Does jailing executives make much difference?
In the aftermath of the 2008 financial crisis, the most commonly heard complaint has been: “Why hasn’t anyone gone to jail?” This past May, Newsweek asked, “Why Can’t Obama Bring Wall Street to Justice?” and Forbes wondered, “Obama’s DOJ and Wall Street: Too Big for Jail?” Even Rupert Murdoch’s New York Post recently chided the president because “not a single Wall Street fat-cat has been charged with violations of securities laws in connection with the 2008 collapse.”
There are many explanations — and plenty of conspiracy theories — about why this is the case, but there’s a different, more important question that needs to be asked: Has sending people to jail fixed anything?
Think back to the post-Enron years. The government convicted roughly a dozen former Enron executives, including former CEOs Kenneth Lay, who died awaiting sentencing, and Jeffrey Skilling, who is serving a 24-year prison sentence, and took accounting firm Arthur Andersen to trial, resulting in its demise. During that era, former WorldCom CEO Bernie Ebbers, former Quest CEO Joe Nacchio and former Adelphia executives were also convicted for misdeeds.
The goal, of course, was to deter future wrongdoing by those who don’t want to play by the rules, and those whose
appetite for risk could destroy a company. After that string of prosecutions, pundits (including yours truly) said that the world — or at least the business world — would be a much safer and steadier place.
Hmmm. By 2007, just one year after Lay and Skilling were convicted, the financial crisis, which had been decades in the making, was about to come crashing down on our heads. Part of the problem is that in corporate America, the odds are still very much in favor of those who game the system because the government, even at its most aggressive, doesn’t have enough resources to go after everyone. In addition, the rules create loopholes that clever people exploit, violating the spirit while still remaining within the letter of the law. On top of that, a lot of what most of us would call wrongdoing doesn’t involve intent — a necessary ingredient for a criminal prosecution. Instead, you find the very human capacity for self-delusion — and, sometimes, sheer stupidity.
Another big part of the problem is that there’s too much money to be made by pushing the envelope, or by keeping your mouth shut when you see others doing it. One Wall Streeter explained it to me this way: “When you work on Wall Street, you have a seat. If you stay in that seat, you know you’ll make a small fortune. So you look around, and you see things going on that you don’t think are right. But you’re not sure — let’s face it, in the modern world, you’re almost never sure… So you have a choice: Leave, forfeit your seat, and watch everyone who stays make a fortune. Or stay, get yours, and when [trouble comes], well, you were just one of the crowd.”
When you probe more deeply into this dilemma you realize that outright crime and envelope-pushing are only subsets of what’s wrong in the bigger crime is that people are being paid huge sums for failure. A banker recently told me the financial crisis was one of the greatest heists in financial history, because so many people made so much money not by succeeding or creating but by failing and destroying. Stan O’Neal drove Merrill Lynch into the ground and walked away with retirement funds and securities worth $160 million. Citigroup CEO Charles Prince got almost $14 million in cash right before Citi began to hurtle toward collapse. And countless inept or crooked junior people, whose names we’ll never know, walked away with fortunes.
In a recent report, veteran analyst Mike Mayo at CLSA noted that the link between bank performance and CEO compensation is weak. Mayo says CEO pay has almost doubled over the past decade, growing more quickly than revenue or profit and almost twice as fast as employee compensation. Over the past decade, Citigroup and Bank of America have had the highest CEO pay and the worst performance. This isn’t an issue that afflicts only the financial world— it is a problem across corporate America. James Stewart recently wrote in the New York Times about Leo Apotheker, whose brief, miserable tenure as the CEO of Hewlett-Packard earned him more than $13 million in termination payments. The Motley Fool notes that Gregg Engles, the CEO of Dean Foods, has received an average of $20.4 million annually over the past six years even as his company’s stock price has fallen 11 percent a year, on average.
Every year, Forbes puts together a list of the worst CEOs based on performance relative to pay. In 2011, Engles got the top honor, but close behind him was Mayo Shattuck of Constellation Energy, whose average annual compensation has been close to $15 million, while shareholders have seen only a 6 percent total return during his tenure. There are countless more examples. So maybe it shouldn’t be people’s liberty at stake but rather their money. Pay people for success — long-term success — that benefits all stakeholders, from shareholders to employees to communities. While that won’t completely eliminate self-delusion, it will certainly help, because it’s often money that blinds people to the improprieties they should see. Unfortunately, there’s nothing easy about administering this cure. The history of attempts to tie pay to performance isn’t a pretty one. Start with stock options. It’s hard to think of a better way to align executive and shareholder interests, but it seems that once people have pocketed enough in cash, or sold enough stock, that alignment goes askew. In its post-mortem on Enron — where the top 200 executives made over $1 billion from stock options in that company’s final year — the Joint Committee on Taxation wrote, “The Enron experience raises a potential conflict between short-term earnings from which executives can reap immediate rewards and longer-term interests of shareholders.”
Under Dodd-Frank, the Securities and Exchange Commission must devise rules so companies disclose how compensation is paid and how it’s linked to performance. Public companies will need to have “say on pay” votes for shareholders. And there are clawback provisions. Goldman Sachs employees who get stock grants are subject to forfeiture and clawback provisions if, for instance, they fail to flag risks that could hurt the firm or the financial system. When JP Morgan suffered a $6 billion trading loss last summer, the executives deemed responsible had pay clawed back for about the last two years. There is also a faint glimmer of hope that shareholders, who have long been silent on this issue, are ready to speak up. Last spring Citigroup shareholders rejected a $15 million package for then-CEO Vikram Pandit (who, by the way, pocketed $6.7 million in compensation for less than a year of work after the board abruptly fired him in October). These changes all seem like lurches in the right direction. Public shaming and even prison sentences haven’t had much impact on malfeasance, so let’s put our energy into ranting about pay, rather than prosecutions, and maybe we can get CEOs thinking more about shareholders, employees and investors than their own overstuffed wallets.
PHOTO: Protesters march through New York’s financial district during a rally against government bailouts April 3, 2009. REUTERS/Brendan McDermid