Corporations - Page 7

American chief executives are paid too much, and their salaries should be reduced to more reasonable levels, Federal Reserve Bank of New York President William McDonough said.

"CEOs and their boards should simply reach the conclusion that executive pay is excessive and adjust it to more reasonable and justifiable levels truly related to the benefit of shareholders," he said in the text of remarks to a service to commemorate Sept. 11.

McDonough cited a recent study that showed a CEO of a publicly traded company made 400 times the average employee's income, compared with the multiple of 42 that CEOs earned two decades ago.

"It's hard to find somebody more convinced than I of the superiority of the American economic system, but I can find nothing in economic theory that justifies this development," he said.

The Fed official said CEO compensation had soared as the "business elite" had argued that motivating executives boosted shareholder value. Recent corporate scandals at companies such as WorldCom Inc. and Enron Corp., he said, proved this "theory has left a large number of poorer stockholders, especially including employee stockholders, not only unconvinced, but understandably disillusioned and angry."

He recommended that corporate boards work to voluntarily pare executive pay packets, freeing up revenue for investment or shareholder dividends.

"If the best companies lead the way, the market economy, through the stock market, will force other companies to follow," he said.

Despite the scandals, McDonough said, it is important not to "label as sinners everybody who has been successful because a relative few have been noticeably lacking in virtue."

(9/12/02) - Flying from New York to Paris for a vacation? A first-class seat will set you back almost $6,000 each way, and coach will cost $1,100-plus if you buy at the last minute.

But if you are a top executive at General Electric or many other large companies you can go on the company's jet — a Boeing 737 in G.E.'s case. While it would cost G.E. about $14,700, by conservative estimates, to fly the plane one way, the cost to the executive would be only $486. And that is only what he or she would owe in additional income tax on the reported value of the flight; the company would receive nothing to cover its costs.

The cost to executives who use corporate jets for personal travel is low because of a 1985 tax law that allows corporate executives and directors to fly on personal trips in company planes at rates far below what business travelers pay to sit in a middle seat in coach. It is another example of how federal tax laws grant favors to the very wealthiest people in America.

"It's a great deal," said Mary B. Hevener, a partner at the law firm of Baker & McKenzie who represents a third of the Fortune 500 companies on tax issues connected with their corporate jets.

A different view was voiced back in 1985 by Senator Howard Metzenbaum, an Ohio Democrat who objected to the tax legislation when it came to the Senate floor. Mr. Metzenbaum, who has since retired from the Senate, said at the time that requiring executives who use corporate jets for personal travel to value the trips at first-class air fares for tax purposes was woefully inadequate given the nature of corporate jet travel.

"Have we lost our heads?" he said during the debate, noting that the Reagan administration also thought that first-class plane fare was too low to cover the true value of private jet travel.

"This is as wrong as wrong can be," Mr. Metzenbaum said. "This is just a matter of playing to corporate executives."

The giveaway, as Mr. Metzenbaum labeled it, turned out to be a lot bigger than even he had suspected.

The formula for valuing the personal use of corporate aircraft by executives allows the executives to pay far less than first-class air fare, and often less than coach.

The basic rates at which the Internal Revenue Service and the Transportation Department value the personal use of corporate jets are currently 20.80 cents a mile for the first 500 miles, 15.86 cents for the next 1,000 miles and 15.24 cents for miles beyond 1,500 — less than the allowance for using a car.

Then, the value of the travel — which the 1985 law generally defines as four times that basic rate, plus a flat $38.02 for the value of using an airplane terminal — is reported as additional wages to the I.R.S. The executive just pays the federal income and Medicare taxes — which for most executives is at a 40.05 percent rate — on the reported value of the flight,

There is one significant exception to the general rule that values a flight at four times the basic mileage rate. If outside consultants conclude that corporate-owned jet travel is needed for security on personal trips, the mileage rates are only doubled.

Ms. Hevener said that such security studies were common before the Sept. 11 attacks and have become much more widespread since then.

Thus, an executive who flies 500 miles in a corporate jet to play a round of golf would be liable — if his company has done a security study — for only $246.02 in additional wages each way, on which he would owe federal income taxes of $98.53.

The taxes are the only cost that executives actually pay. Some companies reimburse executives for those taxes — as well as the taxes on the reimbursement — so that their out-of-pocket cost is zero. Companies that reimburse top executives, however, must disclose this in proxy statements to shareholders.

The companies, meanwhile, get to deduct the full value of operating these aircraft. For a Boeing 737 business jet, which can cost $40 million to buy and an equal sum to fly 800 hours a year for two decades, the operating cost works out to about $4 million a year, or $5,000 for each hour flown.

