Last week brought news of both triumph and despair from the field of corporate governance.
In the win column: Justice was served in the Enron trial, with convictions of two leaders who presided over one of the largest corporate frauds in history. The trial exposed a company where arrogance guided a series of reckless business judgments.
Enron marked an era when the focus was on marketing a company’s image and turning executives into stars who were rewarded with lavish pay for their “efforts”. Miscreants Kenneth Lay and Jeffrey Skilling basked in the limelight and touted Enron as a model energy company of the future. And as long as the stock kept rising, the markets overlooked Enron’s business-an out-ofcontrol collection of value-losing assets. In the end, the debt-ridden company filed for bankruptcy.
Unfortunately, investors can’t mark this milestone judicial decision as the conclusion to the 1990s style of corporate malfeasance. That’s because we’ve now learned more about option-backdating schemes that are under SEC investigation at more than 20 companies.
This blatant form of corporate looting was detailed in a series of Wall Street Journal stories exposing option grants made from 1995 to 2002 that were priced at the most opportune times. The option grants in question were made at nearly the precise low point of the stock and just prior to a sharp rise in price, allowing executives to cash in substantial profits as the stock rebounded. The Journal estimates the probability that such a favorable timing of grants could have happened merely by chance at something like 1 in 100 million.
The inference here is that when options were granted at these companies, the executives went back in time and picked the stock’s nadir to set their option price. If these allegations are found to be true, the executives may face criminal charges and the companies could encounter tax penalties and be required to restate past earnings.
And if that weren’t enough to shake the faith of investors’ confidence in the executive suite, there was the revelation that Home Depot paid CEO Robert Nardelli $245 million for the past five years he has run the company-even though the company’s stock declined 12 percent while shares of rival Lowe’s have risen 173 percent. Angry shareholders were prevented from voicing their displeasure at Home Depot’s annual meeting last month.
Now it would be wrong to paint all corporate executives with a tarnished brush, and no one is suggesting CEOs don’t deserve substantial pay. But these recurring instances of greed are threatening the soul of capitalism.
So while the dirty laundry is still being hung out on the line for all to see, it is time for a major adjustment in corporate behavior. Competent board members ought to be able to design rational pay plans that keep compensation consultants out of the boardroom. Shareholders, who, after all, employ the company’s executives, need to remain vigilant and press for details on compensation packages. One item on their agenda could be to award stock options that annually adjust upward in price to account for retained earnings.
Above all else, as an investor, you should seek companies with strong corporate governance policies that are candid in explaining their compensation policies, versus those that aim to deceive.
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or firstname.lastname@example.org.