Enron Excesses May Spur Salary Reforms

SEE CORRECTION APPENDED; Gary Winnick--James Flanigan's column in Sunday's Business section stated incorrectly that Chairman Gary Winnick of Global Crossing Ltd. received restricted stock and loans from the company. He did not.; FOR THE RECORD; Los Angeles Times Sunday February 17, 2002 Home Edition Part A Part A Page 2 A2 Desk 1 inches; 30 words Type of Material: Correction; Gary Winnick-- James Flanigan's column in last Sunday's Business section stated incorrectly that Chairman Gary Winnick of Global Crossing Ltd. received restricted stock and loans from the company. He did not.

The collapse of Enron Corp., whose executives last week either pleaded the 5th Amendment or offered testimony to Congress that strained credulity, has provoked demands for reform among angry investors, politicians and the public..

So far, talk of reform has concentrated mainly on accounting. But soon it will turn to money--the big money that Enron executives pocketed while the ship went down and employees were hurt. Enron's top officers gained tens of millions of dollars from stock option gains and other forms of compensation on top of their multimillion- dollar salaries and bonuses. Similar patterns have been seen at other companies, notably the recently failed Global Crossing Ltd. Employees lose while top brass walk away with large fortunes.

Reforms are needed to bring discipline to executive compensation, which has become "extreme," says the dean of management experts, Peter F. Drucker of Claremont Graduate University.

Indeed, Enron's collapse and the aftermath of the '90s stock market boom make this a watershed time for improving corporate accountability. "It recalls the era of Theodore Roosevelt," says Warren Bennis, distinguished business professor at USC, referring to the president who attacked corporate trusts at the beginning of the last century.

Drucker predicts reform will come within the next five years and will be in the form of new kinds of audits. In addition to the standard tax audit, "we will have a management audit," Drucker says, to evaluate the risks management faces and how well it's conducting the business. "And finally we will have the economic audit, of all the corporation's relations in industry and in the community," he says.

Drucker, a scholar of management science and author of more than 30 books, puts today's executive pay in historic perspective: "J.P. Morgan, no enemy of wealth, once said that a reasonable ratio of management pay to that of the average worker would be 20 to 1. But in U.S. business today it is 500 to 1."

That's not exaggerated. Average total pay, including stock option gains, for chief executives of America's largest companies rose past $15 million in 2000, says Kevin Murphy, professor of finance at USC's Marshall School of Business and a national authority on compensation.

And yet such incentives have proved an utter failure, Drucker says. "There is not one shred of evidence that the extreme compensation of executives has improved company performance. None!"

To remedy the situation, Bennis says, "government needs to impose rules on corporate directors to do their job of protecting shareowners interests."

Robert A. G. Monks, onetime head of the Labor Department office that protects the U.S. pension system and founder of several firms devoted to corporate reform, thinks the present may recall the 1930s, when legislation created the Securities and Exchange Commission to prevent investment frauds of the kind that proliferated in the 1920s.

Today's specific problem is abuse of stock options and other incentive systems, experts say. Companies have given top management-- and broader groups of employees--incentive options to buy company stock at a favorable price for years.

Stock option gains in the '90s are largely the reason that executive pay has gone so far beyond average worker compensation. Even so, executives have finagled more. If stock prices fall, making options less valuable, compliant boards of directors often have repriced the options to benefit executives.

"Tyson Foods [last year] took 150,000 executive options that had lost value and simply replaced them with shares of restricted stock. It's not an incentive but a payoff at the expense of shareholders," says Frank Glassner, head of Compensation Design Group, a New York- based consultant.

Former Enron Chairman Kenneth L. Lay and Global Crossing Chairman Gary Winnick received gifts of restricted stock along with loans from their company treasuries, a complex way of giving tax-benefited compensation that also dilutes the interests of other shareholders and arguably misuses corporate cash.

Graef Crystal, longtime critic of excessive management compensation, says stock options should be restored to long-term duration. Options were intended to align the motivations of man- agers with those of owners for long-term success of the com- pany. But recently, Crystal notes, executives have been able to cash in options after only a year.

"That's speculation, not incentive. Make them go five years before exercising. That way the company and shareholders can benefit too," because management will pursue longer-term strategies, Crystal says.

If the government does not require better control of stock option compensation, as the British government now is doing by requiring that the value of options be fully stated in financial reports, the major investing institutions, such as the California and New York public employee pension funds, should press their case on company managements, experts say.

What's occurring now is more than a backlash against rich executives, which tends to happen after an economic boom, Drucker says. This time the reaction is selective. Bill Gates' great wealth is not resented because it was earned in building Microsoft Corp., where employees--and arguably the economy and society--also benefited. But outsized rewards for corporate managers at companies such as Enron are resented because the public believes the rewards have not been earned and that ordinary employees have been cheated.

Also, when a company collapses, the pain may extend to more than employees and shareholders. Today's company may have numerous alliances and obligations to long-term programs that may not appear on financial statements, such as research programs at a university and obligations to employees and communities. "The enterprise has human and social obligations that will be evaluated in future," Drucker says.

In the aftermath of Enron, "I think we will see a greater role for public and government oversight of the corporation, a reaction to the 'market rules' philosophy of the last 25 years," Bennis says.

Enron's fall will have reverberations indeed.

James Flanigan can be reached at jim.flanigan@latimes.com.