The New York Times had another article on CEO pay today (at http://www.nytimes.com/2011/09/30/business/outsize-severance-continues-for-executives-even-after-failed-tenures.html?pagewanted=2&_r=1&ref=todayspaper) – by far the most written about corporate governance topic.  Today’s story was particularly about excessive pay for terminated executives – what the article calls “pay for failure.”  Two of the most recent examples, it says, are Leo Apotheker, formerly of HP, and Robert Kelley, formerly of BNY Mellon, who got $13.2 million and $17.2 million, respectively, upon being fired.

The article also refers to two examples from the last decade – Robert Nardelli, formerly of Home Depot, and Hank McKinnell, formerly of Pfizer, each of whom got over $200 million, according to the article.  Don’t let the door of the vault hit you on your way out.

It seems like you can’t read an article about CEO compensation – at least with respect to American companies – without seeing Mr. Nardelli’s name.

The article says that “Perhaps the biggest reason that golden parachutes persist is that corporate boards hire superstar chief executives, rather than groom strong managers inside the company for the top job. That gives outsiders a stronger hand to demand all kinds of upfront stock awards and lucrative severance deals when they are hired.”  I think that was true in Mr. Nardelli’s case.  He was at GE and in the running for the top spot when Jack Welch was retiring.  When Welch pick Jeff Immelt to succeed him, it seems to me that Mr. Nardelli’s consolation prize was Home Depot – then-HD board member and co-founder Kenneth Langone also served on GE’s board.  Who’s happier now – Jeff Immelt at a struggling GE, the subject of withering shareholder criticism – or a retired Bob Nardone with $200 million in the bank?

Anyway, the article makes a nice point that, while adieu packages a la Nardelli and McKinnell are gauche (I’m trying to be suave – savvy?), eight figure termination packages seem to be the norm (hey, can you guys hire me as CEO for a couple days for free, then fire me?  Please?).  And shareholders don’t really seem to mind.  Although the link between the two issues isn’t direct (or even existent?), the article cites an ISS study saying that shareholders at only 38 of the largest 3,000 companies to have say-on-pay votes said no.

I don’t think this is the shareholders’ fault, at least not always.  The SOX rules requiring fuller disclosure of compensation practices have resulted in more words in DEF 14As but less clarity.  I’d rather have a rule requiring publication of the compensation committee’s criteria and/or employment contracts- not description and explanation as is now the case.  That way shareholders’ say-on-pay votes could be more objective.

And remember shareholders – only you can prevent Bob Nardellis.

I’m talking about yesterday’s decision by the U.S. Court of Appeals for the District of Columbia that overturned an SEC rule requiring public companies to give proxy access to candidates for director not chosen by the CEO.  The decision is available at http://www.cadc.uscourts.gov/internet/opinions.nsf/89BE4D084BA5EBDA852578D5004FBBBE/$file/10-1305-1320103.pdf.

One reason for the decision (said the court) was that “The Commission instead relied exclusively and heavily upon two relatively unpersuasive studies, one concerning the effect of ‘hybrid boards’ (which include some dissident directors) and the other concerning the effect of proxy contests in general, upon shareholder value.”  Thank God someone is out there defending us from agency reliance on ”relatively unpersuasive studies”!  Isn’t the SEC supposed to decide what is persuasive and unpersuasive – not the judiciary?

The court also agreed with the Roundtables’s argument that “the Commission acted arbitrarily and capriciously by ‘entirely fail[ing] to consider an important aspect of the problem,’ … to wit, how union and state pension funds might use [the rule]. Commenters expressed concern that these employee benefit funds would impose costs upon companies by using [the rule] as leverage to gain concessions, such as additional benefits for unionized employees, unrelated to shareholder value.   … there is good reason to believe institutional investors with special interests will be able to use the rule and, as more than one commenter noted, ‘public and union pension funds’ are the institutional investors ‘most likely to make use of proxy access.”‘

Those damned unions!

Since when has a union or a state pension fund ever successfully used the proxy system to benefit themselves in a way unrelated to shareholder value?  The court cites no examples.  Let’s see, has anyone ever used the system to benefit themselves over the shareholders?  Does anyone remember Enron, Tyco, Countrywide?  Management is the only special interest that can use corporate governance for its own interest at the shareholders’ expense.  Unfortunately, the Court didn’t recognize – or doesn’t want to recognize – that such a divergence exists.

