
median total compensation down in 2002.
However, while the absolute levels of pay are a concern, perhaps
the most troubling element of executive compensation is the heads I
win, tails you lose attitude of corporate executives. CalPERS is deeply
concerned over what appears to be an attitude of entitlement in the
executive suite of corporate America. This attitude manifests itself in
many forms.
Perhaps some of the more offensive entitlements are the so called
forms of ``stealth compensation.'' Lavish severance packages complete
with perks for life that are fit for a king, guaranteed pension
benefits far outstripping the value of benefits provided to employees,
enormous loans to executives that are eventually forgiven, and
provisions providing that the company shall pay all the taxes due
(including gross-up provisions) should the executive incur a tax
liability all send a clear message to shareowners. The message is that
we do not respect you as owners, and we do not feel accountable to you
as owners.
In other examples demonstrating a lack of respect for shareholder's
capital:
Delta Airlines, Leo Mullin will be credited with 22 years of
service toward his pension upon termination, plus two
additional years in a Supplemental Retirement Benefit. The
company also put $25.5 million in a protected pension trust for
him according to press accounts.
Home Depot has an employment contract that includes a $10
million loan with predetermined criteria for forgiveness in
addition to base salary, 2,500,000 stock options (plus annual
increments of no less than 450,000 more options), a target
bonus of between $3,000,000 and $4,000,000, deferred stock
units (750,000 in 2002), pension benefits and change in control
provisions that include (if the executive leaves for good
reason or for any reason within 12 months) $20,000,000,
immediate vesting of options, and immediate forgiveness of any
outstanding loans and payment of the gross-up for taxes.
We do however feel that there are concrete steps that can be taken
to help reign in abusive executive compensation. Shareholders must take
a more active role overseeing directors at the companies in which we
invest with the goal of increasing the absolute level of accountability
of directors to shareholders must be increased. There are also several
improvements to the structure of compensation programs that we believe
can have a dramatic effect on rationalizing executive pay. Let me
briefly go over the steps CalPERS is taking in the area of executive
compensation and mention some of the specific proposals we have made to
improve the alignment of interests.
Executive Compensation Policies
CalPERS amended its U.S. Corporate Governance Core Principles and
Guidelines recently to call on companies to formulate executive
compensation policies and seek shareholder approval for those policies.
Currently, Compensation Committees issue a statement in the proxy to
briefly describe the company's compensation philosophy. Shareholders
role in this process is relegated to a distant back seat. In
discussions with companies about this issue, they often state
emphatically that only the board has the right and the expertise to
manage the affairs of the company and particularly the issue of
compensation. Companies state that the Compensation Committee must have
the flexibility to attract and retain executives and that shareholders
should essentially trust them to do the right thing. Yet the behavior
of corporate America in regards to executive compensation indicates
otherwise.
We believe it is a completely appropriate role for owners of a
corporation to approve broad policies in relation to executive
compensation. Perhaps most importantly, it would force Compensation
Committees to face shareholders with a plan on how they will use
compensation of all forms in managing the corporation. This will help
to shift the accountability back to where it belongs, to the owners.
Action item 1: Congress could support these recommendations and call
upon the SEC and the exchanges to consider requirements that
shareholder approve executive compensation policies.
We believe that executive compensation policies should provide the
following, at a minimum:
The company's desired mix of base, bonus and long-term
incentive compensation;
The company's intended forms of incentive and bonus
compensation including what types of measures will be used to
drive incentive compensation. Again, we believe companies
should construct incentive plans with a significant portion of
performance based components;
The parameters by which the company will use severance
packages, if at all.
Quantitative Model--Website Application as a Research Reference Tool
CalPERS is also dedicating a portion of its website to executive
compensation issues. In the near future we will post a catalog of
extensive research available in the executive compensation arena. We
are also developing a quantitative model that we will apply to our U.S.
indexed holdings to help identify on a more systematic basis where
compensation abuses are occurring. The model will be used to identify
companies where performance and compensation diverge by analyzing peer
relative and market relative compensation measures along with
performance data. It is our intent to use our website to highlight
cases of egregious compensation much in the way we have used public
means in our Focus List of under-performing companies.
Greater Performance Based Metrics
In another major effort, we are pushing for greater use of
performance based metrics in equity compensation plans. Standard at-
the-money fixed price options--those with the strike price set at the
current market value of the stock on the day of the grant--have been
used extensively in the United States, and have become the largest
single component of CEO pay. While fixed price options do have some
merit as an alignment tool, they are inferior in many ways to
performance based plans. Yet companies have been reluctant to say the
least to adopt performance based equity plans. CalPERS recently co-
sponsored a shareholder proposal at General Electric calling for the
company to make a significant portion of their option grants to top
executives performance based. The company adamantly opposed the
resolution, they said because not many companies are using these types
of equity grants. One can only suspect that it was really because they
do not want to be held to true measures of outperformance to obtain the
highest levels of incentive compensation. It is easy to see why
shareholders and management differ on these issues.
Shareholder Approval of Equity Based Compensation
CalPERS is also lobbying hard to help ensure that shareholders have
the right to approve any equity based compensation plan. Under current
exchange rules, companies are not required in certain circumstances to
obtain shareholder approval to adopt equity-based compensation plans.
In other words, companies are allowed to unilaterally dilute the equity
owners of the corporation. It is ridiculous to think that an owner
should not have the right to decide if he or she is willing to dilute
their equity, no matter what the purpose. It is even more ironic when
you consider the fact that boards and management have a significant
self interest in adopting equity based compensation plans.
While shareholders have fought the NYSE and NASDAQ for years over
this issue, it has finally come to pass that the proposed changes to
the listing standards include greater shareholder approval of equity
based compensation plans. But the fight is not over. Despite the fact
that the proposed changes to the listing standards were developed last
summer, the SEC has yet to implement this change. Most troubling of
all, the exchanges are seeking a number of exceptions to shareholder
approval that would continue to let companies unilaterally dilute
equity owners. We are opposed to these exceptions. We believe this can
be the shortest rule the SEC will ever be able to issue, and it can be
stated in a single sentence: Any new equity based compensation plan or
material change to an existing plan must be shareholder approved.
Action item 2: Congress could join shareholders in supporting
shareholder approval of all equity-based compensation plans
without exception.
Shareholder Access to the Proxy
And finally I would like to mention one remaining reform we are
advocating, shareholder access to the proxy. This would provide that
shareholders who meet minimum ownership thresholds could nominate
directors to corporate boards through management's proxy. While this
may not appear to be particularly relevant to executive compensation at
first glance, it has everything to do with accountability. With
responsible yet meaningful reforms to the SEC rules governing access to
the proxy, shareholders will be given greater ability to hold directors
accountable for poor performance. As I mentioned earlier, we believe
this has a material impact on their behavior and on the quality of
their representation of shareholder's interests. This has an obvious
impact on our ability to right the ship when it comes to compensation.
Action item 3: Congress could join shareholders in seeking fair access
to the proxy.
Thank you, I would be glad to answer any questions that you may
have.
The Chairman. Thank you, Mr. Harrigan. Would one of the
reasons why your measure was not approved, was it because of
proxy voting?
Mr. Harrigan. Yes, I believe it was.
The Chairman. One question for the entire panel. Is the
issue of executive compensation, excessive executive
compensation, having a negative effect on investor confidence?
Beginning with you, Mr. Clapman?
Mr. Clapman. Yes. I started off by saying that executive
compensation in a sense is a window into broader corporate
governance issues. I testified before a House Committee last
year at a time right during the Enron scandals, pre-WorldCom
scandal, and really strongly advocating reform in the corporate
governance system of the United States, much of which was
eventually promulgated in stock exchange rules, which I share
with my colleagues on this panel the SEC should approve as
quickly as possible.
But I put it in the context of investor confidence because
when investors see, as they have seen, articles from
responsible business organizations saying you bought, they
sold, and the whole issue of executive compensation essentially
communicating to the investing public that in effect you were
foolish to rely on the markets, you were foolish to think that
the accounting integrity of the numbers that you relied on was
something that a prudent person should--so I think broadly
speaking executive compensation is one component, albeit a very
major component, in restoring investor confidence in the whole
corporate governance mechanism in this country, and until we do
that we are as a large investor--I said earlier 3 million
people rely on us for their pension benefits and for their
savings, and we have a fiduciary responsibility to those
people. That is why we have the proactive corporate governance
program that we have. And until that confidence is restored, I
think all of us have a problem, the Congress and all the people
on this panel.
The Chairman. Mr. Silvers?
Mr. Silvers. Mr. Chairman, I think I would certainly agree
with what Peter just said. I would add to that that executive
compensation and the pressures that CEOs place on their
corporate governance structures have proven to be an enduring
feature of our corporate economy. I think last year and two
years ago we saw the events at Enron, the events at WorldCom.
In the last few months we have seen the events I alluded to in
my testimony at American Airlines, at Sprint, where the whole--
in many of these companies, the whole corporate governance
structure was warped essentially by CEO pressures to get more
compensation, frankly. At Sprint----
The Chairman. And they want Congress to leave that issue
alone. Yet in the case of the airlines, they will come to
Congress for billions of dollars in bailout. So there seems to
be a little bit of double standard here.
Mr. Silvers. No question about it, Mr. Chairman.
I would just add that what you are seeing here, for example
at Sprint, is that the outside audit function was compromised
at that company by their involvement in creating tax-favored
executive comp packages. That has consequences for investors'
perception of the auditor as an independent watchdog, which is
absolutely at the heart of any investor confidence.
Finally, as I mentioned in my testimony, to the extent that
CEO pay and the political dynamics surrounding CEO pay appear
to be compromising our accounting system, the system of GAAP,
we run the risk as a financial marketplace of being viewed as
having a culture of non-transparency and insiderism that is not
correctable. That perception came to dominate the market's
views of a number of countries in the late 1990s, much to their
detriment, countries in East Asia that were viewed as darlings
of investors, who then the global marketplace viewed as simply
unable to correct themselves. With the continuation of
executive comp-driven scandals that impugn auditors and suggest
that our executives are not accountable and the possibility
that our accounting system will continue to be influenced by
the ability of executives and their representatives to
essentially warp the judgments of accounting professionals, we
run the risk of being perceived just as those Asian tigers
were.
The Chairman. Mr. Hall?
Mr. Hall. I do not have anything much to add, other than to
agree with what has been said and add that the silver lining is
that, even though investor confidence has been--has taken a big
hit, the good news is that this has also led to an impetus for
change, particularly in the area of accounting. So I think
actually investors have reason to be hopeful as long as these
changes are carried through.
It is very hard to do anything in a period like 1999 or the
year 2000. It is just very hard to make changes in a period of
asset bubbles.
The Chairman. Mr. Bachelder.
Mr. Bachelder. CEO pay has not been immune from criticism
for very long at any time over the----
The Chairman. My question was: Is the present issue of CEO
compensation having a negative effect on investor confidence
today?
Mr. Bachelder. I doubt that it does, and I doubt that CEO
criticism over the past 50 years has had much effect on the ups
and downs of the stock market.
The Chairman. Thank you.
Mr. Harrigan. I would agree with my three colleagues to the
far right, my far right. I think it has had and continues to
have an impact on investor confidence. I mean, every day you
read about abuses in the newspaper--American Airlines,
WorldCom, Global Crossings, etcetera, etcetera. But it is not
just the abuses we read about in the newspaper. It is the level
that executive compensation has gotten to, the fact that it has
increased from 40 times the average pay of a production worker
in 1980 to over 400 times. Some statistics indicate it is up to
575 times that of a production worker today, and it continues
to rise.
Mr. Bachelder in his comments indicated that executive
compensation actually dropped in 2002. While that is true on
the average, at the S&P companies it dropped by 23 percent,
when you figure out what the median was, because there is a few
at the very top that dropped, actually the median executive pay
in the year 2002 rose by 14 percent while the S&P was down 22.1
percent.
