The Legal Looting Of Corporations
By Jane Ellis
[email address corrected 2/14/2004, for those of you who may have tried to contact Miss Ellis, I (the webmaster) accidentally put in a bad address originally.]

January 9, 2003

In this day of corporate scandal after corporate scandal, enough cannot be said about the lack of ethics of corporate executives. Thus far, the focus has primarily been relegated to the illegal acts of executives. And while we can (and should) go on a hunt for illegal activity by WorldCom, Enron, or Tyco executives, and the like, we could search for a decade and only find a percentage of their illegal deeds. But, not mentioned by many that we've seen, is the perfectly legal looting of corporations, public and private, that has been taking place.

This is where the lack of ethics factor comes in. Legal and ethical are completely different concepts. From an ethics standpoint, corporate executives are meant to act in the best interests of their companies. In fact, this is what they are paid for. However, a variety of factors contribute to motivate corporate executives to behave unethically, but within the realms of the law, for their own financial gain. This is primarily because the true long term performance and progress of the company is not the benchmark on which corporate executives are compensated. For that matter, in many cases corporate executives are handsomely rewarded even when their company continues to struggle or increases floundering on the edge of insolvency.

Some of the factors that contribute to the unethical motivation of corporate executives include: stock options programs, unreasonable levels of compensation, the aggressive tax treatment of corporate perks, unequal pension programs, and rewards or bonuses based primarily on corporate earnings or stock price. Currently, there are some attempts by the government, unions, and community organizations to curb these ethical dilemmas, but much more still needs to be done.

Stock option programs are predominantly a vehicle used by publicly traded companies. Corporate executives are issued stock options for a variety of reasons:

1) It is a tax-deductible method of compensation that does not have to be reflected in the income statement, as a deduction. This presents a distorted view of the company’s earnings. They can be, and most often are, buried in the footnotes of the financial statements, and potentially ignored by investors and analysts. For this reason, there is growing group of concerned investors and public figures trying to pass legislation that will require stock options to be recorded as an expense on the financial statements.

2) Stock options give corporate officers a financial stake, or ownership interest, in the success of the company. It is believed that when executives have a vested interest in the success of the company they will be motivated to make better decisions to improve the value of the company. While this can be true, it can also work to the company’s detriment. Coupled with greed or the belief that one is being inadequately compensated, having a financial stake in the company can drive an executive to put his or her own best interests above the company’s. They may then attempt to increase the value of the stock or short-term earnings. In fact, the New York Times cited a study by Columbia Business School professors, who followed the earnings of 600 companies, as finding that increasing an executive’s stake in the company does not cause stronger earnings or an increase in the stock price. Instead, other factors, such as research spending, are what tend to improve a company’s performance.

3) Corporate executives pay less in tax when they sell their stock, than if they were to receive compensation in the form of salary. This is because the capital gain rate is 20%, as opposed to the regular top income tax rate of 38% to 39%. They therefore benefit from a tax savings of nearly one-half.

However, it is not just the avoidance attributes of the stock option programs that represent the unethical, but legal looting of corporations. The unreasonable, excessive, but very obvious levels of executive compensation have become akin to highway robbery of the corporation. The current ratio of CEO pay to bottom of the rung employee pay is 411 to 1. It is unfathomable that the value of the work (or should we say worth) of any one employee is so much higher than that of another, regardless of how much education, experience, talent, or genius he or she may have. Companies are built, run and generate earnings on the backs of each and every employee, corporate executive or otherwise.

Some arguments that have been made to justify the outrageously high compensation of corporate executives include:

1) The CEO represents the company as a figurehead. His or her employment or termination with the company can affect both the stock price and the perceived goodwill of the company. However, simply because the stock price can fluctuate by a dollar or two, which may represent $200 million dollars in total, does not in any way imply that the value of the CEO is $200 million dollars. There are many important employees of the company that may have a significant impact on the products or services, and their quality, that are being offered to the company’s customers. Their employment or termination will not result in any market fluctuation, purely because no one knows that they exist. Does this diminish the value of their contribution to the company? Of course not. It is simply the difference between the snake oil salesman that brings the customers in and the creator or provider of products or services that follows through with the sale. Both are needed equally for the company to succeed.

As a side note, the country’s highest level public sector CEO, the president of the United States, does not make on average, as publicly traded company CEO’s do, $11 million a year. Nor does he make 411 times what the lowest rung government employee does. For that matter, he has far more resting on the decisions he makes, that affect the millions of people who live in this country, than any single CEO of a company.

2) It is what the market will bear. Just because you can do something, or earn a certain amount of money, does not mean that ethically you should. That does not make it the best decision for the company. The best decision for the company would be to either keep the money in the company for either asset purchases, research projects, improvement and expansion, to pay higher dividends to shareholders, to reduce the level of debt, or to compensate employees better. Compensating the employees better is important for multiple reasons. First it improves employee morale. It would make the company's workers, so often lectured about the importance of teamwork and group effort, be able to see themselves as a respected part of an organization where their future is not being run into the ground to pay for someone's yacht. Second, it helps to maintain the economy. Putting money in the hands of those who need to spend the vast majority of what they make, unlike handing another dollar to the wealthy, is equivalent to putting that money back into the economy. And, finally, it compensates the employees more appropriately for their work -- an honest endeavor, if ever there was one.