Excluding the purchase price and other fixed costs, the direct cost of operating the plane is $2,000 to $2,500 an hour, according to estimates provided by Boeing, General Electric and two aviation experts. Direct cost, these sources said, is the best measure of the cost of personal use of planes by executives because it approximates the additional use of these planes for personal travel.

At $2,000 an hour, it would cost $14,660 to make the flight of 7 hours and 20 minutes from New York to Paris. Chartering a Boeing 737 business jet for that run would cost more than $100,000, said Randy Brandoff, an executive at Marquis Jet Partners in Manhattan, and a smaller Gulfstream IV-SP, which seats 12, would cost $87,300.

It is not clear from G.E.'s proxy statement that John F. Welch Jr., the company's former chief executive, used the company's aircraft for private travel. However, in divorce papers filed by his wife, Jane, in Superior Court in Bridgeport, Conn., she estimated the value of the couple's use of a G.E. 737 at $291,667 a month.

Publicly traded companies are required to disclose the salary, bonuses, incentives and "other compensation" of the top five company executives in annual proxy statements to shareholders. If any single component, like air travel, accounts for more than 25 percent of this other compensation, it must be specified.

Mr. Welsh's other compensation last year was $171,772, 83 percent of which was for financial planning, the company said. The rest is not broken down, but could include some air travel.

G.E.'s current chief executive, Jeffrey R. Immelt, reported that 60.5 percent of his $137,954 in "other annual compensation" was for personal use of company aircraft by his family traveling without him. Other top G.E. officers also cited personal use of the company's aircraft.

If a company's security study concludes that all of an executive's travel must be on corporate aircraft, as G.E. requires Mr. Welch to do even after retiring as chief executive, then there may not be any disclosure to shareholders. The reason is that the S.E.C. requires disclosure of "incremental expenditures" and such personal travel on corporate planes is not, under these rules, considered to be an additional cost.

The practice of using company planes for personal travel is widespread. At Pfizer, for example, the former chief executive, William Steere, has lifetime access to the company's facilities and services, which would include its aircraft, company documents say. At Wachovia, Edward Crutchfield, a former chief executive, negotiated 120 hours of use of the corporate plane each year for 10 years, and less use after that.

Among those companies that require that their top executives use corporate jets for security reasons, the rules vary subtly.

For years, the Coca-Cola Company has required that its chief executive — including its current chairman and chief executive, Douglas Daft — fly on one of the company's four planes for business or personal reasons.

"We feel that this is the best way for us to insure the proper security for Mr. Daft, " said Sonia Soutus, director of Coca-Cola's media relations. "It includes his wife when she travels with him."

According to the company proxy, Mr. Daft received $118,764 in "other compensation" last year, with $103,898 of that for his personal use of Coca-Cola's air fleet.

Gillette also has a rule that requires its chairman and chief executive, James M. Kilts, to use the company's aircraft "for security reasons." A Gillette spokesman said that the requirement was for business purposes only.

Mr. Kilts does not use the company plane for anything except business, he said.

"That was part of his employment contract," the spokesman said. "If he goes away for the weekend, he arranges his own transportation."

(9/10/02) - One day before the anniversary of 9/11, a CBS News/CBS MarketWatch poll shows many Americans fear the worst is yet to come for the stock market. Despite that, optimism abounds, as only 7% believe a drop of 17% or more is likely in the Dow Jones Industrial Average. By contrast, 32% believe the Dow will close above 9,000 this year -- a gain of 6%.

It's fun to look at numbers like these, but the real story behind the poll is the incredible level of mistrust U.S. citizens have for corporate executives. Get this: While about a quarter of respondents worry about the effects of terrorism on the markets, fully half say scandals such as the ones at Enron and WorldCom make them less likely to invest.

Think about that, all you CEOs, CFOs, analysts, and auditors out there. You have more influence on your country's investing confidence than anything terrorists can muster. Think back to the horrific events of one year ago, and you'll understand what a powerful statement this is. It's a credit to Americans that we have so much faith in our country and our economic system. Wall Street was attacked, the markets closed down, but we knew they would open again.

And yet the dirty, rotten, thieving players who lied to investors and padded their own pockets have accomplished what the terrorists only dreamed of -- undermining Americans' confidence in the markets. Shame on them.

(9/8/02) - In a short memoir of his time at Yale University, James Tobin, the late Nobel-winning economist, separated professors there into two camps: the institutional types and the free agents. The institutional types were committed to building Yale's economics department and stayed loyal to the university. The free agents looked for better job offers and moved often.

The free agents might have been brilliant scholars, but the institutional types, Professor Tobin observed, were more valuable to Yale.

There may well be a parallel in corporate America.

