Executive Compensation

Departures From The Past

Sarbanes Oxley recognizes that the mode of compensation, an increasing share of equity and equity options, in the packages that executives received was responsible for the frauds that were committed at several large companies. This kind of compensation created incentives for fudging the balance sheet and the income statement to engineer stock price increases. In addition, severance packages are overly generous. A survey by McKenzie in 2003, a management consulting firm, found that 52% of the directors of companies believe that executive compensation is way too high. Academic literature also finds significant correlations between a high component of equity compensation and symptoms of fraud such as accounting restatements, high proportions of accruals, capitalization of expenses, etc. A widely quoted study of a professor from the business school of University of Chicago, reports that in a sample of 50 firms accused of fraud by SEC by contrast to another 50 companies which ware not, a clear pattern of higher occurrence of higher-than-average component of stock compensation was found in the former sample. Other studies also confirm that companies are more likely to be subject to enforcement action if their boards are dominated by the management and they don't have a block holder or an audit committee.

Severance pay is another contentious aspect of executive compensation often patently unrelated to performance. A striking case is that of the approval of a $140 million severance package for Michael Ovitz by the Disney Board in response to a request from CEO Michael Eisner, in 1996. Ovitz had hardly worked a year as Disney's president when Eisner decided he wasn't the right man for the job.

Increasingly, governance bodies are concerned that executive compensation does not reflect the performance of the chief executive. While equity compensation is a means to address the agency issue by tying the interests of owners and managers, the executives undeservedly also benefit from the overall increase in market indices unrelated to the financial performance of the company. In addition, severance pay and retirement benefits and a host of other fees paid to former executives are not related to performance. While Sarbanes Oxley has not specifically mandate any rule for compensation for executives, it does vest authority on compensation committees to decide on executive pay is consistent with the overall interest of the company.

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