We are not saying that there are not CEO’s and corporate executives who should not make a few million dollars a year. A great example would be a small, privately held company which has only the sole shareholder and his or her spouse as employees. For this example, the company has annual revenues of $3 million and $500,000 of annual expenses, not including compensation. Assuming the company does not have a need to make significant asset purchases or fund research projects or put aside monies for any other reason, who is to say that the CEO and his or her spouse should not make $2 to $2.5 million that year? The company earned it on the back of their salesmanship and labor. However, this is not the normal scenario when compensating executives.

A less obvious method of compensating corporate executives involves the aggressive tax treatment of corporate perks. For example, an executive often is able to use the company jet for a personal trip. You may be thinking - how is this a perk? The executive is required to include the value of the trip in his or her taxable income and pay tax on it. However, the executive does not have to include the actual, real value of what he or she has received. The company can value the cost of that trip at the cost of say, a commercial airline ticket. It doesn’t take a brain surgeon to know that there is a substantial discrepancy between the value of a flight on the company jet and the value of a commercial airline ticket. So, not only is the company being looted, but the US Treasury is being cheated as well.

Another less obvious method of looting the corporation, involves retirement compensation. This is considered looting the corporation because corporate executives are generally not covered by the same retirement package as the employees, or receive additional special deferred compensation benefits not offered to the employees. Retirement plans are generally designed to reward continued long-term service with a company. Many corporate executives do not come up through the ranks of the company, but in fact job hop their way through other companies to come into their position. However, many more of the employees will have been with the company for the better part of their lives. These employees receive a small fraction of the retirement benefits that the executives receive.

One of the arguments to justify this is that the incoming officer has the right to negotiate his or her position, and this is a benefit of his or her powers of persuasion. At the risk of sounding like a broken record, the company is built and run on the backs of the all of the employees, not just the corporate executives. Another argument that is made is that corporate executives have a certain standard of living to maintain after they retire. Well, let’s be honest, don’t we all? Ok, so executives tend to have a higher standard of living. But if the retirement plan is based on the employee receiving some percentage of salary when they retire, wouldn’t that allow all employees to maintain their own levels of standard of living, similar to when they were giving their blood and sweat to the company?

Finally, we come to the rewards/bonuses awarded to corporate executives for certain objective measures of company performance. Who sets these objective measures of company performance? Generally, it is the shareholders or the board of directors. The shareholders of a public company are generally only looking to make money through dividend payments, increases in stock value, etc. As such, they are only interested in the well being of the company to the point that they are receiving a benefit. The shareholders of a privately held company, if they are actively involved with the day to day operations of the company, are more likely to set standards that are for the long term good of the company. The board of directors is meant to be more independent, and may be required to not have a financial interest in the company. While this helps to protect the company’s interests, in general, they are still responsible to the shareholders. In addition, many of the members of a board of directors will have a company’s CEO on their board of directors. The bottom line is, however, that it all comes back to what the shareholders want to reward. With a large publicly traded company, shareholders are going to want to set standards that reward increased earnings, large dividend payments, and/or increased stock value. While these are not unimportant measures of a company’s performance, they are far from the only, or necessarily the most important measures.

Let’s not forget why these objective measures of company performance are set up pay rewards or bonuses to corporate executives. Once again, it is to fall into a tax loophole. In general, tax law only allows a deduction for compensation up to $1 million. However, there is an exception for performance-based compensation that meets certain requirements. For this reason, many corporate executives receive the bulk of their income from stock options and performance-based bonuses. It is not uncommon for sales people, which corporate executives must have many attributes of, to earn a large portion of their income through incentive based programs. However, when the bulk of a person’s compensation comes from performance-based programs, the person is more likely to behave unethically to obtain what they may consider their rightful compensation. This is why some retail companies have switched their sales people from commission-based compensation to salaried compensation. This will allow a company to promote and maintain better customer service, instead of pushing every possible sale, but not necessarily properly serving their customer base in the long term.

But realistically, the long-term performance of a company is not solely based upon the decisions made by corporate executives. It involves various aspects of the market economy, decisions made by employees, changes in the law, acts of God, etc. In sum, corporate executives often, not always, receive bonuses far above the value they have contributed to the company.

It is important to recognize that a good measurement of the value that corporate executives contribute to a company is hard to define. However, it is very apparent that the law allows compensation in ways and amounts that are often unethical and antithetical to the purpose of the employment of the executives. As such, we think that there should be public published guidelines for the levels of compensation that executives ought receive. Failure to adhere to these standards may not be a legal issue. But, at the same time, let the failure to adhere to these reasonable standards be publicized so that stockholders, employees, consumers, and businesses will know that the company may be being looted, as measured by some commonly accepted and hammered-out standards.

A decade or two ago the Japanese were observed looking askance at the ratio of top-management compensation to lowly-worker compensation, citing their own lower ratio. This raised eyebrow makes sense, and it's a pity that more hasn't been done to bring a little attention to it. In addition, in a report entitled Executive Excess 2002, by the Institute for Policy Studies and United for a Fair Economy, found that the current approach to compensation encourages excessive risk-taking and the widespread adoption of aggressive accounting techniques that blur the truth and overstate earnings, but boost CEO pay. To view this report in it's entirety: http://www.faireconomy.org/press/2002/EE2002.pdf We currently have ISO 9000. And we have pointed out some of the more common problems, and suggested some solutions herein. It’s time to set some public standards and guidelines for corporate compensation. We are not suggesting some draconian overly egalitarian standard, but some very general standards to rule out the more particularly egregious levels of legal corporate looting that far too many companies allow.