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November 3, 2003
Corporate Ethics, CEO Pay Spark Lively Discussions
During BusinessWeek Forum at the McCombs School
By Jerry Mahoney
Back when Enron was still an admired, if opaque, company, and the stock markets were soaring, investors had little time to worry about corporate integrity, ethics and accountability. But the crash of 2001 and the financial scandals that followed have changed that. The once-arcane subject of corporate governance has been pulled into the spotlight as public companies, politicians and government regulators try to show Americans that it's safe once again to put their faith and their cash in Corporate America.
How best to do that was the topic at a fall gathering of executives from key companies and experts from the McCombs School of Business at The University of Texas at Austin. The Oct. 29-30 sessions on "Restoring Corporate Integrity and Public Trust" were part of BusinessWeek's CEO Leadership Forums with America's Best Business Schools, which this year includes sessions at Wharton, Kellogg and UC Berkeley.
At McCombs, panels of professors, chief executives and public leaders-including Southwest Airlines Chairman Herb Kelleher, Dell Inc. CEO and Chairman Michael Dell, and former U.S. Sen. Bill Bradley-debated key governance issues such as the affects of the Sarbanes-Oxley Act of 2002, the need for independent auditors and board members, and the best way to compensate top executives.
Assessing Sarbanes-Oxley
Sarbanes-Oxley has been called the most sweeping corporate regulation measure in decades. Congress intended, among other things, to assure that auditors will point out financial shenanigans by their corporate clients before fraud or conflicts of interest can hurt a company, its employees and its investors.
Just what constitutes conflict of interest, however, remains a topic of heated debate. In the wake of Enron-Anderson and subsequent scandals, Sarbanes-Oxley prohibits public accounting firms that audit companies from providing certain services, such as internal audits and financial information systems design. Notably tax services remain permissible for audit firms, but the Public Company Accounting Oversight Board could still prohibit such services. And debate over the issue continues in the realm of public opinion, where best practices are often effectively established.
Southwest Airlines Chairman Herb Kelleher told the gathering that while he has little quarrel with the overall tenor of the new federal regulations, the idea of prohibiting tax services irritates him. "So instead you have to get a new firm that knows nothing about your company, perhaps nothing about your industry, and you're saying, 'Boy, aren't we lucky to have a complete novice.' "
Moreover, William Kinney, professor of accounting at McCombs, noted that a recent large study he undertook through sponsorship from the American Accounting Association suggests that there is no correlation between non-audit services in general and the incidence of earnings restatements. Further, there is a negative correlation using audit firms for tax services and the incidence of restatements, which are widely accepted as a measure of accounting irregularities. Kinney said the findings indicate that using audit forms for tax services may be beneficial to companies.
Accounting Prof. Michael Granof said Sarbanes-Oxley wouldn't have been needed if regulators had been paying closer attention to the fudging going on inside companies for years. The numbers games were designed to polish financial statements and impress Wall Street. Not only was Sarbanes-Oxley unnecessary, "it does not address the fundamental incentive to manage earnings," Granof said. As long as chief financial officers and other corporate managers' salaries and promotions are linked to earnings, the temptation to polish financial performance will remain, he said.
"The warning signs were there long before the recent scandals," Granof said. In fact, added Kinney, 900 public companies restated their earnings between 1995 and 2000.
Dean of the University of Texas School of Law, William Powers, argued that giving auditors more power in their relationships with their corporate clients is only part of the solution. Powers suggested that in-house compliance officials-CFOs and general counsels whose salaries and promotions are tied to their employers' success-should be fully independent and free from pressure to manage earnings.
Attorney Robert S. Bennett, who defended President Clinton against Paula Jones' allegations of sexual harassment, represents corporate clients who are in trouble with the Securities and Exchange Commission (SEC) and other regulatory agencies. He said the new regulations are causing communication problems at the top level of some companies. "I already see in working with boards almost the adversarial relationship between management and boards," said Bennett, a partner in the Washington, D.C.-based law firm of Skadden, Arps, Slate, Meagher & Flom.
Despite their reservations, the speakers were willing to give the regulations some time to take effect. As expected, the strongest case for the Sarbanes-Oxley Act was argued by Charles Niemeier, one of five members of the Public Company Accounting Oversight Board. The board, which was created by the act, will amass an unprecedented database of corporate auditing and financial information, Niemeier said. "We look for incentives and disincentives for auditors to do the right thing," Niemeier said. "We will see the trends-hopefully, the problems-before they get big."