So this behavior just continues and continues and
continues. Until compensation committees and boards actually
become accountable to the owners, to the shareholders of
companies, I do not see any end in sight and I do not see any
alleviation of the real breach that has occurred between boards
and investors.
The Chairman. Mr. Bachelder, I know you want to respond.
Let me just say while you do, Mr. William McDonough, the
President of the New York Federal Reserve Board and newly named
head of the SEC's Accounting Industry Oversight Board, called
current CEO pay levels, quote, ``terribly bad social policy and
perhaps even bad morals.'' That is Mr. William McDonough, who
is one of the most respected men I know in America, who has
just received a very significant appointment.
But I also want you to respond to Mr. Buffett's statement,
quote: ``One of the arguments was that options are too hard to
value.'' This is Warren Buffett: ``That is nonsense. I have
bought and sold options for 40 years.'' So Mr. Buffett is able
to figure out the value of options. He says: ``I have bought
and sold options for 40 years and know their pricing to be
highly sophisticated. It is far more problematic to calculate
the useful life of machinery, a difficulty that makes the
annual depreciation charge merely a guess. No one, however,
argues that this imprecision does away with a company's need to
record depreciation expense. Believe me, CEOs know what their
option grants are worth. That is why they fight for them.''
I would be glad to hear your response to Warren Buffett,
Alan Greenspan, Paul Volcker, and a broad variety of most
highly respected men in America, but especially Mr. Buffett,
who deals with this, who trades, he has bought and sold options
for 40 years. Go ahead.
Mr. Bachelder. Mr. Chairman, could I just add one note to
my prior statement. I think we need to distinguish those
relatively isolated cases, important and terrible as they are,
of corruption in major U.S. corporations from the question of
CEO pay. CEO pay exists and it exists in terms of statistics as
well as individual cases, and on the whole I do not believe CEO
pay has grown outrageously, and I think stock options at the
present time based on Black-Scholes valuation are a very
misleading factor as to the level of CEO pay.
With regard to Mr. Buffett and the question as to whether
or not you can value a stock option, Mr. Buffett was referring
to having been in the business of trading options. I do not
disagree that if you are in the business of trading options
that you can put a value on an option that is freely tradable
three months, six months out. But try to value an option that
is out for ten years. It is virtually impossible to forecast
all the various elements that are going to happen in a decade
and will impact on that option to put any kind of realistic
value on it.
The Chairman. I guess Mr. Buffett's response is it is just
as hard or harder to calculate the useful life of machinery.
Go ahead, Mr. Hall, and then I will go to Senator Breaux.
Mr. Hall. I was just going to say that a standard
accounting principle is that even when things are hard to
measure we do not call them zero. We just never do that. There
are many other things that are hard to value. Another one, for
example, is stock. Stock is not freely traded, so you cannot
just use the market value. It may be forfeited because it is
vested, and it could also fall in value. In fact, it could fall
all the way to zero if a company goes bankrupt, in which case
the accounting statements would have been incorrect along the
way.
We never seem to use the principle of saying something is
difficult to measure, therefore we call it zero, and I do not
see any reason why we should use it here.
I agree with the points that Senator Allen made earlier
about options being a fantastic device in many ways for
corporate America, and the only question is that we should
account for them correctly, not that we should quit using them.
The Chairman. Senator Breaux.
Senator Breaux. Thank you, Mr. Chairman, and thank all the
panel members for a very informative set of testimony from all
of you.
I agree with Mr. Harrigan's last comment that until
compensation committees and shareholders get involved in what
is happening in their own companies we are never going to solve
this problem. I mean, that is their first line of
responsibility, is making sure the company is being run
properly and that people are being paid properly. That is their
job, that is their responsibility. That is why they are what
they are, and they in many cases are not living up to that
responsibility.
Mr. Clapman, you talked about on page 6 of your testimony,
after you made a number of very helpful recommendations, you
say: ``Congress should be careful not to politicize this issue
and should permit FASB to take on this issue on its intrinsic
merits.'' I guess probably you are speaking of the question of
expensing options. Are you saying that Congress should stay out
of it and FASB should do it, or should we be involved from your
standpoint?
Mr. Clapman. Senator Breaux, you have it exactly correct.
As you know, a number of years ago the issue arose, so this is
not a new issue, the issue of expensing stock options, and at
that point it became politicized and FASB backed off from
dealing properly in our eyes with that issue.
I think people have seen--there is a difference now,
obviously, between 2003 and 1993 in terms of our experience,
and I think our experience now tells us that we really are
trying to analyze this issue in terms of future implementation
of compensation programs and that is the true relevance of this
issue. We can all hash out the past and try to explain it, but
finally our task, all of us here, yours and ours, is to find
effective means to deal with the issue of executive
compensation and corporate governance in the future.
I think the most important point I tried to make is that a
true alignment between shareholders and management is something
that relies on performance measures, not just the vagaries of
short-term stock performance, but long-term alignment, holding
stock and having performance hurdles. And until FASB or the
accounting regulators get the issue of expensing right, you
will crowd out all of the better forms of alignment
methodologies and rely only on the short-term stock effect. So
that is why that issue is so critical in terms of what it will
mean for the future.
Senator Breaux. Your recommendation, though, is that
Congress should butt out of it and let them do it?
Mr. Clapman. Yes.
Senator Breaux. Mr. Bachelder, you tried to make the point
in the first page of your testimony, in comparing CEO pay,
compensation packages, as a percentage of revenues, and that
you point out that--I guess you are making the argument that
actually CEO pays and bonuses and salaries are less today than
they were ten years ago as a percentage of revenues.
Mr. Bachelder. Yes.
Senator Breaux. Is that also true of employees as well as
the CEOs?
Mr. Bachelder. I think that it is true of employees as well
as CEOs. I think the point is that the CEO pay relative to the
growth of U.S. corporations, whether measured by revenues or
measured by market capitalization, has not been out of line.
These gentlemen and women who are the CEOs of these
corporations are custodians and fiduciaries of enormous masses
of capital and revenues, and the pay relative to those, to that
capital and those revenues, has not changed significantly.
Senator Breaux. What do you say when you see CEO
compensation packages that have actually increased by huge
amounts by companies that are losing revenues?
Mr. Bachelder. It depends upon what you mean by the CEO pay
package. If one is referring to stock options, say an executive
is a CEO of a company today that is in 2002 losing, has lost
money. That individual may have stock options dating back ten
years and those options may be exercised in that year. That
person may realize substantial gains for having held the
options for ten years. That is not attributable to the
performance of the company in 2002.
Senator Breaux. Yes, but we are also seeing examples where
CEOs have gotten enormous increases, not in options but in
salaries and bonuses, for companies that are going in the
downhill direction.
Mr. Bachelder. Generally speaking, salaries have a
consistent rate of increase and over the past 50 years, after
taking into account inflation, it has been about just under 2
percent. You are speaking to the bonuses then. Bonuses vary. It
depends--I do not know of a case where a company has had a
significant loss for the year in which an executive, a chief
executive, has received a large bonus unless it was
contractually bound prior to that year. And in some cases a new
chief executive officer, such as one going into Tyco or in
other instances, when they go into the company they may have a
right for a year or two to have a bonus. That is a guaranteed
bonus.
Generally speaking, annual bonuses follow the performance
of the company.
Senator Breaux. I am sure Mr. Hall or Mr. Silvers could
give us some examples of those situations. But I mean, we have
clearly seen executive compensation packages that seem to me to
have very little to do with performance. I mean, I think when a
company does well the employees should do well; when the
company does bad, the employees, including the CEOs, have to
participate and not get huge increases.
Mr. Bachelder. If I might just respond, when you use the
term ``packages'' that is a very important term of reference,
because so many spokesmen, so many media commentators and
others refer to a CEO package which is on different tracks,
whether it is a salary, annual bonus, long-term incentives,
stock options, and they put the package together and say this
person received $50 million this year and the profits went
down. Well, most of that may well have come from exercising an
option that that individual had held for years.
Senator Breaux. My final question. Thank you. Mr. Silvers,
you talked about the AFL-CIO filing a rulemaking petition with
the SEC asking commissioners to democratize the director
election process, and Mr. Harrigan I think talked about the
fact that directors have got to wake up, particularly people
who run compensation packages, and it is too much of a
collusion between the CEOs and the directors and the
compensation committee members.
How do we do that? I mean, thou shall pass a law that says
thou shall have democratically elected boards? What is the
process here? How do we accomplish this?
Mr. Silvers. Fortunately, Senator, I do not think it is
necessary for you to pass a law. The question here is really
the control of the proxy form itself by management. In a
company, in a public company of any size, it is prohibitively
expensive for shareholders who hold small fractions of that
company to themselves nominate and run a director election
contest and send out their own proxy. In a large cap company,
any of the familiar names to the average person, the costs of
doing so run into the millions of dollars.
Management is spending corporate treasury money to run its
slate of candidates. The SEC has the rulemaking authority and
has used it to require that that proxy that management creates
include in certain circumstances shareholder proposals. Those
shareholder proposals, however, are generally not binding.
It is our opinion that the SEC by rulemaking could require
in certain circumstances management to include shareholder-
nominated director candidates on that proxy and offer
shareholders the choice of voting for management's slate or a
shareholder-nominated slate. We believe it is very important--
we believe, A, that that is very important to be done, that if
we are going to make boards real there has got to be some
meaningful way of shareholders affecting what is on the boards.
However, we do not think that this ought to be done in such
a way as to essentially subsidize corporate takeovers. If you
want, someone wants to do a corporate takeover, they should
have to spend money to do it. The trick is to create a
mechanism that gives shareholders some voice, and a particular
kind of shareholder--large, long-term institutional holders
whose interests are closely aligned with that of the company
going forward, as corporate law defines the company's
interests, the long-term interests of the company and its
shareholders.
We believe that can be done and our rulemaking petition
asks for that to be done by requiring companies to place on
their proxy form shareholder-nominated directors for a minority
of the seats up for election, what is called a short slate, but
only to do it if asked by a significant block of shareholders.
Now, we suggest in our rulemaking petition 3 percent of the
company's shareholders have to ask. Others have suggested
higher numbers, 5 percent, 10 percent. Because of the Williams
Act that governs takeovers and shareholder action, those higher
thresholds have some complexity, some complex issues associated
with them.
But the basic notion is that you have to require a block of
shareholders that is a real block, not a gadfly, not somebody
who is doing this for a hobby, but a real block of large
investors. You require that they have held the stock for some
time, so this does not become a vehicle for people coming in
and out of the company and trying to game the system. Also, you
give them the opportunity to run on an economical basis short
slate that would give voice to long-term investors on the
board.
We believe that if that rulemaking petition were adopted by
the SEC--once again, it does not require Congressional action;
the commission can do it by rulemaking--that that would change
the board's dynamics around executive pay, that it would make
comp committees much more attentive to the desires of
shareholders like TIAA-CREF, like CalPERS, like our large
pension funds, and less deferential to the desires of the CEO.
Only by doing that can you create a real market. And I
respectfully disagree with Mr. Bachelder; I do not think in
general we have a real market here.
The Chairman. Senator Allen.
Senator Allen. Thank you, Mr. Chairman.
I think we all agree, at least I believe we do and I
certainly believe, that we must continue to enforce the laws,
we need to improve corporate accountability, and we need to
provide investors with an accurate depiction of the financial
condition of corporations, and that is whether it is an
individual investor or large ones like TIAA-CREF or CalPERS or
any others.
I have enjoyed listening to the testimony. I will make a
few observations and ask a few of you some questions, and some
are very logical on aspects--the issue of stock options, I
would say to Mr. Hall, is not so much--it is not an issue of
expensing, because I do think it is very difficult to determine
what the value is of a stock that is going to be or the
exercise of an option ten years down the road. They are not
traded like the Board of Options. There is only one person, and
that is the person it is granted to, that can exercise it. It
is not freely traded. It is really a matter of dilution and how
you accurately depict that dilution when and if they are
actually exercised.