In recent years, fatter and fatter pay packages, laden with stock options and other rewards like low-interest loans, have helped turn many executives into free agents.

Yet because it was the way to sure gains, the free agents often played to Wall Street and turned their stock and options into quick, easy money rather than ensuring their companies' long-term prospects.

Finding and retaining executives who are committed to helping a company grow over the long run might stop the cycle of skyrocketing pay and dwindling tenure. It might also help to curb the anything-goes ethics that led to the type of excesses seen at companies like Enron and WorldCom.

The question is this: How can companies reward executives in a way that provides proper incentives for good performance and encourages high-performance institutional types?

While corporate boards struggle to answer that question, professional experts on executive pay, as well as academics who study incentives, offer some guidance. Many recommend granting stock, especially with restrictions on its future sale, instead of granting options. Some suggest promoting loyalty and performance by tailoring executives' packages to their personal tastes — within reason. Virtually all the experts recommend an emphasis on long-term rewards for long-term success.

Pay packages "will be more goal-oriented than purely market-oriented," said Steven E. Gross, who leads the United States employment compensation practice at Mercer Human Resource Consulting. Rather than depending on stock prices alone, rewards could include grants of cash or stock for concrete achievements over a period of years, he said.

The trend that culminated last year, when executives of failing companies cashed in huge stock grants and options, actually began two decades ago, during the leveraged-buyout wave of the 1980's. Firms like Kohlberg Kravis Roberts, as buyers of undervalued businesses, looked for ways to link the outsiders they installed as executives to their new companies' futures, according to a recent paper by Brian J. Hall, a professor at Harvard Business School. Institutional investors also pushed executives to take ownership stakes, thinking that the executives would work to increase the return on their investments, Professor Hall wrote. As an added incentive, the tax and accounting treatment of stock options made them cheaper to dole out than cash or stock.

But such pay plans, Mr. Gross said, have little downside for executives. "I'm encouraging you to take risks to raise the stock price," he said, taking the role of a corporate board. "What happens if you fail? Nothing."

In the 1990's, the trend gathered speed. Pay packages became sweeter as the market for executive talent became tighter. The success of outsider chief executives led companies to realize that they might achieve impressive results by bypassing their internal talent pools, said Robert H. Frank, a professor of economics and management at Cornell University.

By 1993, top executives were moving among the country's biggest companies with increasing regularity. In that year, Eastman Kodak, I.B.M., Metro-Goldwyn-Mayer, Sunbeam-Oster and Westinghouse Electric all found new chiefs from outside their own executive suites.

Professor Frank compared the budding market for executives to the advent of free agency in baseball in the 1970's. Once teams could compete to lure talent, some players' salaries broke through the traditionally flat pay scale.

"It just became a free-agent market once there was this seismic shift to the view that people outside your company might be able to help your company," Professor Frank said.

Equity-based pay may have begun as a way to align the interests of executives with those of shareholders. But with more competition for talent, favorable tax treatment and a rising stock market, it often became little more than a cheap solution for attracting top executives. By 1999, some 60 percent of chief executives' annual pay came from stock and options, according to Professor Hall's calculations. Many companies, concerned about meeting quarterly earnings projections, also began to orient their pay packages toward short-term rewards.

Evidence of that shift still pervades pay packages at big companies. "They're not thinking about long-term incentives," said Clair Brown, who heads the Center for Work, Technology and Society at the University of California at Berkeley. "Their long-term outlook is about a year."

In a perverse way, shortsightedness might make sense, given the labor market for executives. A worldwide study of midsized companies released in June by DBM, a human resources consulting firm, found that chief executives in 2001 had been in office an average of three years. Companies that had three or more chief executives in the last decade included especially troubled ones like Kmart and Waste Management, but also others like Apple Computer, Blockbuster and the Ford Motor Company.

Yet it takes about 18 months for a chief executive to feel at home, said Denis St. Amour, president of DBM's Center for Executive Options. "That, in effect, gives you approximately a year, after you've gone through the learning curve and the acclimatization curve, to do your thing."

Executives planning to stay only a few years might have done a good job of massaging numbers for quarterly earnings reports, when that practice was more in vogue. But taking time to think about creative, long-term projects could have been contrary to their best interests. Investing in such projects could hurt earnings in the short term, and executives could not necessarily count on being in office long enough to reap the rewards of the projects.

"How many quarters does a chief executive have before people are going to start grumbling?" Mr. Gross asked. "You force people to be courageous."

Executives had a stronger incentive to engineer quick jumps in stock prices. Having stock options that could be exercised at will only enhanced that incentive. "The idea that you could cash them in at any time did really give a huge payout to anybody who could jack the price up in a hurry," Professor Frank said.