The topic of the testimony was “Enhanced Oversight After the Financial Crisis: The Wall Street Reform Act at One Year.”  You and I refer to The Wall Street Reform Act as Dodd-Frank.

Anyway, Dodd-Frank covers a lot of ground, as did MS’s testimony, but I’ll only mention here the parts about corporate governance.  Among other things, the SEC has issued Dodd-Frank rules regarding say on pay and prohibition of brokers voting uninstructed shares.  Rules the SEC is working on (she promises!) but are not yet ready are ”rules mandating new listing standards relating to specified ‘clawback’ policies, and new disclosure requirements about executive compensation and company performance, executive pay ratios, and employee and director hedging. “

I’m generally in favor of those rules, especially disclosure of executive pay ratios and hedging.  These are facts that can easily be ascertained and reported, and I think many will find them useful.

But what about “new disclosure requirements about executive compensation and company performance”?  Didn’t we just do that with Sarbanes-Oxley?  And does anyone think that the narrative disclosures regarding executive compensation are better than they were before SOX?  The main effect of the requirement of more disclosure has been more words and less meaning.  I doubt the Dodd-Frank rules are going to do much better.  I want to say to the Chairwoman, “Just the facts, ma’am.”

And another thing – don’t the guy Commissioners at the SEC ever testify?  Sheesh.  C’mon  guys, don’t be chicken.

Last Friday’s Philadelphia Daily News (July 15, 2011, p.6) had a story about CEO pay at companies headquartered in the Philly area.  According to the article, Philly CEO pay increased 32.6 percent in 2010 as compared with 2009.  The article then cites the New York Times for the nationwide figure of 23 percent, meaning Philly is “slightly ahead of the curve” (the article says).

So are Philly’s boards more generous than boards in the rest of the country?  I don’t think so.  The 32.6 number is skewed by what people like to call an “outlier”: the pay of Sunoco’s CEO, Lynn Elsenhans (the only woman in Philly’s top 10), increased 524 percent, from about $1.9 million to about $11.3 million.  According to the article, Ms. Elsenhans’s pay suffered in 2009 but rose in 2010 as a result of a swing in Sunoco’s stock price.  But is $1.9 million really suffering?

Anyway, in absolute terms, the highest paid Philly CEO is cable guy Brian Roberts of Comcast (the same people who like to use the word “outlier” like to say “cable giant”), whose 2010 pay was about $31 million, according to the article.  And if you didn’t already know who Philly’s highest paid CEO is, you would be guessing right if you guessed the same company that built the tallest building in Philly, the Comcast Center.

Ya think Leno will move his studio here?

According to the article, shareholders disapproved of pay plans at only 39 of 2,502 companies in 2011 proxy votes.  One reason, the author posits, is that “independent board members are often not in an effective position to push back forcefully. The chief executive runs the company. … It doesn’t help their objectivity that independent directors may be using the same strategy to increase their salaries at their own full-time jobs.”

Yeah, I agree with that.  But do we really need say on pay?  I guess other things being equal, I would rather have say on pay than not, but a non-binding referendum doesn’t do much good.  The only effective way for shareholders to have a seat at the table would be to make say on pay votes binding.

But I’m not for that either.  Isn’t the board supposed to set executive pay?  Why are shareholders involved at all?  Because the Congress that enacted Dodd-Frank believed -  correctly, I think – that directors are beholden to management.  Shareholder control over directors was ineffective, so the only way shareholders can influence executive pay is to bypass the board and have a direct vote.  That’s turned out to be not so effective, as the article points out.

The real way to solve the problem is to allow shareholders to nominate their own directors so they can vote out the directors who approve pay packages to which the shareholders object.  In that case, we wouldn’t need say on pay.  The SEC wrote such a proposal, but the Business Roundtable and the Chamber sued to block its implementation, and the SEC withdrew the proposal pending the outcome of the lawsuit.

As to which way the lawsuit turns out, I’m all goosebumps.

In a June 29, 2011 speech (text available at http://www.sec.gov/news/speech/2011/spch062411klc.htm), she said a number of endearing things.  My favorite is that ”shareholder empowerment … reflects more than just giving greater effect to shareholder voice and promoting important dialogue between shareholders and the companies they own. Rather, it more fundamentally reflects the transfer of corporate power from the board of directors to the shareholders themselves.”

