[Corp. Watch] The end of shareholder aristocracy, executive royalty

[Corporation Watch]

A Need to Re-Connect

  By Francesco Guerrera

(Financial Times, March 12) -- In different times, the offer at the  
airline check-in counter would have been accepted with alacrity.

	But in the midst of the worst economic downturn since the Great  
Depression, with an angry public, populist politicians, and an  
aggressive press baying for a crackdown on Wall Street's "excesses",  
the banker paused for a moment when he heard the usually welcome words.

	"Sir, you have been upgraded to first class. Please follow me."

	Finally replying, "I am fine in coach, thank you", he gave up the  
better seat and opened another chink in the armor of beliefs and  
practices that corporate America had built and spread around the world  
over decades.

	Once hailed as examples of an American dream that rewarded success  
with large paychecks, lavish perks, and popular admiration, executives  
and their companies have been caught in the grip of a storm that will  
revolutionize business.

	The deep freeze of capital markets, the implosion of financial  
companies, and the resulting rise in governments' sway over the  
private sector have called into question some of the foundations of  
Anglo-Saxon capitalism.

	Long-held tenets of corporate faith -- the pursuit of shareholder  
value, the use of stock options to motivate employees, and a light  
regulatory touch allied with board oversight of management -- are  
being blamed for the turmoil and look likely to be overhauled.

	"We are in uncharted waters," says Jack Welch, the former General  
Electric (GE) boss who embodied an era when the untrammeled interplay  
of market forces, domineering chief executives, and the laser-like  
focus on quarterly earnings rises reigned supreme.

	If, as it has become painfully apparent, the value system and  
operating principles that informed the corporate psyche since at least  
the end of the Cold War were found wanting, what should replace them?

	Business leaders are by instinct glass-half-full type of people but,  
this time, few believe their companies' future lies in their own hands.

	The financial sector's role in causing the shocks that have jolted  
the world economy has had a big side-effect: The debate on the future  
of corporate governance is no longer confined to the boardroom.

	Stakeholders ranging from trade unions to activist investors and the  
government itself are claiming the right to draw the boundaries of a  
new corporate order. In the words of one union leader: "The time for  
corporate dictatorships is over. This is our time."

	Such pressure, combined with an internal reassessment of companies'  
priorities precipitated by the crisis, is starting to crumble one of  
the cornerstones of the previous corporate edifice: the cult of  
shareholder value.

	Since Jack Welch made the concept famous in a speech at New York's  
Pierre Hotel in 1981, the short-term goal of rewarding shareholders by  
increasing profits and dividends every quarter has become a mantra for  
companies around the world.

	With the share price of GE and other shareholder-focused companies  
soaring, executives from all over the world took up the credo Alfred  
Rappaport spelled out in his 1986 book, 'Creating Shareholder Value'.

	"The ultimate test of corporate strategy," Rappaport wrote,"the only  
reliable measure, is whether it creates economic value for  
shareholders."

	Fund managers encouraged this attitude, as pressure from their own  
quarterly reviews addicted them to the periodic improvements in  
earnings and stock prices promised by the prophets of shareholder value.

	Today, that focus on the here and now is seen as a root cause of the  
world's economic predicament.

	"Immediate shareholder value maximization, by itself, was always too  
short-term in nature," says Jeffrey Sonnenfeld at Yale School of  
Management. "It created a fleeting illusion of value creation by  
emphasizing immediate goals over long-term strategies."

	Even GE's Welch argues that focusing solely on quarterly profit  
increases was "the dumbest idea in the world".

	"Shareholder value is a result, not a strategy," Welch says. "Your  
main constituencies are your employees, your customers, and your  
products." Like many business figures, he wants the task of charting a  
new course away from the short-term to fall to directors and executives.

	But unions, regulators, and government authorities argue that a drive  
for change led by the same corporate elite that helped bring about the  
turmoil would not remove the contradictions that undermined the  
previous regime.

	"We don't feel companies should be run in the interest of short-term  
investors and executives who are hell-bent on making a killing  
regardless of the risks, and leave taxpayers and real long-term  
holders to pick up the pieces," says Damon Silvers of the AFL-CIO.

	Unions and "socially responsible" investors argue that the focus on  
short-term profits should be replaced not just by long-term strategic  
thinking, but also by attention to issues such as the environment and  
the needs of customers and suppliers.