If the share price did not rise, options offered little incentive for an executive to stay, said J. Mark Poerio, a lawyer specializing in executive compensation issues at Paul, Hastings, Janofsky & Walker in Washington. If a shock to the market sent the stock tumbling, the executive might have considered the options worthless for the near future. "The stock options created an incentive to stick around and get rich," Mr. Poerio said, "but at the same time, if it didn't happen fast, it didn't give you the retention incentive."

During the recent boom, boards often found themselves looking for a hot new chief executive to slake Wall Street's thirst for shareholder value. A popular strategy, Mr. Poerio said, was to look for top talent holding apparently worthless options and to offer new grants at attractive prices.

Of course, companies trying to hold on to executives can also grant new options, or simply change the prices at which old options can be exercised. And many did.

In addition to encouraging decision-making horizons too short to guarantee long-term growth, the use of options might have made pay packages too mechanical. Job performance came down to a numerical formula involving stock prices and option values, both of which the executive could influence. "If I have a very complex performance package, I'm going to be spending all my time thinking, `How do I game this system?' " said W. Bentley MacLeod, director of the Center for Law, Economics and Organization at the University of Southern California.

The system may well turn institutional types into free agents. "You've maybe taken a chief executive and you've turned that individual around to do things in a way that will only get short-term results," Mr. St. Amour said.

Even executives who are loyal to a company increasingly feel the lure of swimming with the sharks to become richer. "The stayers definitely are getting left behind," Professor Brown said.

The cycle that caused pay packets to bulge while companies sought out free agents may soon slow. Whether or not options work for setting incentives, the spreading practice of accounting for them as expenses — and the wide perception of their misuse by executives — is likely to limit their popularity.

Professor Frank said easy-money deals would fade. "We'll definitely see many fewer of these short-term options packages," he said. "No one had worked out what the possible implications of those packages were."

The diminished attractiveness of stock and options could make more room for traditional compensation, like cash, bonuses and benefits, or for new strategies.

"Some of this less-expensive compensation is not going to be there," Mr. Gross said. "Now, all of a sudden, the rules change."

Mr. St. Amour said companies could strengthen relationships with executives by tailoring pay packages to a particular person's aspirations. "You need to try and address what's important to the individual," he said. "For some people, maybe it's a secure retirement. For other people, maybe it is a plane, a car or a boat. For other people, maybe it's the opportunity to do something in the organization in a leadership-coaching role."

Mr. Gross said he favored indexing pay to a company's earnings relative to the market. "If the stock goes down, it doesn't mean you're a loser," he said, if other stocks are falling as well. Though the notion of using relative, or indexed, returns "hasn't been real popular," Mr. Gross said, more companies are beginning to consider it seriously.

A trend is already emerging toward restricted and deferred stock grants, Mr. Poerio said. These can cut down on poaching of executives by other companies, he said, because they are worth something even if a company's share price falls. Grants might be made on condition that certain goals are met or only after an executive has stayed several years; executives might also be barred from selling stock for long periods.

"You get rich if the company performs well long term," Mr. Poerio said. "That really better aligns the executive's interest with stockholders.' "

Experts offered some suggestions for deciding how and when to grant stock.

"What a chief executive really needs is a short-, medium- and long-term plan that's tied into compensation options," Mr. St. Amour said. "They need to have milestones for that. You can actually build in the safeguards that will prevent someone from doing something in the short term that will give a negative impact in the medium or long term."

Mr. St. Amour suggested that companies invest part of their executives' short-term compensation in an "internal banking system" from which it could be withdrawn at later dates, based on continued success. He also recommended giving a bonus at the end of a longer period, like 5 or 10 years, for consistency in meeting milestones.

Milestones should not be based solely on profits and revenue, he said. "To use and measure against them alone is to disregard the fundamental things that keep an organization strong," he said. Initiating projects for growth and building relationships with clients should also be rewarded.

A milestone plan would have to rely on regular, subjective evaluations — a common feature elsewhere in the American workplace. "One of the big benefits of good management and subjective evaluation is that it allows the worker to be creative, do good things for the firm and be rewarded after that," Professor MacLeod said.

Such plans rely on implicit contracts — unwritten agreements between executives and boards that long-term performance will be rewarded. Executives might commit to forward-looking investments, and directors would wait for long-term growth rather than fixating on quarterly numbers.

Professor Frank predicted that the stock market, having recoiled somewhat from the culture of quarterly earnings manipulation, might welcome this type of a model as long as chief executives communicate their plans clearly.

Such a trend could benefit the longest-serving chief executives, who are often founders or scions of founding families. In the 1980's, several such executives found themselves supplanted by professional managers installed by impatient boards or leveraged-buyout firms. Those who remained usually had an implicit contract with their boards by dint of their deep personal stakes in their companies.