Mr. Harrigan talks about a certainly reasonable
consideration and that is performance-based compensation. I
like that concept. That is the way it ought to be. It would
seem to me, though, that long-term stock options would be a
method by which that performance long-term--not these three-
month, six-month, which probably ought to be expensed because
those can be. Those do have a value that you can determine, but
not something five or ten years down the road.
Now, in looking at how you--you brought up American
Airlines and that, Mr. Silvers, in your comment and others.
Well, that CEOs misdeeds, poor judgment, and egregious
behavior, there was reaction. The board of directors removed
him, and so there were consequences, and I applaud the American
Airlines board for acting.
The idea that you cannot figure out the cost of options
because they are inaccurate, but, gosh, there are other
inaccuracies in determining depreciation of machinery or
equipment. Well, with machinery and equipment you know what you
paid for it. Maybe somebody paid $30,000 for some machinery or
equipment. The IRS says you could depreciate that equipment,
say it is some types of equipment, three to five years. Others
are ten to fifteen years. But there is an actual value to it.
Now, Mr. Silvers, you mentioned in your testimony, written
testimony, that there is a crisis in executive compensation
that is a microcosm of the crisis in corporate governance that
brought us Enron, WorldCom, and HealthSouth and so many others.
Let me add a couple other names to your list of corporate
wrongdoers: Union Labor Life Insurance Company, where union
leaders created a scheme to give themselves $6.5 million while
costing millions of workers their pension funds they were
entrusted to and invested in in this Union Labor Life Insurance
Company. I will put this into the record, an article from the
Wall Street Journal on that.
[The information referred to follows:]
Wall Street Journal, August 20, 2002
REVIEW & OUTLOOK--Big Labor's Enron
AFL-CIO chief John Sweeney is having a high old time with business
scandals, condemning ``corporate greed'' and capitalist ``thieves.''
Yet his acute moral antennae have somehow missed the shenanigans at
Union Labor Life Insurance Co., or Ullico, a labor-owned insurance
company that looks like Big Labor's Enron.
Last week the National Right to Work Legal Defense Foundation asked
the National Labor Relations Board to investigate if Ullico's board
members--all top union officials--profited at the expense of rank-and-
file union members in a dubious stock-selling scheme. A federal grand
jury and the Labor Department are also probing those stock
transactions.
Ullico was founded in 1925 as a way to provide low-cost life and
health insurance to union members. The insurer is privately held, and
to ensure labor control it allows only unions, as well as officers and
directors, to buy its stock. For years a share of Ullico was fixed at
$25.
In the go-go 1990s, however, Ullico decided to join the pursuit of
stock-market riches. In 1997 the company invested $7.6 million in a
modest little venture known as Global Crossing. By May of 1999, when
Global Crossing's stock peaked, Ullico's stake was worth $2.1 billion--
almost 10 times what all of Ullico was worth when it first invested.
As Ullico's investment grew, it decided to cut its stockholders in
on the windfall. It abandoned its old fixed valuation of $25 a share
and began adjusting its share price annually, as determined by a year-
end accountant's review. The board would ratify the new price, and then
Ullico would repurchase shares to allow investors to realize gains. And
so in May of 1999, the Ullico board ratified a share price of $53.94,
and went ahead with a plan to buy back as much as $15 million worth of
shares from investors.
But here's where things get Enron-esque. In December of 1999
Ullico's chairman, Robert Georgine, sent a confidential letter to the
company's senior officers and directors offering to let them buy as
many as 4,000 Ullico shares at the $53.94 price. But two weeks later, a
year-end audit pointed to a higher price of $146, which the board
ratified in May 2000. Those insiders were in effect ratifying nearly a
tripling in value of their own Ullico investments.
By then, however, the telecom bubble had begun to burst. By
November 2000, Ullico's investment had fallen dramatically (Global
Crossing's shares had dropped below $25 from a high of $64.25), but the
Ullico directors authorized another stock buyback--and at the same $146
price.
That buyback was technically open to all shareholders. But it was
crafted so that large shareholders--mainly the unions--faced
restrictions on how much they could sell. Meanwhile, those with small
holdings--officers and directors--were allowed to sell back all of
their shares. And the board agreed to extend the sell deadline by five
months. As a result of prices and buyback rules that they themselves
had set, a handful of directors made a windfall estimated at $6.5
million.
These weren't just any old union members, either. Among those who
sold back shares were Martin Maddaloni, president of the plumbers
union; William Bernard, former head of the asbestos-workers; Jacob
West, former ironworkers' chief; carpenters' president Douglas
McCarron; and Morton Bahr, president of Communications Workers of
America.
So at the same time that the value of Ullico was falling like a
rock, these insiders made out like, well, Andrew Fastow. These union
bigshots insist they've done nothing wrong, but that's what Enron
executives also say. ``These leaders have damaged millions of workers'
pension funds which were entrusted to and invested in Ullico,'' says
National Legal and Policy Center President Ken Boehm. Mr. Georgine and
Ullico decline comment.
Mr. Sweeney has said that he himself did not sell any shares, and
he publicly called on Mr. Georgine to appoint an outside investigator.
(Former Illinois Republican Governor James Thompson is leading the
probe). But what Mr. Sweeney hasn't done is turn his moral indignation
loose on his labor peers as he has so often against corporations.
As long as we're talking about blind eyes, we might also mention
the quiet in Congress. Perhaps it's a coincidence that Ullico is a big
political donor, especially to Democrats, and that Ted Kennedy, who
runs the Senate labor committee, was also an Ullico donee his last re-
election. More alarming is the fact that Iowa Democrat Tom Harkin is
insisting on language in an appropriations bill that would block
greater public disclosure by unions. In the wake of the Ullico fiasco,
that's a scandal in its own right.
We look forward to the result of the Labor and Thompson probes,
especially given that 10 of the current Ullico board members also sit
on the AFL-CIO's executive council. If it turns out there was corporate
abuse, no doubt Mr. Sweeney will deal appropriately with the
``thieves.''
Senator Allen. I would also like to mention another
corporate scandal, one where the American Federation of
Teachers failed to maintain oversight of the Washington, DC
Teachers Union--this is just a recent story--resulting in the
theft of more than $5 million by union leaders. And I will ask
that these be put as part of the record.
[The information referred to follows:]
Labor Watch, March 2003
Teachers Union Scandal in the Nation's Capital
washington teachers union officials embezzle millions, sully city
politics
By Patrick J. Reilly
Summary: Last month we reported on the Ullico scandal, a major
embarrassment to AFL-CIO president John Sweeney who had publicly
ridiculed Enron executives for their ethical lapses. Once again we find
that a vocal critic of Enron is embarrassed by scandal in her own
ranks. Sandra Feldman and the American Federation of Teachers failed to
maintain careful oversight of the Washington Teachers Union, resulting
in the theft of more than $5 million by union leaders. Here we take a
look at the unfolding story and the characters who play major roles.
Sandra Feldman, president of the American Federation of Teachers
(AFT), thinks the corporate scandal at Enron highlights what's most
admirable in public education and what's most lacking in private
schools.
``Unlike the private sector, public agencies and their employees
received systematic monitoring and oversight,'' Feldman told AFT
delegates to the union's annual convention last summer. ``And that's a
good thing. Just look at Enron.''
But when Feldman repeated her rant against Enron in her January 15
``Where We Stand'' column, a paid advertisement that is placed in
newspapers nationwide, her hypocrisy was obvious even to AFT members.
By that time they knew of the major scandal uncovered at AFT's
affiliate in Washington, DC and caused in part by AFT's failure to
enforce its own oversight rules.
The day after Feldman's Enron column appeared, AFT appointed an
administrator to run the Washington Teachers Union (WTU)--the first
forcible takeover of a local union since AFT's founding in 1917. It was
an embarrassment the likes of which AFT has never seen, and the scandal
just keeps unfolding daily.
Millions Misspent
WTU officials might still be plundering the union were it not for a
single mistake made by WTU president Barbara Bullock last April.
Bullock told District of Columbia finance officials to withhold $160 in
union dues from special paychecks sent to teachers as part of a newly
contracted pay raise. But teachers actually owed only $16, resulting in
an overcharge of more than $700,000.
No one may ever know whether the overcharge was a mistake or
intentional. But about the same time, Bullock paid about $700,000 to
AFT to cover national dues payments that were years late.
It was then that teachers began to complain about the overcharge,
prompting AFT to take notice and initiate an internal audit of WTU's
finances.
AFT should have known there was a problem years prior to the audit.
Indeed, AFT rules require affiliates to conduct internal audits every
two years, but WTU had not done so since 1995. AFT repeatedly requested
an audit but took no action against the union, which reportedly had not
even employed an accountant since 1996.
By last year, WTU was in financial trouble. The union had to settle
a lawsuit filed by its landlord for failure to pay rent on its downtown
DC headquarters. Many bills were late or unpaid, including companies
providing employee health benefits. The dues overcharge only made
matters worse: recently the union had to take out a $250,000 loan to
reimburse teachers, saddling the union with repayment of the loan plus
interest. (AFT later announced that it would pay off the loan.)
The results of AFT's audit were stunning. Auditors found that at
least $5 million in union funds had been misappropriated by WTU
officials, including president Barbara Bullock, her special assistant
Gwendolyn Hemphill and treasurer James Baxter. The three had boldly
used union credit cards and cashed checks for thousands of dollars that
were used for personal expenses.
A week before Christmas, FBI officials raided the homes of the WTU
leaders and their family members, seizing business items and an
astonishing array of personal clothing, jewelry, and household items
allegedly purchased using WTU credit cards and other funds.
On December 27, Nathan Saunders, a history teacher at Anacostia
Senior High School, filed suit in U.S. District Court against WTU and
AFT claiming fraud and negligence due to the union's failure to conduct
audits required by AFT. He asked the court to dissolve the WTU's
executive board and establish an independent body to oversee the union
and hold new board elections.
Two other teachers--Alfred Hubbard and Roland Ashby-Rier--also
filed suit asking the federal judge to ensure that teachers continue to
have some role in overseeing the union. Last month, another four
teachers filed suit seeking class-action status on behalf of all DC
teachers.
The scandal continues to grow as District and federal investigators
uncover not only the theft of WTU funds but inappropriate meddling by
union officials in District politics and city government. The
allegations are causing major headaches for the District's mayor
Anthony Williams just as he begins his second term.
As the scandal unfolds, it's difficult to piece together the story
of what may be one of the worst cases of union corruption in many
years. But a review of the major players in the scandal offers a
glimpse of how far-reaching the investigation has already become.
Barbara A. Bullock
Barbara Bullock was WTU president for almost a decade, beginning in
1994. For almost the same period of time, she allegedly stole more than
$2.1 million from the union's members.
An FBI search warrant filed in U.S. District Court alleges that
Bullock charged WTU for personal goods and services worth more than $1
million, including a $57,000 Tiffany sterling silver set and several
hundred thousand dollars on expensive clothing and jewelry. But WTU's
internal audit identifies more than $1.8 million in personal charges to
the union's American Express account and more than $381,000 in union
checks applied to personal expenses. The auditors' report also says
Bullock issued more than $1.5 million in union checks with the
intention of laundering money. Bullock reportedly admitted to auditors
that ``most of her charges to the American Express charge account were
for personal items.''
Over the span of two weeks in August 2000, Bullock made four
contributions totaling $9,000 to the Democratic National Committee. The
final gift of $5,000 was assigned to non-federal campaigns, possibly in
the District of Columbia. That same year she gave $2,000 to Hillary
Rodham Clinton's U.S. Senate campaign. All of the payments, according
to WTU's internal audit, were charged to the union's American Express
account.
Labor Watch has also identified a previously unreported
contribution of $1,000 that Bullock made to the Gore 2000 presidential
campaign in June 1999. Although the source of the funds is unknown,
Bullock allegedly was stealing from the union at the time.
