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October 14, 2004
Book Inspires Symposium on How Governance Codifies Excessive Executive Pay
    by William Baue

The book is written by Harvard Law Professor Lucian Bebchuk and Berkeley Law Professor Jesse Fried, and the Symposium is hosted by Columbia Law School.

Average compensation of CEOs of S&P 500 companies quadrupled from 1992 to 2000, from $3.5 million to $14.7 million, and the value of stock options granted to them rose ninefold, according to the new book Pay Without Performance. Such increases in executive compensation are not necessarily problematic, according to the book's authors, Harvard Law Professor Lucian Bebchuk and Berkeley Law Professor Jesse Fried, if they correlate to concomitant rises in shareholder value.

Unfortunately, the lack of true arm's-length bargaining between corporate boards, which are supposed to represent shareholders' best interests, and executives, who represent their own best interests, impedes even-handed bargaining of reasonable financial incentives. Far from being an isolated issue, the problem is encoded in corporate governance genetics, according to Profs. Bebchuk and Fried. Hence, the authors prescribe systemic corporate governance overhaul as the cure.

The book serves as the launching pad for a "Symposium on Executive Compensation" convening tomorrow at Columbia Law School. Speakers include academics, investors (such as former TIAA-CREF CEO John Biggs), regulators (such as former SEC Chair Arthur Levitt), executives (such as former Harris Trust CEO Kenneth West), and advisers (such as compensation consultant Brian Foley).

"One aim of our book is to persuade readers that flawed compensation arrangements have been widespread, persistent and systematic, and they have stemmed from defects in the underling governance structures," Prof. Bebchuk told "We hope the symposium about the book will contribute to such recognizing of these problems and the reforms they require."

The "official view" supporting current executive compensation structures rests on the notion of arm's length bargaining between executives and the board, but Profs. Bebchuk and Fried argue that this assumption of distance does not match reality. In fact, managerial power exerts persuasive influence over directors.

"Although many directors own shares in their firms, their financial incentives to avoid arrangements favorable to executives have been too weak to induce them to take the personally costly, or at the very least unpleasant, route of haggling with their CEOs," the authors write.

The authors describe how executives seek to surreptitiously extract "rents," or benefits greater than those obtainable under true arm's-length bargaining, masking what would otherwise be revealed as outrageous compensation.

"We present evidence that compensation arrangements have often been designed with an eye to camouflaging rent and minimizing outrage," the authors state. "Firms have systematically taken steps that make less transparent both the total amount of compensation and the extent to which it is decoupled from managers' own performance."

Profs. Bebchuk and Fried recommend that institutional investors pressure firms to improve executive compensation structures. Such measures include increasing pay scheme transparency and comprehensibility, adopting pay-for-performance plans that filter out stock price rises attributable to anything other than manager performance, and limiting managers' ability to unload stock options.

"Shareholder resolutions can also help, but their potential effect is limited because they are non-binding," said Prof. Bebchuk. "A main thesis of our book is that the most effective way to improve executive compensation in particular, and corporate governance more generally, is by changing the arrangements that now make boards so insulated from shareholders."

The corporate governance reforms enacted thus far in response to the Enron-related scandals, such as requiring increased board independence, "would likely improve matters but . . . much more needs to be done," according to the authors. Foremost is shareowner access to the corporate proxy to nominate director candidates, a rulemaking proposal that is currently stalled at the Securities and Exchange Commission due to the same problem plaguing executive compensation: undue influence from corporate executives.

"Shareholder power to remove directors is now largely a myth," said Prof. Bebchuk. "Shareholder access to the corporate ballot will help make shareholder power to replace directors a viable option that would operate to make boards more accountable and more attentive to shareholder interests--both in general and in setting compensation schemes."


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