After the market bubble burst, companies did look more toward longtime employees for leadership. The DBM study revealed that in 2001, the number of chief executives hired from outside dropped by half from the previous year.

But Professor Brown said the job market for executive talent could still obstruct a return to old-fashioned relationships built on patience and trust. "I don't think you can restore the implicit contract," she said. "We're in a new situation. Workers are going to continue to maximize their career possibilities, and companies are going to hire as they see fit. Everybody's given up on long-term loyalty."

Over the past few months, as pundits pontificated on the merits and risks of attacking faraway Iraq, Americans were undergoing one of the most profound changes in attitude in nearly half a century. And, the issues they were reassessing had nothing to do with terrorism, al-Qaeda or Saddam Hussein.

In the wake of massive stock losses and ten months of back-to-back corporate scandals Americans began to rethink long-held views on management and labor. While overpaid Beltway consultants fretted about the implications of war with Iraq, Americans worried about their own financial security.

Now, the numbers are in and they show that Americans' 40-year love affair with big business is over.

The last major shift in attitudes began during to post-war boom years of the 1950s. Large companies were viewed as the vanguard of America's growing affluence. By 1954 only 16 percent of respondents polled said they believed that large corporations were "the biggest threat" to America. Meanwhile, in the same poll, 46 percent identified "big labor" as the major threat.

Fast forward to Labor Day 2002. Now, only 10 percent of those polled say they believe big labor is the nation's biggest threat while nearly 40 percent respond they considered big business posed the biggest danger to America - that's up from 22 percent in October 2000. As of this Labor Day the percentage of Americans that view big business as a threat is at its highest point in the 48 years pollsters had been asking the question.

"It's still the economy, stupid," said Mike Lux, President of American Family Voices. Lux also served as a domestic policy advisor to former president Bill Clinton. "Americans are of course concerned by issues of war and terrorism. But, they understand that America's strength comes from within, from a strong workforce and strong economy. They understand, better than this administration apparently, that corporate profiteering, exploding federal debt and growing unemployment are ultimately are a bigger threat to the nation than Saddam Hussein."

"Working Americans are anxious and struggling," AFL-CIO President John J. Sweeney said. "Wages are stagnant, unemployment is up, and people are angry that they are losing their savings to a corrupt corporate system they thought they could trust."

The growing mistrust of corporate executives shows up in different ways in almost every recent poll. In a poll by San Francisco-based Employment Work Alliance, 73 percent of respondents said there should be mandatory representation of rank-and-file workers on corporate boards, and 84 percent said employee pension funds should force corporations to be more accountable.

The poll showed a "high level of mistrust, anxiety and frustration . . . that can be felt in every assembly line and cubicle throughout America," said Stephen J. Hirschfeld, chief executive of the ELA. "This is a major change in people's perceptions."

This is very bad news for Republicans, who are most associated by voters with big business. Conversely the issue works in favor of Democrats who in decades past have often suffered for their party's close association with labor.

(8/25/02) - Critics outraged by the pay disparity between CEOs and their workers find themselves with new and powerful allies this year.

Wall Street's heavyweights -- institutional investors, money managers and other large shareholders -- are demanding change. Some are even speaking publicly, a rare step.

"It's kind of off the charts as far as attention from investors," Patrick McGurn, a vice president with Institutional Shareholder Services in Rockville, Md., said of executive pay. "From what they're saying publicly, and what we've heard privately from our clients, this is going to be a watershed year when it comes to shareholder reaction to what they believe are abusive pay practices."

In the past, pay critics have largely attacked on moral grounds, saying what they considered excessive pay was just plain wrong. Many proposed a socialist sort of pay-flattening.

"What we think is morally right and also sound business practice is to share the prosperity and share the sacrifice," said Betsy Leondar-Wright of United for a Fair Economy, a Boston advocacy group.

But the voice of Wall Street has transported the pay debate to the mainstream.

"It's a matter of national attention right now," McGurn said.

This year already saw shareholder proposals win surprisingly strong support. At Bank of America Corp., for example, shareholders defied management and voted to limit severance-pay packages.

The trend appears to be accelerating.

• Two weeks ago, N.C. treasurer Richard Moore joined counterparts from California and New York to host a meeting with some of the biggest U.S. pension fund managers. The overseers of large state pension funds were rallying support for reforms that go beyond a new corporate-fraud law President Bush signed last month.

• One of the nation's most successful mutual fund managers, Legg Mason's William Miller, has been sharply critical of stock options as part of executive pay.