Ironically, Bullock seized the presidency in 1993 because of the
troubles of then-president Jimmie Jackson. Jackson won reelection that
year over Bullock, but the AFT declared the count invalid because of
``many irregularities'' in the voting procedures. Bullock won the
second election.
Bullock's emphasis on politics earned her tremendous clout in the
District. In an internal memo to WTU members dated August 26, 2002,
Bullock urged them to help Mayor Williams' write-in campaign, noting
that ``Williams' support was critical in getting your 19 percent raise
and the prepaid legal plan for which several council members were also
in line with their support.'' The promise of payback at the polls was
genuine: all of the WTU-endorsed candidates--including Williams, DC
Delegate Eleanor Holmes Norton and six members of the DC Council--won
their races last November.
The benefits to the union were apparent to all. The prize Bullock
sought throughout her term as WTU president was a huge increase in
District teachers' pay to bring it in line with salaries in the
Maryland and Virginia suburbs. Williams was not shy about publicly
supporting Bullock's proposal, which she eventually won with a contract
last year that increased teacher salaries by 19 percent over three
years. At Bullock's urging Williams pushed for the plan, even though he
had already forced the District school board to trim its budget by $30
million, pulling $15 million away from much-needed repairs of the
city's dilapidated school buildings.
Even one of Williams' appointees to the school board lamented the
salary increase as ``a terrible message to be sending to our
students.''
``The price that we are paying for this contract is going to be at
the expense of our students,'' said board member Laura Gardner to the
Washington Post. ``And I think that we constantly, constantly send a
message to our students when we do this that everyone except them is
worthy of some consideration.''
But Williams' involvement didn't end there. The school board
intended to meet its cost-cutting goal partly by eliminating $1.1
million in personal legal assistance to District teachers, a special
benefit that was also taken off the bargaining table in contract
negotiations--or so school officials thought. After WTU and public
school negotiators shook hands on the contract, Williams' chief of
staff Kelvin Robinson and deputy chief of staff Gregory McCarthy
reportedly demanded that school officials write the benefit into the
formal contract.
Gwendolyn M. Hemphill
A major player behind Bullock's political success and her scheme to
steal millions from the union was her special assistant, Gwendolyn
Hemphill.
It was in large part because of Hemphill's many years of experience
as a DC political insider that WTU was able to hold sway over District
officials. She first got involved in DC politics in 1963, when she
joined activist Marion Barry--later DC mayor and a disgraced felon--in
a civil rights demonstration. She later worked for the Federal
Government and the American Federation of State, County and Municipal
Employees (AFSCME) before chairing former mayor Walter Washington's
campaign in 1974. Subsequently Hemphill was Mayor Barry's labor liaison
for three of his four terms and retired from city service in 1996 to
assist Bullock at WTU.
When Anthony Williams became mayor in 1998, Hemphill quickly became
a key advisor. Williams appointed her to his Finance Committee and
Employee Appeals Board, and she became executive director of the DC
Democratic State Committee. In 2001, Hemphill hosted a lavish party at
her home to welcome Williams' new chief of staff Kelvin Robinson.
Stories of Hemphill's influence in DC politics are numerous. Mayor
Williams allegedly instructed Mark Jones, then his chief of staff, to
hire Hemphill's husband, Lawrence Hemphill, as director of the DC
Office of the Public Advocate and later director of the Office on
Community Outreach. (Williams fired him in January because of the WTU
scandal.) Jones also says the mayor told him to prevent the firing of
Michael Bonds, a community service representative who worked with
Lawrence Hemphill, noting that ``Barbara [Bullock] and Gwen [Hemphill]
don't want him fired.'' Jones is currently suing Williams over his
firing after he allegedly solicited money from nonprofit organizations
for Williams' reelection campaign.
In hindsight, Hemphill's spending beyond her means and her repeated
proximity to scandal might have indicated that problems were brewing.
The same woman who threw lavish parties already had a history of
financial trouble, including bankruptcy in 1986 and a 1984 appeal to
the District's emergency mortgage assistance fund. Federal
investigators are now asking why Hemphill used a WTU credit card to pay
$20,000 to the caterer for her 2001 party in honor of Kelvin Robinson,
just the beginning of a long list of alleged misuses of WTU funds.
According to WTU's internal audit, Hemphill made unauthorized
personal charges to the union's American Express account exceeding
$311,000 and wrote checks for unauthorized expenses totaling $181,000.
She allegedly used the funds to purchase a $13,000 plasma television
and other luxuries for herself and family members.
Like Bullock, Hemphill made political donations during the period
of embezzlement, but the source of funds is unknown. Labor Watch has
discovered a $250 contribution last year to EMILY's List, a political
action committee that supports female abortion-rights political
candidates. Hemphill and her husband Lawrence also gave $1,000 to Al
Gore's presidential campaign in May 2000.
Hemphill was co-chairman of Williams' reelection campaign last
year, overseeing most day-to-day operations during a period when the
campaign collected hundreds of fraudulent signatures, a scandal that
kept Williams' name off the Democratic primary ballot and forced him to
fight for reelection with a write-in campaign. Hemphill resigned from
the campaign soon after the scandal became public, and although she was
called to testify before the DC Board of Elections and Ethics, no
charge of impropriety was ever filed against her.
But the DC inspector general is reportedly investigating Hemphill's
use of WTU funds to pay for expenses incurred last year by William's
reelection campaign. Hemphill claims that she acted under the
impression that Kelvin Robinson, the mayor's chief of staff, wanted the
union to cover the $2,000 bill when he told her to ``take care of'' it.
But Robinson says he expected Hemphill to use campaign funds to pay for
the DC voting rights t-shirts and other items distributed at the
Democratic National Convention in Los Angeles.
The Washington Post also cites an anonymous former employee in
Williams' office who claims Hemphill gave the mayor a $5,000 check in
2000. The check drawn from WTU funds was allegedly used to sponsor
Christmas parties organized by For the Children, a nonprofit charity.
The DC Office of Campaign Finance has ruled that the mayor's office
violated city rules by soliciting money for the organization and not
disclosing the gifts. Also, funds intended for children's parties were
allegedly diverted to pay for a reception for Williams' supporters.
In January, the DC Office of Campaign Finance opened a new
investigation to determine whether the Williams campaign failed to
report contributions from WTU. The campaign did not report use of WTU's
telephone banks to get out voters as an in-kind contribution. Also
under scrutiny is Hemphill's work for the campaign while a full-time
employee of WTU, an arrangement that would ordinarily be considered an
in-kind contribution from the union. WTU's alleged $5,000 donation for
the For the Kids Christmas parties will also be investigated, as will
two Williams fundraisers hosted by WTU attorney Curtis Lewis in 1998
and 2002 for which expenses were allegedly charged to a WTU credit
card. The Williams campaign has turned over to federal prosecutors
copies of checks totaling $33,025 that Hemphill allegedly failed to
deposit for several months, far beyond the five-day limit imposed by
city election laws.
Hemphill is implicated in an incident disclosed on January 17 by
Philip Pannell, Democratic chairman for the District's Ward 8, to
shocked listeners of a WAMU radio talk show. Pannell claims Hemphill
talked to him in August 2001 about arranging for funds to support his
reelection campaign. On the day of the vote, Pannell says a car pulled
up, and he was handed an envelope filled with $2,500 in cash--just as
Hemphill had promised, he says. Hemphill denies Pannell's account,
which he presumably disclosed out of concern that he might have spent
WTU funds on his campaign.
Despite her resignation from WTU and the DC Employee Appeals Board,
Hemphill remained executive director of the DC Democratic State
Committee until December. Even after submitting her resignation letter
to committee chairman Norman Neverson, he kept the letter secret and
allowed committee members to debate Hemphill's fate for three weeks
before announcing her departure. Neverson seemed to be searching for a
way to keep Hemphill on board, telling the Washington Times, ``The
party would be extremely impoverished without Gwen's outreach'' and
``We would be shortsighted to ask her to step down.''
Local reporters seemed at a loss to explain Neverson's actions, but
they may be just another example of a Hemphill attempt to benefit from
her vast network of cronies. Hemphill and Neverson are close neighbors
and have been friends for 35 years. In 1998, Hemphill convinced
Neverson to return from retirement and help elect Williams mayor, an
effort that landed Neverson the chairmanship of the DC Democratic State
Committee.
Vice chairman Pat Elwood has requested an audit of the committee's
finances, and Neverson has agreed. Although party officials say they
don't expect the audit to turn up any irregularities, former committee
treasurer Robert Artisst told the Washington Times that he had some
concerns about the committee's use of a separate series of checks of
which he had no knowledge. Artisst said he had noticed some checks that
were not dually signed by the treasurer and another executive committee
member.
Leroy Holmes
Bullock's chauffeur Leroy Holmes is perhaps the most colorful
player in the WTU scandal. For his trouble driving Bullock on her
shopping trips and collecting union cash from the bank, Holmes was
awarded a salary of $105,000 and more than $7,000 toward expenses for
his Cadillac, about four times more than a typical driver's salary in
the nation's capital. He has now pleaded guilty to a federal charge of
conspiracy to launder proceeds of an unlawful activity.
Holmes reportedly told WTU auditors that he routinely went to
Independence Federal Bank in the District and cashed union checks made
out to him, allegedly totaling more than $1 million from 1997 to 2002.
The amounts were usually just under $10,000, the minimum required for
currency transaction reports, but sometimes more. He allegedly would
often call ahead to ensure that sufficient cash was available, cash a
check, then stuff his pockets full of bills as he walked out the bank.
Most of the cash would be handed over to Bullock or Hemphill--some he
deposited directly in Bullock's personal account--and he would keep the
rest for himself to the tune of about $100,000 a year, according to
prosecutors.
James O. Baxter III
Asked in October to resign from WTU with Bullock and Hemphill, the
union's treasurer James Baxter has not been the focus of much media
attention. But his unauthorized charges to the union exceed Hemphill's,
according to WTU auditors. Baxter is accused of charging more than
$311,000 to the union's American Express account and writing union
checks for $270,000 for personal use.
Court documents cite evidence that Baxter failed to accurately
report his union income to the IRS and the Labor Department. He
allegedly joined with Bullock and Hemphill to hire an accountant to
help them hide their misconduct.
In 1997, Baxter was hired by Mayor Marion Barry to serve as
director of the DC Office of Labor Relations and Collective Bargaining
while also serving as WTU's treasurer. Although the dual role was a
conflict of interest in violation of District law, Baxter remained in
that post for 16 months after Williams took office in 1999. Baxter was
fired by Williams in spring 2000 because of the violation, but only
after Bullock and Hemphill reportedly used their clout to frustrate
several attempts to remove him.
Anthony A. Williams
DC Mayor Anthony Williams was confronted with the WTU scandal just
weeks after his reelection campaign struggled its way to victory
despite submitting fraudulent signatures to the elections board and
failing to get on the Democratic ballot.
During Williams' first run for office in 1998, the WTU stood by
Williams when every other city labor organization shunned him.
Williams, a former chief financial officer for the District, had fired
more than 200 city workers during his tenure, acts not easily forgiven
by union leaders. But WTU's Bullock made a shrewd calculation that
supporting Williams, who had little experience with DC schools and
needed the union's help, could significantly increase the union's clout
if he defeated DC Council member Kevin Chavous. WTU's endorsement is
credited with solidifying Williams' victory, just as the union had
ushered the infamous Marion Barry to the board of education in 1971 and
the mayor's seat in 1979.
The endorsement was particularly important because Chavous was the
city council's education committee chairman and an early favorite to
win the race. Chavous later said WTU ``gave the mayor momentum at the
time because I was the education chair . . . It cut into what should
have been my base. I think the mayor always felt he owed them
politically.''
William's close relationship with Bullock and Hemphill is now
costing him dearly. He has responded testily to questions about the
scandals and has attempted to distance himself from WTU.