Executive Pay & Corporate Integrity
During a panel discussion on executive compensation, Prof. Laura Starks, chair of the McCombs Finance Department, noted that in 1980 CEOs were paid 26 times the average annual pay of their employees. By 2002, the ratio had soared to 360 times. Starks said that during the 1990s, it seemed as though CEOs were being generously rewarded for having the good fortune of riding the economic boom. "But CEOs are taking on much more risk, so we would expect their compensation to reflect that," she said. Starks also noted that 65 percent of the compensation for former New York Stock Exchange Chairman Dick Grasso was based on stock options. Grasso resigned in September after details of his $140 million pay package were made public.
Sherron Watkins, the Enron whistleblower who was attending the forum, said compensation plans such as Grasso's are unnecessary as well as excessive. She suggested that a dozen competent candidates would line up for Grasso's old job if it paid a mere $2 million a year.
During a CEO response panel, EDS Chief Executive Michael Jordan said that institutional investors have been pressuring corporate boards to tie salaries more closely to the company's performance. He said equity-based compensation might be the best method to pay top executives. But Jordan noted that the average tenure of CEOs in public U.S. companies is less than six years.
Is regulating executive compensation the answer? CEOs and panelists said no, citing problems with earlier attempts to regulate compensation in the 1980s.
Dell Inc. Chairman and CEO Michael Dell, in a Q-and-A segment with BusinessWeek Managing Editor Mark Morrison, said that Congress can't legislate ethics. Companies have to hire ethical people at the top, and their job includes inculcating those values throughout the culture. (For more on Dell, see our own Q-and-A with him on integrity and corporate governance.)
Sometimes, team players not involved in running the organization provide the best examples of doing the right thing. Bill Bradley, whose diverse career includes a stint in the NBA, three terms in the U.S. Senate, and a presidential run in the 2000 Democratic primary, moderated a panel on Public Policy: Politics, Corporate Integrity and the Public Trust. Bradley told the story of how Larry Bird, the NBA hall of famer, retired in 1992, foregoing $9 million.
Bird, who at 35 was hampered by back pain, had a contract provision that would pay him $4.5 a year for two years if he did not retire before Aug. 15. Nonetheless, Bird told the Boston Celtics management a week before that.
"He left $9 million on the table," said Bradley, who now is a managing director at Allen & Co. "That's integrity."
More notable soundbites from the conference
Robert S. Bennett, Partner, Skadden, Arps, Slate, Meagher & Flom, LLP
On Sarbanes-Oxley and aftermath of current reforms:
"I already see in working with boards almost the adversarial relationship between management and boards."
"With all of this focus on structure and the heavy emphasis on having people with financial skills in on key management decisions, the question I have is are you going to get people [in management] who know how to build a product."
On the American system:
"We shouldn't forget that our American enterprises, our companies, are the greatest in the world. We have the world's greatest companies. We built these companies without Sarbanes-Oxley."
On corporate malfeasance:
"From my experience, it comes from the culture. They say that a fish rots from the head. If you have a place where everybody is out only to make money for themselves, you're going to have problems. If you have a place where the little guy doesn't feel that he has a palce in the system, that he can raise problems without losing his job, you're destined to have problems."
Herbert D. Kelleher, Chairman, Southwest Airlines Company
On corporate governance ratings now in vogue with some analysts:
"A punch list approach to corporate governance has no place in corporate governance. Interestingly, a lot of the people who have the punch lists, if you them a little fee, they'll help you govern a little better."
Kelleher noted that a dean at the Yale School of Management, at a recent conference, pointed out that three of the companies that score the lowest on the new corporate governance ratings are Berkshire Hathaway, Dell and Southwest Airlines. "What does that tell you? That the ratings are not results oriented. The public may be misled into believing these lists are important, but they're not. They're nonsensical."
On the recent vogue for having independent board directors:
"I notice that having independent directors of the New York Stock Exchange really paid off handsomely."
Michael Mandel, Chief Economist for BusinessWeek
On the economic outlook:
"We could be on the cusp of a tech boom that -- I hate to say it -- could be larger than the last one."
For further information on the Corporate Governance Forum or McCombs Executive Education contact Assistant Dean and Director Chantal Delys (512-471-1064).
For information on specific programs at the McCombs School, consult our contacts page. For media information, contact the Communications Director by phone at 512-471-3314 or by email at CommunicationsDirector@mccombs.utexas.edu.