• In a Pearl Meyer & Partners survey this year of mutual fund managers, nine out of 10 said pay practices affect their investment decisions. In 1998, only 58 percent of the surveyed managers said they considered pay when making those decisions. This year, 70 percent of the managers surveyed also said CEO pay is too high, compared with one-third in 1998.

• The Council of Institutional Investors in Washington represents 125 pension funds with more than $2 trillion in assets. Members plan an unusual fall meeting to discuss what they can do about reforming executive pay.

"Everybody is fed up," said Ann Yerger, the council's research director. "Institutional shareholders have the ability to put more pressure on boards. It's time collectively for them to get moving."

While large investors have clout companies can't ignore, Yerger and others say individual shareholders also must do more.

For starters, investors should pay attention to the annual proxy from companies where they own stock. Review proposals from the company as well as outsiders. Don't just vote the way the company recommends.

"Go to the annual meeting and speak out," said Carol Bowie, a director at the Investor Responsibility Research Center in Washington.

Mutual fund investors should pressure fund managers to demand changes at companies where they hold stock, Yerger said. "Ultimately, mutual funds represent individuals," she said. "Individuals need to hold their mutual funds accountable."

(8/25/02) - Charlotte management consultant Jim Hlavacek has spent the last 30 years advising executives and directors at some of the world's largest companies.

Founder of Market Driven Management Inc., Hlavacek is a frequent speaker, workshop leader and author of five books, including recently published "Profitable Top-Line Growth for Industrial Companies" (American Book Co., $49.95).

Hlavacek, 58, sits on the boards of three companies, including Charlotte's Nucor Corp. He talked with Observer reporter Stella Hopkins about new pressures facing outside directors and changes needed in compensation for executives of publicly traded U.S. companies.

Q. What went wrong?

CEOs and boards are not accountable enough to the owners -- the shareholders. The system has been wired for management.

At the CEO level, in many companies -- not all, but many -- they are just trying to get all they can get in terms of pay. Many are failing as leaders or, at best they are mediocre, yet they want the highest imaginable pay. They've distorted and misled people so they could get huge pay. Boards were co-conspirators in that. They're supposed to be the oversight.

Q. Are directors in the hot seat now?

They're in a warmer seat now. From what I hear and see, they're scared. They've basically been sheltered from a lot of accountability. Now, they're more accountable, thank God. More independent thought and behavior is urgently needed.

Q. What are problems you see with directors?

There are good directors, but at large, public companies, a lot of directors don't have sufficient business background in companies at a strategic business level. Even if they do have the background and do see questionable decisions and activities, they lack the guts to speak up.

A lot of directors don't make the time to prepare for meetings, to get to know the company and the industry. They're operating with very minimal information, only that given to them by management, which often does not contain all the facts and certainly not the early warning signs.

Some directors simply don't care. They're there for the quarterly check and the status, for cocktail talk about how many boards they're on.

Q. How do complacent directors affect executive compensation?

Show me an overpaid group of top management, and I will show you a board that acts more as lap dogs than as watchdogs.

Q. When you review or work with executive pay packages, what are the biggest problems you see?

Compensation is absolutely not related to performance. They talk a lot about pay in board meetings, but not much about performance. Risk and reward should go together. They've got the reward, not the risk. Even when boards throw CEOs out, they're giving them big umbrellas -- exit packages that are pay for failure.

The pay is too short-term oriented. For example, they can quickly cash in options. The alignment (of pay with performance) that was intended doesn't happen. I'm for holding periods to get that long-term horizon. In general, pay needs to be based on the long-term performance of the company -- return on equity. Executives' interests must be aligned with the interests of shareholders.

The guy that bought stock with after-tax money, he's the one we have forgotten in the pay packages -- the real shareholder.

Q. What other problems do you see with how executive compensation is set?

In theory, the outside pay people are working for the board, but they're hired and paid by management. Are they going to tell management they're overpaid?

Q. What's the downside if there aren't changes?

A number of good U.S. public companies are conservative in accounting and open with disclosing the true pay packages. Unfortunately the companies that stretch the rules threaten the integrity of all companies. The deceptive practices and absurd pay packages are unpatriotic and threaten the capitalistic system that has brought so much to America and other countries.

If some of the reforms don't have an effect, it will hurt the ability to keep good employees and attract capital. Capital has no passport. It will go around the world to where (investors) feel they're getting what's in order. A lot of people are spooked. I hear from my foreign-based CEOs they've taken money out of this market. Trust has been eroded, and it won't come back without reforms. Pay is vital, but it's just a piece of it.

I love this country. It's the greatest country on earth, but Enron and the degrees of Enron that exist in other companies threaten the fabric of our nation.

Without trust, what do you have?