Curtis Lewis
Last September, the former director of the DC Office of Human
Rights filed a $55 million lawsuit against Mayor Williams, claiming
that he was fired for refusing to violate DC contract-procurement laws.
Charles Holman said WTU president Bullock pressured him in 2001 to
award a $296,500 contract for handling human rights filings to the law
firm Curtis Lewis & Associates. Although Holman initially refused, he
says William's acting chief of staff Joy Arnold pushed the contract
through. The city says Holman was fired because of worker complaints
including accusations of racial discrimination.
What makes this especially interesting is that Curtis Lewis is
James Baxter's brother. His firm was hired by Bullock to handle the
union's legal affairs. According to WTU's internal audit, the union
made ``large payments to and improper health insurance premium payments
of approximately $55,000'' to Lewis' firm.
The Washington Post reports that an anonymous former official of
the DC Office of Boards and Commissions says Hemphill provided Mayor
Williams a list of nominees for various boards, many of whom were
appointed. The official says Hemphill recommended Lewis to chair the DC
Alcohol Beverage Control Board and was outraged when the official told
her that Lewis was not qualified for the position.
In a January 16 editorial, Washington Post editors suggest that
Lewis was also the reason for Mayor Williams' alleged insistence last
year that DC school officials award free or low-cost legal assistance
to teachers as a $1.1 million benefit--after contract negotiations had
already ended.
``But why would the mayor intervene in a negotiation that had
already given union members handsome pay increases totaling 19 percent
over three years?'' the editors ask. They suggest that Curtis Lewis &
Associates, then representing WTU, would have also represented union
members and would have collected the $1.1 million. Given union leaders'
close relationship with the firm, they may have lobbied for the benefit
partly to enrich Baxter's brother.
Michael & Cheryl Martin
Hemphill's daughter Cheryl Martin and her husband Michael Martin,
operations manager at the DC Health Department's HIV/AIDS office, also
have been named in court documents as participants in the WTU
embezzlement scheme. Their home and Michael's office were raided by FBI
agents in December.
The FBI has filed court documents alleging Martin personally
received more than $20,000 in WTU checks signed by Bullock and Baxter.
The union also allegedly paid more than $400,000 to Expressions
Unlimited, a company owned and operated by Martin and business partner
Errol Alderman, who also works in the District's HIV/AIDS office. The
FBI says there is ``probable cause'' that Martin's business did not
provide many of the services for which it was paid. Court documents
suggest that funds from the Expressions Unlimited account were paid to
Bullock and Hemphill.
On January 23, the DC inspector general announced a review of
millions of dollars spent by the District HIV/AIDS office to ensure
that Martin and Alderman did not misappropriate the funds.
Cheryl Martin reportedly was temporarily hired by Esther Hankerson,
general vice president under Bullock, and received a union paycheck.
Details of the employment have not been reported.
Gwendolyn Clark
Bullock's sister Gwendolyn Clark has been identified in court
documents as a co-conspirator in the looting of WTU, but her exact role
is not yet known. Her home was among those raided by the FBI in
December.
Independence Federal Savings Bank
One of the nation's largest minority-owned thrifts with assets of
$260 million, Independence Federal Savings Bank is suffering serious
problems, now much worse in the wake of the WTU scandal.
Now the U.S. Attorney's Office is considering charges against the
bank for aiding the fraud at WTU by cashing forged checks and violating
the Bank Secrecy Act by failing to report suspicious transactions. The
WTU's internal audit suggests that three of the bank's employees
colluded with union officials. Last month federal prosecutors
subpoenaed account records from the bank.
WTU, Mayor Williams' 2002 reelection campaign, and the DC
Democratic State Committee all have bank accounts at Independence
Federal.
Often the original names on the checks cashed by the chauffeur
Holmes were scratched out and replaced with Holmes' name. The bank
accepted the checks because the changes appeared to be initialed by the
check signer--usually Bullock or Baxter--but auditors say the
handwriting does not appear to match that of the signers. WTU auditors
say bank personnel failed to file suspicious activity reports although
most of the checks cashed were just under $10,000, the minimum required
for currency transaction reports. Even more suspicious, the bank has
not turned over any transaction reports for four checks over $10,000,
auditors say. They also accused bank officials of failing to cooperate
with the investigation.
Esther S. Hankerson
Esther Hankerson, WTU's general vice president since 1994 under
Bullock, automatically assumed the union presidency when Bullock
resigned last October. The union's bylaws require that the general vice
president fill the vacancy until members elect a new president.
But members raised concerns that Hankerson should have known about
the illegal activity. More than 150 teachers gathered at a District
school on January 13 for an unsanctioned emergency meeting at which
they voted no confidence in Hankerson and WTU's 21-member executive
board. Hankerson didn't last long enough for the members to oust her at
a monthly meeting scheduled for January 27--the AFT took control of the
union on January 22, suspended the union's constitution, canceled the
membership meeting and assigned a temporary administrator.
Although Hankerson is not mentioned in FBI court filings, she is
reportedly under investigation for improper use of her union credit
card. Hankerson has admitted reviewing her own expenses after the
scandal broke and finding at least one inappropriate expense to cover
her granddaughter's plane travel--a charge that Hankerson says was a
mistake made by her assistant. The card also was charged for meals that
Hankerson cannot account for, so she says that she voluntarily
reimbursed the union about $1,500.
More serious questions linger concerning the extent to which
Hankerson knew about the looting of WTU. In 1997, the Independence
Federal Savings Bank notified Hankerson that her signature had been
forged on an $8,000 check payable to Bullock, according to auditors.
Hankerson reportedly confronted Bullock, who admitted the forgery and
said she needed the money and would repay it. Auditors say Hankerson
never reported the incident to other WTU officials and the check was
never repaid.
Hankerson also should have known about missing contributions to
employees' pension funds. For the past two years, WTU's executive board
approved pension fund contributions equal to 11 percent of staff
salaries, but much of that money reportedly was never deposited to the
funds. Hankerson was a member of the executive board that approved the
contributions, and in her dual role as a union employee, she should
have received routine statements showing the status of the pension
funds. She claims that she never knew of a problem.
Nevertheless, Hankerson's dual role as an executive board member
and WTU employee seems to have violated the union's constitution.
Hankerson received a salary throughout her eight-year tenure as general
vice president--$90,000 a year before her promotion to president in
October. But except for the president and treasurer, the union's bylaws
prohibit payments to members of the executive board to avoid conflicts
of interest.
Implications for DC Schools
The actions of WTU's leaders will have a harmful impact on DC
public schools for many years to come. Had Bullock and her team focused
their energies on teacher development and quality, the future for many
DC children might not be so bleak.
But bleak it is. Only six percent of the District's eight graders
perform math at grade level, according to the 2000 National Assessment
of Educational Progress (NAEP). The 1998 NAEP found that 10 percent of
the District's fourth graders read at grade level. Yet DC public
schools spent $10,477 per pupil in 2000-2001, far above the national
average of $7,483, and only 43 percent of the system's 11,000 employees
teach.
If lawmakers take note of DC's plight, it may be an opportunity for
reform. Syndicated columnist Walter Williams, an economics professor at
George Mason University in Fairfax, Virginia, has seized on the WTU
scandal as yet another reason why the District of Columbia should
embrace vouchers that allow children to escape to private or other
public schools. Vouchers would empower teachers to establish their own
schools and would break unions' stranglehold over education.
``Teachers, rather than administrators and union officials, would
be in control and set the agenda,'' Williams wrote in his January 12
column. ``Parents would be empowered through choice. Students would get
a much better education. Finally, taxpayers would be less burdened.''
A few days following Williams' column, Scripps Howard columnist
Deroy Murdock also called for more public support for President George
W. Bush's plan to fund voucher experiments in Washington, DC and other
cities.
``It's hard to imagine a place that more urgently needs school
choice than the District of Columbia Public Schools,'' Murdock wrote.
Other school policy proposals may have a better chance of approval
with a weakened teachers union. In her inaugural address on January 7,
DC board of education president Peggy Cooper Cafritz called for
literacy tests for all teacher's aides and competency tests for all new
teachers. Perhaps emboldened by WTU's problems, she dismissed the
union's opposition to any form of testing teachers, saying ``I would
much rather offend an adult than damage a child.''
Such positive reforms would be an appropriate response to the WTU
scandals. But absent school reform and serious change at WTU and city
hall, Washington, DC will remain what Washington Post columnist Colbert
King has dubbed ``The District of Corruption.''
______
Fox News, January 17, 2003
DC Teachers' Union Plagued With Scandal
By Liza Porteus
A 46-page audit released Thursday night at the request of parent
group the American Federation of Teachers alleges that three former
union officers looted more than $5 million over the last seven years
and used the money to buy items such as flat-screen TVs, fur coats and
silver.
``The massive misappropriation of union funds and the betrayal of
the members that are outlined in our audit are reprehensible and
sickening,'' said AFT president Sandra Feldman. ``The individuals
responsible must be held accountable, and the AFT will do everything in
its power to see that these funds are returned to the WTU and its
members.''
With audit in hand, the AFT filed a lawsuit in Federal District
Court in Washington under the Racketeer Influenced Corrupt
Organizations Act and other federal and state statutes. The group is
seeking restitution on behalf of the nearly 5,000 members of the WTU
for the misuse, misappropriation and conversion of union funds.
The lawsuit alleges that eight individuals, including former WTU
President Barbara Bullock, elected union president in 1994; James
Baxter, the WTU's former treasurer; and Gwendolyn Hemphill, former
assistant to Bullock, ``in their positions as union officers, agents,
representatives and employees, or through their relationships with
union officers, agents, representatives and employees, aided and
abetted, participated in, and used the union as part of their
conspiracy to embezzle and convert funds of the union.''
The lawsuit and audit detail a scheme to defraud the union and its
members, embezzle WTU funds and convert those funds for personal use.
The complaint charges that defendants defrauded the union by forging
checks, illegally converting them or using checks without authorization
and that some of the individuals made ``substantial unauthorized
purchases'' with union credit cards.
``In summary, due in large part to the deliberate override of the
system of internal controls at the WTU, Bullock, Hemphill and Baxter
appear to have systematically diverted millions of dollars in WTU funds
to themselves, family members, and others for personal benefit,'' the
forensic examination states.
A WTU receptionist on Friday told Foxnews.com that he was not aware
of any lawsuit and no one was available to discuss the charges. An open
letter from interim WTU President Esther S. Hankerson in December said
she was ``shocked and angered'' by the allegations leveled against
Bullock, Baxter and Hemphill.
``It is very upsetting to see the worst of our fears possibly
coming true, and to realize that perhaps those in whom we placed our
confidence have violated their trust, abandoned their personal and
professional responsibilities and severely abused their position of
authority,'' she wrote nearly a month before the charges were filed.
Auditors began scouring two years of the local union's books in
July after the AFT was alerted by a WTU member to an overcharge of
union dues. What they found was a long trail of forged signatures and
altered checks, as well as $1.5 million in ``inappropriate'' personal
charges on a WTU credit card. Another $948,000 is labeled
``questionable.'' The audit also unearthed nearly $700,000 in
``undocumented expense reimbursements.''
While union rent and utility bills often went unpaid and union
teachers allegedly weren't receiving promised services, the AFT
investigation concludes that Bullock wrote $381,000 in checks to
herself, Hemphill diverted at least $492,000 through unauthorized
credit-card charges or unauthorized checks and Baxter diverted at least
$537,000 to buy himself art, clothing and sports tickets.
The three also allegedly made $12,000 in political contributions--
charged to the WTU's American Express credit card--to the Democratic
National Committee and to the 2000 senatorial campaign of Hillary
Clinton, D-N.Y. Other political donations charged to that account
totaled $4,200, made to groups including the National Political
Congress of Black Women and the (former DC) Mayor Marion Barry
Constituent Services Fund.
Both the DNC and Clinton's campaign have since reimbursed AFT with
the funds.
