Opinion: SEC demands more details on executive compensation

Passive board members allowed powerful corporate executives to take control of corporations. Board members gave executives huge salaries, outlandish bonuses, profitable stock options, and other costly perks. Executives prospered even as their corporations suffered financial losses.

Congress passed the Sarbanes-Oxley Act of 2002, or SOX, to force executives and board members to be more fiscally responsible. Unfortunately, SOX has not stopped unethical executive compensation.

Mercer Human Resources Consulting recently found CEO bonuses at the top 100 companies rose 46 percent in 2004. The increase was the largest in five years.

A report by the Institute for Public Studies estimates the 2005 ratio of CEO pay to that of the average worker at 411-to-1, a ratio almost 10 times larger than the 1980 ratio of 42-to-1. In comparison, workers’ median wages stagnated the past four years and lost buying power.

When is pay excessive?

Excessive pay is difficult to define, especially since company-hired compensation advisers justify compensation practices. Excessive compensation may be like pornography, you cannot always define it, but you know it when you see it:

• Former Exxon CEO Lee Raymond retired in 2005 with a lump-sum retirement considered obscene by many investors: $405 million.

• Suspected accounting flaws recently lowered UnitedHealth’s stock value. Regardless of the potential scandal, CEO William McGuire may realize $1 billion from stock options.

• Fannie Mae’s directors paid CEO Franklin Raines $90 million from 1998 to 2003. During that same period, the company’s leaders overstated revenues by $11 billion.

SEC action

A 2005 Watson Wyatt survey found that 90 percent of institutional investors consider executive pay “dramatically” excessive. According to a 2006 Bloomberg poll, 80 percent of Americans consider executives overpaid.

Responding to such polls and more than 20,000 public comments on executive compensation, the Securities and Exchange Commission is ordering companies to reveal publicly more details of executive pay. Beginning in 2007, a company must file with the SEC “plain English” explanations of the total pay and benefits given yearly to a company’s top five executives. A lump-sum statement of the total cost of a company’s executive compensation is unacceptable.

Stock, retirement packages

Stock options enable recipients to buy company stock at a named exercise or “strike” price. The strike price is the stock’s fair market value the day of the grant.

Unethical executives and board members, however, manipulate options. They search the company’s past stock trades and cherry-pick dates when the stock’s value was low. Using an earlier date for the options gives a recipient the lowest possible strike price and almost guarantees the recipient a profit on exercising the options.

Backdating is not illegal when a company gives the SEC timely notice of the backdating and an explanation for its use. Companies have not been following the rules and more than 80 companies are under federal investigation for manipulating options grants to increase individual profits.

In August, the Department of Justice filed criminal charges against several Comverse Technology Inc. executives, who supposedly made more than $8 million on improperly backdated options.

Under the new rule, a corporation must file an enhanced narrative on its options and answer tough questions. Do company grants to executives differ from those given other employees? If so, why? Who sets the rules for making grants? Do executives help fix options awards, including their own? Are awards ever backdated, and if so, why?

While some companies are reducing or dropping retirement benefits for their workers, some boards continue to give retiring executives enormous retirement benefits.

Currently, the SEC requires executive perks revealed only if their total value exceeds $50,000. The new rules beginning in 2007 lower the nondisclosure limit to $10,000.

John D. Copeland, J.D., LL.M., Ed.D., is an executive in residence at the Donald G. Soderquist Center for Business Leadership and Ethics and professor of business at John Brown University in Arkansas.[[In-content Ad]]