(8/25/02) - In Alice in Wonderland fashion, we talk of expansion and ignore the contraction all around us. We convince ourselves that out of cost-cutting will come prosperity. But while cost-cutting can lift a single company or two, when practiced widely enough it can pull down an economy. And that is happening today.

Few economists acknowledge this dynamic. Corporate cost-cutting and labor-saving layoffs appear in the forecasts as the golden road to greater productivity and rising profits. Never mind that we have just fired the workers and extinguished the salaries that would have been spent on the merchandise and services to fatten the profits. With sales revenue failing to rise, we cut costs more. The process feeds on itself — until there are not enough workers and salaries left to generate sales and profits.

There is hyperbole in this description, but not much. As a nation, we are caught in the strangest and perhaps most perilous recovery since the Depression — featuring a dynamic that William Dudley, chief domestic economist at Goldman Sachs, characterizes as "the corporate paradox of thrift."

"If everyone tries to cut costs and save more, no one saves more," he said. "If you and everyone else cut costs, costs do indeed go down, but revenue also goes down, so profits eventually go down, too. Collectively, we can't cut our way to prosperity."

Individual companies — defending themselves, not the economy — have good reason to throw themselves into this behavior. In one profit report after another this summer, the story has been the same: Sales revenue was flat or barely rose in the second quarter, but don't worry, profits were up. Cost-cutting and labor-saving efficiencies fattened the bottom line, and revenue will soon rise as lower costs allow us to cut prices and take sales away from competitors.

That is fine, for a while, for the winning company. But consider what happens in an imaginary country where Burger King and McDonald's are the entire business sector and the total national output — 100 hamburgers a day, evenly divided between the companies — matches the demand from this nation's consumers. Demand and sales revenue, however, stay flat. So Burger King lays off two workers and uses the saved wages partly to fatten profits and partly to discount prices by just enough to take sales and revenue away from McDonald's. And McDonald's responds in kind.

But soon, the four laid-off workers, with little income, buy fewer hamburgers, and the nation's total consumption drops to 95 hamburgers a day. That sets off another round of cost-cutting and price discounting, and our imaginary nation sinks gradually into stagnation or deep recession not unlike America in the 1930's.

Why isn't that danger uppermost in everyone's mind? Why are forecasters like James Glassman, a senior economist at J. P. Morgan Chase, so optimistic? In a nutshell, they expect an infusion of demand from somewhere that will reverse the cost-cutting and persuade companies to expand investment, production and hiring. Their main hopes are more tax cuts, more growth in federal spending and more interest rate cuts by the Federal Reserve. They also count on people to finance consumption by continuing to extract equity from their homes, which are still rising in value.

Mainly, though, it is stimulus from Washington that for Mr. Glassman will save the day. "If Washington cannot get us moving toward full employment within a year," he said, "then there will be more federal stimulus. We have learned a lot since the Depression about how to fix the economy."

BUT perhaps not enough. Perhaps we have become too accustomed to the other post-World War II recoveries, which were so different. There were no excesses to overcome from a stock market bubble and an insane rush by business to expand far beyond demand. Instead, when consumption rose, there was shortage and rising prices. To control inflation, the Fed pushed up interest rates. In response, consumption subsided, provoking a recession — until rates came down and pent-up demand reasserted itself. Business stepped up investment to keep output abreast of demand, and recovery was on its way.

In the current cycle, however, consumption — particularly for cars, housing and appliances — never tapered off from very high levels during the nine-month recession that started in January of last year. It has still not tapered off, but it is not rising, either, and that is a problem. Recovery requires increased consumption and business investment to make the economy grow. The danger today is that demand will decline instead, and recession will return — or there will be prolonged stagnation. Unfortunately, Mr. Dudley's "corporate paradox of thrift" is pushing hard in that direction.

(8/24/02) - Now that CEOs and accountants are being brought to justice, the next task for business leaders and Congress is to bring derivatives under control before they lead to more disasters.

As one hedge-fund manager told me recently, derivatives have become "Wall Street's dirty secret." They are the financial world's equivalent of anabolic steroids. And just as steroids are corrupting big-time sports and harming the health of athletes, derivatives are corrupting the financial statements of American corporations and preventing investors from getting an accurate picture of the health of those companies.

Derivatives -- contracts between two or more parties based on the underlying value of stocks, bonds, interest rates, currencies or other commodities -- can play an important role in helping corporations and other entities deal with the risks associated with price swings in food commodities, energy, interest rates and even the weather. But there is no question that the business has gotten so big that it must be regulated. The notional value of the global derivatives market is about $100 trillion -- that's 10 times the total of America's gross domestic product. For another comparison, the total value of American corporate equities markets is about $15 trillion.