Then there's the $1.2 million allegedly paid to the Bullock's
chauffer, Leroy Holmes. Auditors say he kept some of that cash and gave
the rest to Bullock or Hemphill, who also co-chaired District of
Columbia Mayor Anthony Williams' re-election campaign. Holmes said he
thought his 2001 salary was $105,000, but $150,000 was noted on his tax
forms. Holmes said the WTU also paid for expenses related to his three
Cadillacs.
The Washington Post reports that Washington's Office of Campaign
Finance this week began investigating whether Williams' re-election
campaign failed to report in-kind contributions from the union. The
mayor and his staff have denied any wrongdoing.
``This is a perfect example of why workers need to have the freedom
to choose for themselves when it comes to union membership,'' said Dan
Cronin, legal director for the National Right to Work Foundation.
Cronin's group argues that this kind of union corruption could be
minimized if workers weren't forced to pay union dues in order to get
jobs.
Included in the WTU's bylaws is a section saying the District of
Columbia Board of Education recognizes the WTU as the ``sole and
exclusive bargaining representative'' in negotiating for teachers'
wages, rights and other job-related issues.
``If workers have the freedom to leave the union and stand on their
own . . . then you would be forced to be more responsive to the
workers,'' Cronin said. ``Compulsory unionism breeds corruption--they
go hand and hand.''
The Post reports that the AFT is considering placing the 5,000-
member WTU in an ``administratorship,'' which would dissolve local
leadership for as long as 18 months. A two-member, AFT-appointed panel
held a hearing Thursday with the local union's executive board and AFT
could vote on a takeover, the Post reported.
Senator Allen. Now, Mr. Silvers, two Rutgers University
professors testified on May 8th at the roundtable on stock
options that expensing will do nothing to constrain executive
pay, which is the general purpose here and stock options kind
of get blasted in the midst of it. Indeed, their research
indicates that researching stock options will lead to the
concentration of stock options among the most senior executives
and, more importantly--and this is what I care most about, is
the elimination of broad-based plans which distribute options
to rank and file workers, whether they are secretaries or
wherever they may be in that company.
So the point is expensing stock options will not solve the
executive pay problem, but it will harm rank and file workers,
who lose out when broad-based plans are reduced. Now, is that a
result, Mr. Silvers, that you would support?
Mr. Silvers. Senator, let me begin in response to your
questions by talking about ULLICO. You correctly identified
that there were a number of insiders that profited at ULLICO
and that ULLICO, the Union Labor Life Insurance Company's
parent, is owned by union pension funds.
The president of the AFL-CIO demanded an investigation into
that matter a year ago. He resigned from the board when that
investigation was not followed. He led the majority of
shareholders two weeks ago, together with President Terry
O'Sullivan of the Laborers Union, in a successful effort to
throw out both the CEO who led that effort and the board
majority that supported it. The incoming CEO, Terry O'Sullivan,
led a board majority that voted to demand that the money be
repaid and that the independent investigation be complied with.
That vote occurred last week.
The management, the new incoming management of ULLICO, is
currently investigating each and every aspect of executive pay
at that company. Key aspects of executive pay at that company
that have been the focus of this issue have been frozen. The
current CEO of ULLICO is serving without pay.
I defy you to find a single example in all the annals of
corporate America of any significant repayment to the
shareholders absent Government action, in fact any significant
repayment at all. The only thing I can think of, frankly, is
the WorldCom settlement announced yesterday. There is no
example that I know of, of significant repayment absent
government action in corporate America, and no example, really
with the exception of American Airlines that you mentioned, of
action being taken to remove people.
The labor movement stands by its record in responding to
what went wrong at ULLICO and stands by President Sweeney's
statement at the beginning of this matter that we intended to
hold ULLICO to the same standards that we held corporate
America to. We said we would do it and we did it.
With respect to the two Rutgers professors, the issue of
stock options in the non-executive context is a significantly
different issue than the issue in the executive context. The
reason for that is because the perverse incentives I alluded to
in my testimony are rather difficult to act on for the average
employee. Therefore, we view as investors options as an
inferior way of compensating executives and would prefer to see
them replaced by restricted stock.
We view options as a somewhat inferior way of compensating
employees as well, but for a different reason, which is that
they create risks when they are part of an employee's base pay
package which the typical employee is ill-suited to bear. The
typical CEO, whose base compensation--Mr. Bachelder could tell
us the exact numbers since he is very focused on the base--the
base compensation is in the millions of dollars, has an ability
to absorb risk that the typical employee does not. When options
become a central feature of the average employee's pay package,
that employee often, as I said, is taking a risk they cannot
afford to take.
That being said, we do not think that options are sort of a
non-starter for the typical employee. However, there is just no
getting around the fact that options are a real cost. You are
paying with a right to the profits of the company and the
returns on equity for labor. Frankly, the bizarre accounting
treatment, that is the result of a political distortion of the
accounting standards-setting process, has led to distortions in
terms of the use of stock options both for executives and for
line employees, in ways that have harmed the average working
person because they are being paid in essentially a debased
currency because companies like to pay in debased currency
because they do not have to expense it.
But we are not going to take the position, which we could
be inconsistent. We could say we would like to see executive
stock options expensed, but do not expense everyone else's.
That might be kind of convenient in away. But there is just no
getting around the fact these are expenses of the company. They
should be expensed and they can be valued.
This talk about Black-Scholes not applying far in the
future is frankly unpersuasive to me. At least where I learned
finance, Black-Scholes was applied to options of any duration.
There is, of course--everything becomes more uncertain as you
go far into the future, every accounting measure becomes more
uncertain.
The Chairman. Mr. Silvers, you have got to shorten your
answer, please.
Mr. Silvers. I am finished.
The Chairman. Go ahead, take a couple more minutes, please.
Senator Allen. All right. Thank you, Mr. Chairman.
The point I was trying to make is that if you require the
expensing of stock options it will be the end of broad-based
stock options. Yes, they probably will have the restricted
stock and all sorts of different things for the executives. And
for the investors here, whether CalPERS or TIAA-CREF, Mr.
Clapman, Mr. Harrigan, you undoubtedly have invested in
companies over the last ten years that use stock options. Some
of them are these start-ups, innovative companies. Some of them
are no longer with us. Others are still with us.
Now, in the event--just look back. Just look back in the
last ten years. Using the Black-Scholes method, how many of
those--using the Black-Scholes method of expensing, how many of
those would have been accurate or not, and what impact would
that have had on those, especially the start-up companies? And
I like ESOPs as well. I like employee stock ownership. But I
like the idea of employees caring about the long-term future of
a company. It helps keep people with them.
What would be the impacts, Mr. Clapman, on some of the
companies that undoubtedly TIAA-CREF have invested in in the
last decade?
Mr. Clapman. Senator Allen, we did not include in your
materials the TIAA-CREF policy statement on corporate
governance, which has our voting guidelines on management
option plans, but it is accessible. We can send it to you. It
is also accessible on our web site.
But what we do in there is have variable standards for when
we will vote in favor of option plans, taking into account just
the issue you are addressing of the broad-based plans. So that
we would for younger companies have much higher guidelines for
when we will support such plans, and we have different
standards for more mature companies.
So we certainly agree that a certain amount of
discretionary analysis about that, to recognize that there are
certain companies where it is much more important in terms of
compensation.
But in terms--I mean, basically the Black-Scholes or a
similar methodology, which means effectively you value
something at grant, as opposed to valuing something in terms of
whether it made money or lost money, frankly is something that
corporate America will be supportive of more than the
alternative of valuing depending on subsequent stock movement.
The reason for that is that earnings will be much more volatile
if you do not do it at grant, and you will recall that about
250 companies have agreed to expensing, and they do it on a
grant basis because it will have less impact on their
accounting statement, and their earnings record, than if they
chose some other methodology.
But that is again only part of it. You said earlier you
were supportive of performance-based options as a better way to
go. The problem in America today is that compensation
committees disregard performance-based options because they are
expensed and they have been expensed for a long period of time.
So it is the crowding out of something that is a far better
compensation alignment between management and shareholders that
is the dilemma of the current system. So that is why expensing
of all options will put matters on par.
One final thing about----
Senator Allen. But do you not think expensing of all
options would reduce the number of options granted broad-based
to employees?
Mr. Clapman. We do not think so. We do not think it will be
a reduction.
Senator Allen. Have you listened to many companies that use
this that say this will be the death knell of broad-based stock
options, because they will not feel comfortable even signing as
a CFO, signing, here is the figure, which is an estimate--even
by those who are advocates, it is an estimate--and then five
years, ten years down the road, that shows to be somehow wrong?
Mr. Clapman. Candidly, we think, Senator, a lot of the
people that want to preserve the current system are trying to
use scare tactics in terms of the effect of expensing. Just one
final word on that. The footnote----
Senator Allen. It is their business, though.
Mr. Clapman. I realize it is their business. But currently
if you look at the footnotes of any company, you will see the
effect of expensing there. So that sophisticated institutional
investors can get the effect even of fixed price options today.
The people what are not the beneficiaries of that kind of
analysis are individual shareholders who rely on what the
reported earnings in the financial sheets are. But investors
can do their own expensing calculations even today, and I would
say that most significant sophisticated investors are already
taking into account the true cost of those options even before
expensing, and it is only the general public that is being
misled on that issue.
Senator Allen. Let me ask, Mr. Bachelder, what is your view
of the impact of mandatory expensing on the use of broad-based
stock option plans?
Mr. Bachelder. I think it would curtail it. I think it
would curtail it not only on a broad-based basis, but I think
the lifeline of American business are the young, new businesses
that are started up all the time, just as we saw in the age of
the development of Internet and high tech companies. Whether it
is Silicon Valley or Route 128 or other locations in other
industries, these young companies need to have the opportunity
to grant options without having them a charge against earnings.
In fact, I think a very good argument can be made that
those companies, if not other larger companies, in fact are
transferring to those who receive the options the opportunity
to acquire equity in the company, and that is a transfer of
capital. Legitimate arguments can be made that this is a
transfer of capital and not an expense.
Senator Allen. Thank you, Mr. Chairman. I know I went over.
Thank you, Mr. Chairman.
The Chairman. Thank you.
Senator Allen. Thank you, gentlemen.
The Chairman. Could I just quote again from Mr. Buffett:
``Why then require cash compensation to be recorded as an
expense, given that it too penalizes earnings of young,
promising executives? Why not have cash compensation as a
footnote? Indeed, why not have these companies issue options in
place of cash for utility and rent payments and then pretend
that these expenses as well do not exist? Berkshire will be
happy to receive options in lieu of cash for many of the goods
and services that we sell corporate America.''
Senator Lautenberg.
Senator Allen. Mr. Chairman, can I----
Senator Lautenberg. Very good, Mr. Chairman. Excellent
meeting, if I may----
The Chairman. Go ahead.
Senator Allen. The very reason someone would not take a
stock option for payment of electricity or anything else is
because they have no idea of what it is worth.
The Chairman. Mr. Buffett says he knows what it is worth
and he would take it. So perhaps you and Mr. Buffett have a
different opinion. I think I would go with his record versus
yours.
Senator Lautenberg.
Senator Allen. I think he is talking about--I think he is
looking at a different kind of option.
STATEMENT OF HON. FRANK LAUTENBERG,
U.S. SENATOR FROM NEW JERSEY
Senator Lautenberg. Thank you very much, if I might, if the
Senator from Virginia--you have run several very good,
interesting Committee hearings, Mr. Chairman. I want to commend
you.
The Chairman. We have made a lot of friends, too, have we
not?
Senator Lautenberg. I think that this panel is a very, very
good one. It demonstrates the attitude that we ought to be
looking at. I came here 20 years ago and I had been one of the
founders and CEO of a company called ADP. We started with
nothing and I am going to wind up with nothing if I spend a few
more years here.