Since when does a board of directors wield power?  As anyone other than a cheerleader for the Business Roundtable or the Chamber can tell you, “Boards are really working for management rather than shareholders,” as Professor Espen Eckbo of the Tuck School of Business at Dartmouth College has said.  “Shareholder empowerment,” as Commissioner Casey calls it, is really a struggle between management and shareholders over who controls the directors.

And another:  ”While I look forward to considering proposals to address the potential conflicts of interest at proxy advisory firms and the questions regarding the accuracy and transparency of their research and voting recommendations, I do believe we must look at the proxy voting system holistically because of its complex mechanics.”

Hmm, I didn’t know that proxy firms have conflicts of interest or that their research isn’t accuarate or transparent.  Oh, wait a minute – the Commissioner only said there were potential conflicts.  And that there were questions about accuracy and transparency.  Not that there are actual inaccuracies or obfuscations.  Hey, we better get the SEC looking at these potential problems!  Lord knows there’s a dearth of actual problems out there.  And doesn’t Commissioner Casey also decry the “expansion of the objectives and purpose of the securities laws”? Since when did “the objectives and purpose of the securities laws” include regulation of the recommendations of proxy advisory firms?

Ok, I think you get my point.  And maybe I’m not as in love as I thought I was.  Well, as Gloria Gaynor says (not Professor Espen Eckbo of the Tuck School of Business at Dartmouth College, as far as I know), “I will survive.”

FYI, here’s a good article on CEO pay at the Simon Property Group: http://www.breakingviews.com/2011/07/08/simon.aspx?sg=nytimes

The article says that CEO pay was up 18% in 2010 from 2009, compared with the average worker’s 2.6% gain in the same period.  Nothing new here – it would be news if that weren’t the case.

But the main point of the article is how some CEOs got a majority or a substantial portion of their pay from exercising stock options.  The foremost example (according to the article) is John Hammergren, CEO of McKesson, who earned $150.7 million in 2010, $112.1 million of which came from exercising options.

I don’t begrudge the CEOs their option pay, mostly.  If the CEO (or others) make huge gains from options, that probably means the stock is doing well and all shareholders share the wealth.

But stock options are dilutive.  I did a study of Microsoft a few years back and found that in some years the dilutive effect of the exercised options, i.e., the difference between the striking price and the value of the stock at the time of exercise, nearly equaled the company’s net income.  Which was substantial.  And people wonder why the stock doesn’t move.

Also, doesn’t it seem that options are issued at times when the stock is low?  I haven’t looked at this empirically, but I wonder if most stock options are issued when the stock is trading below its 50-, 60-, 100- day moving averages.  This is significant because most options are granted such that the exercise price is equal to the stock close on the day of grant (to receive favorable tax treatment).  The lower the price on the day of grant, the lower the exercise price, the higher the profits for the holder when the options are exercised.

If anyone knows about such a study, or wants to comment on what I said here, or on Derek Jeter, please do so.

It turns out the Catalyst study is just one of dozens of studies that tried to prove or disprove such a link.  A recent article by a couple of Stanford Law School professors (available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1685615##) notes that some studies conclude that gender diversity on the board helps a firm’s performance; other studies show that it hurts performance; and yet others show that it makes no difference.  The article concludes that no conclusion can be drawn.

What’s worse, gender diversity is just one of many board factors that have been studied ad nauseam and, after all that, can’t be said to affect firm performance.  Studies of the “usual suspects” of poor performance: “large board size, few outside directors, little or no investment by directors, and the CEO serving as board chair  … have not yielded much evidence that these usual suspects have any meaningful connection to board performance,” says the article.

As to gender diversity, the article says that the problem with the Catalyst study may be “endogeneity.”  Meaning that good firms may go out and recruit women for their board.  In other words, good financial performance causes gender diversity on the board, not the other way around.

I was so proud of myself, too.