	The corporate social responsibility movement, on the rise before the  
crisis, is likely to receive fresh impetus from an investor  
recognition that companies' narrow search for profits was not always  
the best strategy.

	Many business leaders object to what they regard as the growing  
encroachment by the state and other interest groups on their ability  
to run the company.

	"If there is a danger in the current situation, it is that we don't  
know how to exit from this little adventure in socialism so that the  
private sector can do what it does best – which is to innovate, grow  
and create job," says John Castellani, president of the Business  
Roundtable, the lobby group for some of America's largest companies.

	But the arrival of President Barack Obama in the White House on the  
heels of a Democratic majority in Congress has, coupled with increased  
public antipathy towards plutocrats, already resulted in big wins for  
unions and other campaigners.

	Reforms that activist investors had demanded for years without much  
success, such as an (albeit non-binding) annual vote on executive pay,  
have already been approved by Congress.

	Others, such as "proxy access" -- the right for shareholders to  
nominate candidates to the board and vote down underperforming  
directors -- are on the way, while the bonus caps imposed on the banks  
that took government funds have sent chills down many an executive  
spine.

	These moves give campaigners new ammunition in the first big battle  
to reshape the rules of the business game: executive compensation.

	The failure of Wall Street's high-risk, high-reward model is set to  
bring about change on two main fronts: top management's pay and the  
use of stock options. After years of soaring pay, business chiefs in  
America can expect to reap relatively meagre rewards in the coming  
years.

	As the downturn moved from Wall Street to Main Street, even companies  
that have not received federal aid, such as GE, FedEx, and Motorola,  
have joined those on government life support in slashing top  
executives' compensation.

	Many are also re-examining the gap in pay between executives and  
other employees.

	In America, the discrepancy between the compensation of those at the  
top of the corporate tree and those further down the trunk has grown  
steadily for decades, reaching an estimated 275 times the average in  
2007 and contributing to rising wealth inequality in the country.

	A significant portion of the blame for rocketing executive  
remuneration and managers' obsession with short-term goals is being  
pinned on stock options and other forms of incentive pay.

	Hitherto praised as a tool to align executive compensation with  
shareholders' gains, options have been increasingly discredited for  
rewarding executives for stock market rises that have nothing to do  
with them.

	In banking, end-of-year awards of options and stock had the added  
drawback of remunerating staff well before the company or its  
shareholders could find out whether their bets had paid off.

	Several banks have announced plans to claw back future bonuses from  
employees whose deals sour in later years. But the fall-out from what  
one executive calls "an era of rewarding ourselves with other people's  
money" will be felt beyond the financial sector.

	Regulators and investors look certain to strengthen the link between  
pay and long-term performance by introducing measures such as a ban on  
the sale of shares and options until after retirement, or even a  
straight pay cap.

	Fred Smith, founder and chief executive of FedEx, spoke for many  
corporate leaders when he predicted, "Some of the fantastic outsized  
gains that were offensive to people will be increasingly less likely.  
At board level ... [they] will not be looked at as costless to the  
shareholders."

	Boards themselves will be in the line of fire. The losses suffered by  
financial groups have exposed the belief that directors were the  
knowledgeable guardians of shareholders' interests as a fallacy -- one  
that will not be lost on angry investors and their fee-hungry lawyers.

	As a result, the composition of boards is likely to change  
dramatically. Russell Reynolds, the doyen of American headhunters,  
says directors will have to be both more knowledgeable and more  
selfless.

	"Gone are the days when directors played a good game of golf, but did  
not understand the risk-reward ratio of the business," he says. "And  
yet the current environment calls for people who can devote time to  
the business for relatively little pay. It is almost a charitable act."

	Investors such as Bob Pozen, who runs MFS Investment Management,  
believe that listed companies' boards should become more like their  
private-equity-owned rivals: smaller, nimbler, and more competent.

	"The directors on those boards have the expertise, the time, and the  
incentive to fully understand the company's issues," he says.

	"Anybody could run a business in the 1990s. A dog could have run a  
business," lamented Jeffrey Immelt, who since succeeding Welch at GE  
in 2001 has presided over a fall of about three-quarters in the price  
of its shares, and this week saw the removal of its triple A credit  
rating by Standard & Poor's.

	Unfortunately for Immelt and his contemporaries, these are not the  
1990s, nor are they the years that followed. As business structures  
that were thought to be indestructible collapse in the meltdown, the  
corporate sector will have to give up a lot more than first-class seats.