But the fact of the matter is that I came in and I think I
took the trophy for having given up the highest compensation
package to come to the Senate, which before me was held by
Percy from Illinois. I guess it was Bell and Howell that was
his company. My compensation was about 450,000, which at the
time was pretty rich. But now when we look at things, we see it
quite different. That was on $60 million worth of after-tax
earnings. Now it looks like an executive can get $60 million
worth of compensation for $450,000 worth of revenues. There has
been a huge reversal out there.
[Laughter.]
Senator Lautenberg. But I want to say, I think we have an
attitudinal crisis here in terms of corporate governance. I am
on the board of the Columbia Business School. Mr. Hall, you are
perhaps one of your leaders in the field, but we are talking
about competitive schools in a way. And I just gave a chair in
corporate governance to Columbia Business School because I
think that there is a lot of things that are so wrong, that
have created attitudes supported by incredible greed out there.
Mr. Bachelder, with all due respect and I liked hearing
from you, when I look at Jack Welch and you compared the growth
of the company's value to his compensation, he does not own the
company. One of the things, the mistake we made here--and I am
sorry the Senator from Virginia has left the room. He said: Who
are the owners? Well, who are the owners are not simply the guy
sitting at the top reaping the harvest from a lot of people's
efforts, from a lot of people's ideas.
I am a member of the Information Processing Hall of Fame.
That entitles me to nothing except the fact that I have seen
lots of companies started with good ideas, that had sudden
stock value bursts, took their packages, and went home like a
ballplayer. The problem is that there is not enough long-term
obligation. This is now the seduction of CEOs. Bring someone in
who has got a good record and give them a pretty fat package,
and if he is there three years, what the hell, he makes $30
million or $50 million, and so things did not work out quite
the way they were supposed to.
The most egregious example, not just those companies that
we have seen go down the tubes, but those that are negotiating
for bankruptcy proceedings and taking out huge packages of
compensation and asking--and discharging employees and asking
those that are there to take less in pay. What has happened in
America?
When I see Mr. Welch--and I hardly know him, but I have
read an awful lot about him--and to see that in the final
insult to corporate opportunity was the fine wines and the
dinners that had to be included on top of it, I think it was
about a $300 million retirement package, after hundreds of
millions had already been paid in compensation. He got paid
amply for his work. He is not running a casino and if you hit
he gets more money.
I think it is time we started looking at the--it is not as
much in my view the CEOs, but it is the board of directors who
are conspirators in these things. It has got to be changed. And
American confidence--your question, Mr. Chairman, was an
excellent one: Are these things destroying American confidence
in these companies? Absolutely, absolutely.
First of all, there is, in my view, there is an attempt to
conceal lots of things. I do not know how the term ``EBIDTA''
came up or when it came up, but, boy, if that is not a
smokescreen. It is earnings before taxes, interest, and
depreciation. What is the significance of that? I hear now
people comparing their companies. You have to pay your taxes,
you have got to pay interest on the loans that you have got,
and the depreciation. If the equipment that you are using to
make a product is wearing out, why should you not account for
the fact that you are going to have to replace it one day?
I am sorry, Mr. Chairman. Please excuse the lengthy
introduction. I want to put my statement in the record as if
read, my opening statement.
The Chairman. Without objection.
[The prepared statement of Senator Lautenberg follows:]
Prepared Statement of Hon. Frank Lautenberg,
U.S. Senator from New Jersey
Mr. Chairman,
I commend you for holding today's hearing on executive
compensation. It's a subject I happen to know something about. At the
time of my election to the United States Senate in 1982, I was the
highest paid CEO to cross over to the public sector. The year that I
was first elected, ADP--the company I helped to found with two friends
in 1949--had 750 million dollars in revenues and posted 60 million
dollars in profit. I made 450,000 dollars.
Today, it seems that some companies are making 450,000 dollars in
profit and paying their CEOs 60 million dollars!
Executive compensation is out of whack. Too many CEOS and other top
executives see their pay go up and up while their companies' stock goes
down and down. Too many CEOs and other top executives are insulated
from poor performance and even bankruptcy while employees and share-
holders lose their jobs, their pensions, and their retirement savings.
The system for determining executive pay is broken: greedy CEOs
appoint each other to their boards so they get to determine each
other's compensation. I don't know whether to call that a ``conflict-
of-interest'' or a ``confluence-of-interest'' but either way, it
stinks.
The Congressional Research Service (CRS) has issued a report
comparing the total compensation of top executives to the average
earnings of non-managerial private sector employees. According to the
report, which is based on Business Week surveys, top executives made 45
times as much as workers in 1960. In 2000, they made 531 times as much.
The ratio has come back down; now, top executives are ``only''
making 282 times as much as their employees--largely because so much
executive compensation takes the form of restricted stock and stock
options, and the stock market has plunged. But the gap is still much
too wide.
Supporters of the status quo will argue that this changing ratio is
proof that the executive compensation ``market'' is undergoing a self-
correction. That's true.
They will further argue that attempts to legislate on the issue
will fail and cause unintended consequences. That's true, too.
But I do think there is something useful that Congress can do in
this realm of private contracts: mandate that total compensation for
the CEOs and other top executives of publicly-held companies be made
public in annual reports in a way that is comprehensive, transparent,
and understandable.
As Supreme Court Justice Louis Brandeis said, ``Sunlight is the
best disinfectant.'' Give share-holders all of the information they
need to determine whether executive compensation is reasonable.
Companies that bury the true cost of such compensation in dense text
spread throughout obscure parts of an annual report obviously feel they
have something to hide.
The only way to assess whether CEOs and other top executives are
doing their job is to know how much they are being compensated--no more
``stealth wealth.''
Right now, public confidence in our markets has been shattered--
with good reason. People need to have faith in financial statements.
People need to have faith that analysts are objective. People need to
have faith that brokers are looking out for them. People need to have
faith that the Securities and Exchange Commission is up to the job. And
people need to have faith that top executives are running companies to
meet sound, long-term objectives.
If we want to encourage the resurrection and expansion of the
``investor class,'' we have to restore the public's confidence that our
markets are on the ``up and up,'' and not just a game that's rigged to
benefit the very few. It's going to take a lot of work to rebuild that
confidence but our economic prosperity depends on it.
Thank you, Mr. Chairman.
Senator Lautenberg. I want to ask a couple of questions.
What would happen--first of all, I think that we have to--when
people are hired at the top of these companies, there has to be
a longer term commitment. One of the things that I worried
about as we discussed the dividend debate here was whether or
not a CEO would look at the company and say: Hey, if I pay
dividends and they are tax-free, it inures to the stock value,
it gets to my pocket; what do I care about ten years from here?
I have a chance to make 100 million bucks in the next few
years. Why do I want to fool around with plant and machinery
and running the risk of building new terminals or things of
that nature? Let me boost the earnings for now and let the
devil take the hindmost.
What would be wrong--that is Lautenberg's view. Forgive me.
I want to bring you up to date with ADP. It is a company I
started with two other guys, two other fellows. Their father
and my father worked in the silk mills in Paterson. It was
common labor. We started with nothing. We started a long time
ago, over 50 years ago.
The company this last year did $7 billion, had $7 billion
in revenues and $1.1 billion after tax and paid taxes of about
30 percent or 40 percent on that. Pretty good performance. That
CEO now gets about $7 million and took a decrease in
compensation because we did not grow at the 10 percent that we
had grown for the first 41 years that we were listed on the
exchange.
What would be wrong to encourage the CEOs, the senior
executives in the company, to say your vesting period and
exercise period is deferred for a long time? So you know, even
if you leave the company if things have not gone right, you
have got a package out there, but the work you have done will
help this company deliver its value, deliver its product, for
lots of years to come. Anything wrong with that, Mr. Clapman?
Mr. Clapman. Well, as starters the TIAA-CREF shareholder
resolution in the area of equity compensation not only calls
for performance-based options, but substantial long-term
holding periods for holding stock. That is why--and I believe
other members of this panel had a similar view--that stock is
really a far superior linkage of shareholder concerns,
interests, and management interests.
Hitting exactly the point that you are raising, it is the
short-term pervasive way that stock option cashing out can be
manipulated in the current system that is one of the root
causes of the problem. The long-term holding of stock, our
resolution really did not--and we thought we were giving
deference to management on this, to say that you should have a
substantial holding period, for a substantial period of holding
your stock, and even that was opposed by most managements that
we came into contact with. So we would agree certainly on your
basic thrust, that long-term holdings, perhaps for a senior top
executive not to be able to cash out until they leave the
company. This is all really getting to the heart of the
difference between the long-term and the short-term in terms of
incentives.
Senator Lautenberg. Anybody else? Mr. Harrigan?
Mr. Harrigan. I think that would also be consistent with
CalPERS policy. We obviously think at least a great portion of
executive compensation should be based on long-term,
sustainable performance, and that ties right into the comments
that you made. So that seems to be--in terms of designing an
executive compensation program, your suggestion certainly would
make sense to CalPERS in terms of a component of that.
Mr. Hall. I would just add that I too think it is a great
idea. The one thing we have to ask is, why does it not happen?
The answer comes back to corporate governance. You know, when
Joe Bachelder, who is a very effective negotiator, goes and
negotiates a package for a CEO, typically they want something
shorter; Joe gets it for them. They want to have cliff vesting
at the time that they leave; Joe gets that for them, too. And
then all of a sudden we have very short vesting.
So fundamentally, assuming Congress is not going to begin
passing rules about the vesting periods of restricted stock or
something like that, fundamentally what we have to do is reform
corporate governance and give shareholders a greater say.
I just want to point out how remarkable it is that the AFL-
CIO is supporting a proxy--a set of ideas that are so
shareholder friendly in terms of making--enabling shareholders
to actually get their potential candidates on the board. That
would be a dramatic change in corporate governance, and people
who believe in stronger shareholder rights, as I do, in
academia have been making arguments like this for a long time.
I just find it pretty remarkable that this issue could actually
bridge a very wide political spectrum, in large part because
the members of the AFL-CIO hold lots of assets in their
pensions and so they become very concerned about this.
The Chairman. We should let Joe, I think. Since your name
was mentioned freely, you want to respond there?
Mr. Bachelder. Right, right. I think that the problem with
delayed vesting and delayed exercisability, meritorious as it
is, is the very fact that we do have relatively speaking a free
market in compensation, and if you do at company A decide that
we are going to delay the exercisability on our options and
make it five years cliff or six, seven, eight years, and then
you are trying to attract a new executive from another company
and in order to get that executive, where that company does not
have a wait of five, six, seven, or eight years, what do you
do? I certainly think----
Senator Lautenberg. Give them cash. The expense--in all due
deference, Mr. Bachelder, the expense has to be recorded and
that is the problem. It is the dishonesty that we see where the
greed takes over, clouds the judgment on what you do to run a
business, and suddenly now we are figuring out all kinds of
ways to make sure that our calf is fat and the devil with the
rest of them.
I think if all of these things start to get recorded it
will be a little different transition. But CEOs are not
ballplayers. They do not have a limited life of five years or
eight years or something like that to fill the stands. It is a
different world out there, and we have lost sight of what the
CEOs responsibility is.
Mr. Bachelder. Senator, I do believe that, in further
response, that we seek to have the companies of this country
led by CEOs who will seek to develop new ideas, new products,
to maximize profits, to maximize growth. The individuals who
make up the senior levels of management in this country are
people that are driving for that goal, which we all want, to
increase the profitability of our corporations and to enhance
the value of the investments of the institutional investors of
this country.
You do not have people who are doing that who are not going
to be trying to drive to improve their own compensation
packages. I agree that boards of directors need to take an
objective look at any CEO proposal. But I do believe that there
is more of an objective look at CEO pay than we are giving
credit to.
The Chairman. Senator Breaux had a comment if that is all
right.
Senator Breaux. I would just make a comment that I think
fits in with what Senator Lautenberg is saying and also Mr.