As the petition points out, casting a “withhold” vote is not (as a shareholder might think) equivalent to a “no” or “against” vote in a director election, but confused shareholders (like me) could easily believe that it is so.  Instead, a “withhold” vote is merely a shareholder’s way of saying that management does have the shareholder’s permission to vote the shareholder’s shares for the director.  No matter how many “withhold” votes are cast with respect to a particular director, even one share cast in favor of that director will get him or her elected where a plurality wins.

Which brings up another subject.  The petition points out that most of the biggest companies (S&P 500) have adopted majority voting, meaning a director must get an affirmative majority of votes cast with respect to his or her seat in order to get elected, as opposed to plurality voting.  As the petition also mentions, corporate America’s adoption of majority voting occurred without the SEC or the states telling it to do so.  For this corporate America should be applauded.  Or at least the portion that has adopted majority voting.

My favorite part of the petition are the appendices, which break down the S&P 500 by whether the company requires a majority vote for director election, plurality vote, or “plurality and resignation,” meaning a plurality gets you elected, but if you fail to get a majority, you must tender your resignation to the board.  In my view the latter is almost as good as having a majority vote rule.

Anyway, the vast majority (I love that word) of the companies has majority voting for directors: 77 %.  8.6 % have “plurality and resignation,” while 14.2 % have straight plurality voting.  I know, that doesn’t add up to 100 %, but you’ll have to take that up with your carpenter.

So only 14.2 % of the S&P 500 firms have plurality voting for directors, but tech companies are much more likely to do so.  That 14.2 % includes Apple, Broadcom, Compuware, Expedia, Google, JDS Uniphase, Microchip Technology Incorporated, NetApp, Inc. and priceline.com.  Why?  It seems like the guys most likely to have shareholder-unfriendly voting would be the guys in expensive suits sitting in corner offices in New York.  Turns out they’re open shirted ultimate Frisbee players belly up to the juice bar.  Go figure.  Anyone who knows the answer (or has a hunch), please chime in.

Kudos to Amazon, Cisco, Intel, Microsoft and Yahoo! for requiring a majority vote.

My boss is not a Jewish carpenter.

I wonder if the Board’s desire for a leadership change had anything to do with the fact that the SEC sued McCarthy in March of this year for signing financials in 2006 that materially overstated Beazer’s income.  Or the fact that McCarthy agreed with the SEC to repay Beazer his ”entire fiscal year 2006 incentive bonus ($5,706,949 in cash and 40,103 in restricted stock units), $772,332 in stock sale profits, and 78,763 shares of restricted stock granted in 2006.”  But don’t worry – McCarthy still pulled down $1.2 million in base salary in 2006 and over $6 million total compensation in each of the last three years, accoring to Beazer’s proxy statements.   (See Beazer’s 2006 (http://www.sec.gov/Archives/edgar/data/915840/000110465907000138/a06-25984_1def14a.htm) and 2010 (http://www.sec.gov/Archives/edgar/data/915840/000119312510285745/ddef14a.htm#toc119334_15 ) proxy statements. The SEC’s complaint is available at http://www.sec.gov/litigation/complaints/2011/comp-pr2011-61.pdf.  The SEC’s press release (which I just quoted from) is available at http://www.sec.gov/litigation/litreleases/2011/lr21873.htm. 

What about the auditors?  Why didn’t they catch the misstatements?  According to Beazer’s proxy statement for 2006, Deloitte & Touche were the auditors during the time of the misstatements.  And they’re still Beazer’s auditors!  Nothing like pay for performance. 

But the nub of the issue is why the Board acted so slowly in firing McCarthy.  It was clear in 2008, when Beazer restated, that McCarthy had profited by the misstatements in the form of a higher bonus, even if he did not perpetrate any fraud.  He didn’t offer to repay the company then?  And isn’t a CEO ultimately responsible for the accuracy of the statements?

The timing of the firing indicates that the SEC’s March 2011 suit against McCarthy had something to do with it.  But what could possibly have come to light through the SEC’s actions that the Board hadn’t known previously?  It seems to me that McCarthy’s firing was due to the adverse publicity brought about by the SEC’s suit, not by the underlying behavior.  The Board knew about the underlying behavior since 2008.

Beazer’s Board members who have served continuously from the 2006 misstatements through the most recent proxy statements are Laurent Alpert, Brian Beazer, Peter Leemputte, Larry Solari and Stephen P. Zelnak, Jr., which together constitute a majority.

We’re talkin prime beef.