Enron provides the most tawdry example of what can go wrong with derivatives. In 2000 Enron claimed it made more money from its derivatives business -- $7.23 billion -- than Tyson Foods made from selling chicken and other products. If Enron's derivatives business had been a stand-alone Fortune 500 company, it would have been the 256th-largest company in America. By the time Enron failed, its derivatives liabilities exceeded $18 billion. The notional value of those derivatives positions approached $700 billion.

How did Enron arrive at those numbers? Easy. It made them up.

Despite the size of its positions, Enron's energy derivatives business was almost completely free of regulation. Thus it could use any pricing models and scenarios it chose to value its positions. Enron operated with a free hand thanks to a 1993 exemption passed by the Commodity Futures Trading Commission (CFTC). That exemption became law when Congress passed the Commodity Futures Modernization Act in 2000.

Although some derivatives (such as stock options) are traded on major exchanges, which are subject to federal oversight, a panoply of derivatives are sold over the counter. Enron specialized in over-the-counter derivatives and ran what became, in essence, its own derivatives exchange. Enron's bankruptcy was hastened by the fact that it could not provide collateral to all the companies it was trading derivatives with. While Enron might have gone bust anyway, it would've been far more stable if it had been required to maintain capital reserves sufficient to cover its derivatives exposure.

The collapse of Enron, the near-bankruptcies of several big energy-trading companies and the discovery of abuses by several energy traders in California have led several lawmakers to push for regulation of energy derivatives. Sen. Dianne Feinstein (D-Calif.) began pushing for regulation this year but couldn't get enough support. Now, with Congress in full-tilt reform mode, she has an important new ally, Sen. Richard G. Lugar (R-Ind.), who was a key supporter of the law exempting energy derivatives from federal oversight. Lugar is a co-sponsor of Feinstein's bill, which would close many of the loopholes contained in the 2000 law.

The bill would make over-the-counter energy derivatives traders comply with reporting, recordkeeping, registration and capital reserve requirements similar to those that apply to regulated exchanges, such as the New York Mercantile Exchange. The bill also restores the CFTC's regulatory authority over electronic exchanges that handle energy and metals derivatives.

CFTC Chairman James E. Newsome told reporters recently that Feinstein's bill is not needed because "we have all the authority we need."

Federal Energy Regulatory Commission (FERC) Chairman Pat Wood III disagrees. On July 10, Wood endorsed Feinstein's bill, saying federal oversight "can ensure greater transparency and provide an early warning signal to those charged with protecting the public interest."

Feinstein's bill would allow the CFTC and the FERC to work together to make sure that consumers and investors are protected. And while energy derivatives make up only a small part of the overall derivatives business, it's time for "Wall Street's dirty secret" to be brought out into the sunshine.

The writer is an Austin-based journalist who writes about energy and telecommunications issues.

DURHAM, N.C. (AP) - Enron Corp.'s chief executive said the string of collapsed U.S. businesses shows the need for more corporate oversight and predicted the resulting plunge in public trust is likely to spur a wave of regulation unlike any since just after the 1929 stock market crash.

"We continue to prove we can't govern ourselves effectively," said Stephen Cooper, a turnaround specialist hired by Enron in January as its interim chief executive officer. "I think we'll see a lot of changes coming out of Congress and the regulatory agencies" to prevent corrupt business leaders from padding their pockets first and bailing out on investors and employees.

Cooper, who was a keynote speaker Thursday at a leadership conference at Duke University's business school, blamed the collapse of big companies first on CEOs who came to see themselves as stars entitled to whopping salaries no matter whether the company made money. Kenneth Lay, who preceded Cooper as Enron's chairman and CEO, was one of a number of top executives who took hundreds of millions of dollars in stock and other benefits out of their failing companies.

"Those shareholders were left holding the bag," Cooper said.

Cooper declined to answer questions about whether he had seen evidence of fraud since joining Enron. He also would not comment on the plea deal formalized Wednesday with Michael J. Kopper, a top aide to former Enron financial officer Andrew S. Fastow and the first Enron executive to plead guilty in the company's collapse.

Kopper faces up to 15 years in prison on one count of conspiracy to commit wire fraud and one money-laundering charge. He agreed to give up $12 million in illegal profits and cooperate in the government's criminal probe of Enron's collapse.

Cooper, 55, is managing partner of New York-based restructuring firm Zolfo Cooper LLC. The firm's previous clients include Sunbeam Corp. and Federated Department Stores Inc.

He plans to rebuild Enron as a smaller and more conventional energy company that owns gas pipelines and power generating companies and avoids the power trading business which Enron developed and turned into its most profitable unit.