Bachelder. The argument is made that you have to really
compensate CEOs in large companies in order to get the very
best and the very brightest to do the very best job. I have got
a list of the CEO compensation, the top 100 compensation
packages for CEOs of large revenue companies in the United
States in the last year. Honeywell, the CEO was compensated at
over $68 million when the stock of the company's value was
going down 27 percent.
I look over the top 100. The largest company in the world,
Wal-Mart, is not even in the top 100. I mean, there is a real
fallacy and a breakdown in this argument that somehow you have
to be compensated millions and millions of dollars regardless
of the performance of the company in order to have a good
company. The facts do not bear that out.
Senator Lautenberg. There is a mythology out there. In
order to have a decent CEO. You look at the brown company,
United Parcel, and see, they have got a CEO there that has come
out of the worker ranks. I am not advocating that the CEO must
come from the worker ranks, but the fact is that there is a
very modest compensation package there for a huge company, and
lots of companies do it.
My old company, with its $1.1 billion of profit after tax,
probably paid with any bonuses, etcetera, about $15 million to
the CEO. The fact that he was hand-picked by me 20 years ago--
he was the number two guy. But that is the way we regard the
company as having an obligation to its shareholders. We try to
make it very clear what it is about what we are doing.
Now, if you look at the proxy statements, you can hardly
wade your way through it. You cannot get enough people to
understand what it is they are looking at to want to be excited
about voting their proxy. It is not beguiling, there is no
interest at all there.
Mr. Clapman, you must have views on these things, or Mr.
Silvers, about what ought to be in a proxy statement beside the
very strict recitation of what the expenses are and what they
are going to be?
Mr. Clapman. Well, in my written comments, Senator
Lautenberg, I indicated that current disclosure rules are
inadequate to really understand fully about executive
compensation. We are partly an insurance company and when we
look at the what is called supplemental employee retirement
whatever--SERP's is the acronym for them--and try to value
them, even with actuaries we cannot do it.
It took a divorce proceeding to disclose fully the Jack
Welch retirement package. It was not disclosed in any proxy
statement, which I guess shows the benefit of long-term
marriages to avoid having that problem to deal with.
Senator Lautenberg. A deferred expense.
Mr. Clapman. But I agree fully with your point that
disclosure is inadequate. In fact, you raised an earlier
accounting issue which, just to make a brief reply to:
Institutional investors have a pretty sophisticated investment
analysis process. We do all our own investment management. We
do not hire outside managers. We look at, ``pro forma
earnings'' or reported earnings with great skepticism in terms
of how we value stocks. We have our own methodologies for all
of that, and that is a commentary on the state of disclosure in
general at the present time, and it is something clearly the
SEC has got to address.
It is a problem in executive compensation, but it is a
problem in the much broader securities analysis area as well.
So I agree with your point. We could start very--first of all,
the SEC had a project a couple of years ago to get better
disclosure on executive compensation. Unfortunately, it did not
go far enough.
Mr. Silvers. Senator, I will make two points that I hope
you will find responsive. First, there is a kind of--there are
two sort of fallacies that have been floating around in this
discussion that go to this question of whether disclosure is
adequate and whether investors and the general public really
understand what is going on.
I will give you one example. It has been raised in this
discussion that some of these annual pay numbers that seem so
large are in fact not, are in fact misleading, that some of it
is just the sale of stock into the marketplace, that it was
accumulated in the past. Well, it may be that--whether or not
you want to count that as annual compensation, the fact that
that is a major component of executive comp should be very,
very disturbing, because what you are essentially seeing when
you see executives selling into the market built-up options,
exercising and then selling the underlying stock into the
market while their stock price is declining and the corporate
performance is declining is that essentially that executive is
betting against themselves. They are saying: I know something
that is not in the marketplace that tells me I ought to dump
right now and, by the way, I am not going to tell you, the rest
of you, what that is; I am just going to exercise it.
It is in fact worse than simply paying them for bad
performance. It is you are watching somebody gaming the system.
Secondly, the argument has been made here that American
executives are people that are trying to do their best by their
companies. I would not necessarily disagree with that as a
generalization. I think my sense is that is generally true of
most of us, that we are trying to do the best in the roles we
find ourselves in life.
But that does not entitle any of us to infinite
compensation for that effort. If you talk to a construction
worker or a Government employee or a driver at UPS and say to
them--you know, if that person comes to work one day and says,
you know, I work very hard, I produce a lot of value for this
company, I would like $100 million, please, because my net
contribution to this company is positive, that is the end of
that person's career. It also ought to be the end of an
executive's career who does the same.
Senator Lautenberg. I will conclude, Mr. Chairman, with
just two quick things. One is, since our distinguished Chairman
quoted Warren Buffett so frequently, I will quote him once
more. He says; ``The more taxes I pay, the more I have left
over.'' So I think that is probably a good end.
Lastly, you know what I think as I am listening to the
discussion? You are a very good panel and, Mr. Bachelder, I
include you. That is that we ought to--the proxy statement, the
first thing on the first page beside the name of the company
ought to be what the executives sold in terms of shares in the
past year, to give you some flavor as to where this company is
going.
Thank you, Mr. Chairman. Excellent, excellent idea for
this.
The Chairman. Thank you. Thank you, Senator Lautenberg, and
thank you for the benefit of your experience.
It seems to me that this hearing reinforces the argument
that we need greater stockholder involvement and we need
greater transparency, and I am not sure you can have one
without the other.
I am not sure that Congress is prepared to act
legislatively at this time. Maybe around the edges--we have got
a new SEC head and we have got a new man, Mr. McDonough, and
Mr. Donaldson and others, so perhaps we need to exercise some
patience here.
But I am convinced--I am looking at the report from some
time ago that the Tyco CEO spent $6,000 for a shower curtain.
He did not pay for that, it was paid for by the stockholders of
Tyco. Then I am intrigued to see that the new CEO of Tyco is
compensated $62 million. Was that really--in order to get a
replacement for Mr. Kozlowski you had to pay compensation of
$62 million, Mr. Bachelder? They could not find somebody who
could do the job without, especially with the track record of
the flagrant expenditure of stockholders' money, including $11
million for antiques, $18 million for a Fifth Avenue duplex, $2
million trip to the Italian island of Sardinia? All that was
not paid for by Mr. Kozlowski. It was paid for by the
stockholders of Tyco.
So then we see Tyco hiring a new CEO and we cannot get
somebody for less than $62 million annual payment?
Senator Lautenberg. They could have gotten me. I would have
stopped in.
[Laughter.]
The Chairman. I am sure they did not know you were
available.
Senator Lautenberg. I did not know it either until I heard
$60 million.
The Chairman. Life is anecdotal. It is anecdotal about
politicians and our misdeeds and our misdemeanors. Life is
anecdotal about $6,000 shower curtains. I get a laugh at every
speech that I give where I say; ``I would like to have gone
over there and taken a shower; I have never seen a $6,000
shower curtain.'' But you laugh and you cry, and a lot of the
audiences I speak to have seen their 401(k)s decimated while
this kind of excessive pay, benefits, retirement.
Mr. Bachelder, I think you only made one mistake in your
testimony today, bringing up Mr. Welch's package, because no
one understands that retirement, those benefits on retirement.
No one can understand that, that even flowers are paid for.
Maybe you can, but I do not think many other people can believe
that when someone is no longer performing they should get that
kind of benefit.
As Mr. Clapman pointed out, if it had not been for his
divorce we would have never known about it. And I am a great
admirer of Mr. Welch and the outstanding job that he did
leading this corporation.
So I guess my conclusion is that we will be looking at this
issue and looking at and seeing what happens with the SEC and
other oversight agencies. But I also think you may reach,
depending on what happens to the economy, some kind of a
critical point here and then Congress does act, and I am not
sure that Congress always acts in the wisest fashion. That is
why I have always been reluctant to see Congress act.
But these kind of excesses are making a lot of Americans
angry. They certainly are in my State and the places where I go
and speak.
You all have helped a lot today. It would have helped,
frankly, in this hearing if at least one of the many CEOs we
invited to come and testify would have accepted our invitation.
And that is hard to understand, why people who are doing such
great work would not come before this Committee and justify the
compensation they receive for it.
So I thank the panel and I would like to ask if you have
one more comment, closing comment, advice and counsel for us,
beginning with you, Mr. Clapman?
Mr. Clapman. Again, the focus should be on the future and
not just to try to explain the past, and to really get it right
for the future. Certainly TIAA-CREF as a shareholder, a
proponent of shareholder rights and better corporate
governance, is going to be pressing compensation committees,
pressing on board independence.
But I think it is essential to let FASB do its job properly
on the issue of expensing, because it is not just this value
and that value. I think too often we focus too much on that.
The real issue is it crowds out better forms of equity
compensation and true performance and long-term shareholding,
and it is only that will finally get it right.
The Chairman. Mr. Silvers?
Mr. Silvers. I will just echo what Peter said and again
commend you for your leadership on the stock option issue. I
think it is the central place where this matter is really being
fought right now. Again, Congressional action is not needed,
frankly. The regulators have the powers to fix this, both on
the accounting side and on the corporate governance side. They
need to be given the space to do it.
My last comment, and I am sorry Senator Allen is not still
with us, is that I know that some of his constituents feel that
the large option packages they have received cannot be valued.
Anyone who truly believes that, I have ten dollars for them; I
would like their options.
The Chairman. Thank you, Mr. Silvers. I will relay that to
him.
Mr. Hall. Thank you, Senator. I guess I would just like to
conclude by saying that the argument about broad-based option
plans probably going away is overstated, but it probably is
correct that broad-based option plans would be decreased if we
expensed options.
The Chairman. What has been the experience of the
corporations that have already announced that they are now
expensing stock options?
Mr. Hall. Unfortunately, the vast majority of those
corporations give very little stock options.
The Chairman. So we have no lessons to learn yet.
Mr. Hall. There are no profiles in courage there for much
data to be gleaned.
But I guess what I would say in response to that is, if we
are giving stock options to lower level workers in broad-based
plans because of the distorted accounting, we should not be
doing it. So in some cases they will do it because it was a
good reason to start with and the accounting will not get in
the way, and in other cases they will stop giving stock options
and they will give stock or other things that employees like,
like cash. So I really do not think the argument for broad-
based option plans going away is a very good one.
Thank you for letting me testify.
The Chairman. Thank you.
Mr. Bachelder. I think that I would strongly endorse the
point of view that this is not an area where legislation will
provide the answer. I think we found that in connection with
the excise tax on change of control agreements and with the $1
million cap in the tax code. I do believe that encouraging
transparency and more active shareholder participation in the
process would all be positive encouragements.
The Chairman. Thank you.
Mr. Harrigan. Yes. First of all, I want to begin by
thanking you for asking me on behalf of CalPERS to be here.
I think this whole issue about executive compensation,
executive compensation is a serious problem and does have an
impact on investor confidence in the markets in this country.
But it is really about transparency and accountability, and the
comments that I made really focused on those issues. It is
about really having independent board members and independent
compensation committees who really are accountable, not to the
CEO but the owners of the company.
The only way that that is going to occur is if compensation
plans are required to be submitted to the shareholders for
approval and the shareholder votes are binding. It is only
going to happen if compensation committees are truly
accountable to the owners, meaning that shareholders have
access to the proxy as was discussed by Mr. Silvers earlier.
The problems that we face in terms of the lack of
confidence in our markets and corporate America today I think
really are, the fundamental basis of that is just a lack of
transparency and a lack of accountability. CalPERS, I think
along with TIAA-CREF and the AFL-CIO, will continue to be
active in the area of corporate governance and try to bring
more accountability and transparency. But we need your
leadership and the leadership of members of this Committee to
make sure that the regulatory agencies act and act properly.
Thank you very much.
The Chairman. Thank you and I thank the witnesses.
This hearing is adjourned. *
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* The HR Policy Association, submitted a paper entitled, Restoring
Reasonableness to the Sarbanes-Oxley Loan Ban. The paper has been
retained in Committee files.
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[Whereupon, at 11:39 a.m., the Committee was adjourned.]