Excessive Pay and Poor Governance Practices Can Impair Investor Returns, per the WSJ

By Cydney Posner

The article "10 Things CEOs Won't Tell You," in today's Wall Street Journal, focuses on the perils of excessive executive compensation and poor governance practices.  Among the points made:

• While CEOs are supposed to be answerable to the directors, who oversee CEO performance on behalf of shareholders, "at about 60% of big U.S. companies, the person running that board is the CEO himself. ‘That's a fundamental conflict of interest,'" according to a representative of the Council of Institutional Investors. Research shows that having an independent board chair and other "good" corporate governance policies leads to better investor returns: "For example, a hypothetical portfolio of stocks meeting certain governance standards, including having an independent board chairman, would have outperformed the Russell 1000 index by 2.75 percentage points a year from 2003 to 2010, according to a report by the Corporate Library…."
• This article reports that, in 2010, the average CEO of an S&P 500 company made $11.4 million in total compensation (which equates to the salaries of over 250 firefighters, according to the AFL-CIO, cited in the article). Moreover, academic studies have tied higher CEO pay to lower returns for shareholders: "For example, a 2009 study by researchers at Purdue University and the University of Utah found that the companies with the highest-paid CEOs (the top 10%, adjusted for size and type of company) fall more than 4% behind expected average stock-market returns every year. How much the CEO makes compared to the other executives in the C-suite also matters: Companies where the CEO grabs a bigger piece of the total compensation pie awarded to the top five executives tend to have a lower value and generate lower stock returns as the CEO's share of the pay pie increases, according to a 2009 study by Harvard Law School professor Lucian Bebchuk and colleagues at the Yale School of Management and INSEAD." The analysis is again that a "weaker board of directors… will be more likely to overpay its CEO and less willing to fire him if he doesn't perform. "
• Golden parachutes can be very big and are often replete with bells, whistles and ipads. The CIC "considers excessive perks, golden parachutes and generous retirement packages for departing CEOs to be major red flags for shareholders: These practices may indicate that a board of directors is under a CEO's thumb."
• And speaking of bells and whistles, perks are abundant for CEOs. The article cites one company that spent $5.9 million on tickets last year to watch the pro basketball team partly owned by the CEO. Personal use of corporate jets can also be problematic. (See may email of 6/17/11.) According to a 2006 study from NYU, companies that permit their CEOs to use the corporate jet for personal flights underperformed a benchmark by 4 percentage points a year.
• Another sore point is the use of corporate funds by CEOs and other executives to make political contributions on behalf of the company, often without board oversight or corporate disclosure. Some commentators have expressed the concern that, especially following Citizens United, "corporate resources will be deployed in a way that's either counter to the company's interest, or supporting some other agenda…." And again, "companies that make large political contributions often see lower returns than their peers, according to a 2007 study by researchers at the University of Minnesota's Carlson School of Management that's been cited by the Council of Institutional Investors as part of its support for greater disclosure of political contributions. The study also found that companies with strong corporate governance policies tend to make smaller contributions."

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