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Ending the Era of Entitlement

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Despite the astronomical discrepancy between the compensation of most chief executive officers and average employees, some companies' actual performance doesn't always match the rich pay and perks their CEOs often receive.

Vast amounts of shareholder capital get squandered  as these so-called leaders forget or ignore their duty to shareholders. CEOs shouldn't feel entitled to lucrative pay and preposterous perks if their performance isn't up to snuff.

From the everyday to the extreme, I've rounded up a few examples that should make self-respecting shareholders pause -- or shudder.

Slippery slopes for shareholders
Abercrombie & Fitch's (NYSE: ANF  ) CEO Michael Jeffries ranked high on a list of well-compensated CEOs for 2008. What has Jeffries done during his tenure to do deserve that plush reward? Well, for starters:

  • The retailer's shares fell 70% in 2008.
  • Sales growth has slowed dramatically since the fiscal year ended January 2006.
  • Earnings per share have fallen steadily since the year ended February 2008.

But that's all in the past. Surely, Jeffries turned things around in Abercrombie's most recent fiscal year, right? Wrong:

  • The retailer's revenue dropped 17.3%.
  • Same-store sales plummeted 23%.
  • Earnings per share took a 70.8% swan-dive.

While not every example is as egregious as Jeffries', even well-intentioned CEOs can still send the wrong message. Starbucks' (Nasdaq: SBUX  ) Howard Schultz asked the company's board to reduce his salary last year. However, a discretionary bonus awarded later in the year took a little of the feel-good "oomph" out of his earlier gesture.

Starbucks did improve profitability in 2009, and like many other retailers, its stock certainly soared (deservedly or not). But let's not forget that Starbucks was closing cafes and firing workers while Schultz collected his extra cash. His "discretionary bonus" sounded a little indiscreet -- and maybe a little indecent -- given the circumstances.

Still, Schultz looks angelic compared to some of his peers. InfoGroup's (Nasdaq: IUSA  ) founder and former CEO Vinod Gupta recently settled with the SEC over allegations that he embezzled $9.5 million from his company. The cash allegedly funded a whopping nine vacation homes in places like Maui and Las Vegas, yachts, private jet travel, and -- I kid you not -- something like 20 fancy cars, including a Humvee, a Jaguar and not one, but two Mercedes.

We need a positive attitude adjustment
Many individual investors shrug off corporate managers' money misdeeds, forgetting that each share they own represents a real piece of a company. They accept the status quo, believing that selling their stock is their only recourse when faced with disturbing behavior from their companies' leadership.

Meanwhile, large institutional shareholders' focus on short-term performance, often tied to the vagaries of bipolar Mr. Market, can further encourage CEOs to ignore true operational performance and abandon responsible behavior. And weak boards of directors certainly don't keep executives' pay packages (or egos) in check.

Too often, top executives face few if any real consequences for poor performance, which may foster even more apathy among shareholders. When Stanley O'Neal, former CEO of Merrill Lynch, was ousted from his failing, risk-riddled company, he didn't just receive a golden parachute -- he also ended up on the board of directors of Alcoa (NYSE: AA  ) with startling speed. No wonder so many investors grudgingly believe that this behavior will never change.

A few bright spots
Happily, all is not lost in the quest to better align CEOs' pay and performance. When corporate governance expert Nell Minow spoke at the Fool last fall, she counted Berkshire Hathaway's (NYSE: BRK  ) (NYSE: BRK-B  ) Warren Buffett and Costco's (Nasdaq: COST  ) Jim Sinegal as among the few CEOs who responsibly pin their pay to their performance.

Furthermore, at least one wayward top executive will pay the price for his malfeasance. As part of his settlement with the SEC, InfoGroup's Gupta is barred from ever serving as a CEO or a director again. His banishment should serve as a welcome reminder for managers to check themselves before they wreck themselves.

Meritocracy, not mediocrity
When managers think they're entitled to pig out at shareholders' expense, are they really the best stewards for the companies you own? Fools, remember -- that's your capital on the line. Doing nothing when faced with executives' bad behavior condemns you to a mediocre investment at best, and invites an all-out business disaster at worst. Shareholders who voice concern -- or even outrage -- over these lousy situations aren’t bad for business; they're champions of good capitalism.

Hopefully, more companies will adopt say-on-pay policies, to more forcefully tie CEO pay to true operational performance. That way, shareholders will no longer passively submit to repeated muggings from power-tripping managers.

Knowing how prudent and responsible managers behave, and keeping a sharp eye on those who exhibit troubling signs, is the first step to a more robust and shareholder-friendly marketplace.

Berkshire Hathaway and Costco are Motley Fool Inside Value recommendations. Berkshire Hathaway, Costco, and Starbucks are Motley Fool Stock Advisor selections. The Fool owns shares of Berkshire Hathaway and Costco. Try any of our Foolish newsletter services free for 30 days.

Check back at every Wednesday and Friday for Alyce Lomax's columns on corporate governance.

Alyce Lomax owns shares of Starbucks. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (19)

Comments from our Foolish Readers

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  • Report this Comment On March 24, 2010, at 8:04 PM, michnow wrote:

    How about Ending the Era of Entitlement of the American people? What next a promise of a free car and a free garage to put it in? Why work if the gov't will give to you with no strings?

  • Report this Comment On March 24, 2010, at 11:11 PM, jvalerii wrote:

    Is the title of this article meant to be ironic? if entitlement is the "law of the land" it might as well be the law of business. good by capitalism and goodbye prosperity. we'll all be equal and we'll all be mediocre

  • Report this Comment On March 24, 2010, at 11:11 PM, jvalerii wrote:


  • Report this Comment On March 25, 2010, at 8:49 AM, catoismymotor wrote:

    Thank you, Alyce.

    I think the entire world of investing would greatly benefit from the top dogs of most companies earing their pay, and eating theor own cooking, the way BRK and COST bosses do. When you have rock star or entitlement mentalities in the boardroom it could be a sign of bad things to come. Ego needs to be set aside when it comes to running a multi-gillion dollar business. You have thousands of investors, employees and customers counting on you.

  • Report this Comment On March 31, 2010, at 10:11 AM, foolishfoible wrote:

    I find your argument pretty disingenuous. irst pay packages are voted on essentially through the annual proxy process whereby people vote for their directors who in many cases vote on the structure of pay for executives. In some cases proxies contain votes on the pay package of executives directly. The era of entitlement you speak of is odd. The marginal tax rate for self employed people is scheduled in many states to reach a level of nearly 63% in many jurisdictions in the US. No before you tell me there used to be tax rates in this country of as high as 90%. Let me point out some poignant differences. In the 1960s when many of these so called punitive rates existed you could maneuver out of the tax bracket through deductions for all sorts of things. Hows this for an could deduct the depreciation of land. Yes land. Last time I checked land usually didnt decline in value according to its use. Secondly until the early 1980s you could deduct your interest expense from credit cards and non home loans which already had a deduction and still do. The top 10% earners in the 1970s paid less in share of government than they do currently and have for most of the bush and clinton administrations. Attacking CEOs is very popular thing today. Why its simple those that do the attacking are generally not CEOs and they view what they have as theirs if not for a quirk in the hiring process or some such other nonsense. Now, there are CEOs that are ineffective and shouldnt get their contracts renewed for failing to achieve the board's and by proxy the shareholders' long term interest. As for highlighting Berkshire Hathaway and COST in another post in this regard. I find it also exciting that COST has paid its CEO for his performance in a way that he or she can celebrate. But honestly BRK has gone no where as a stock for nearly 10 years....and earlier last year it was down over 12 years. So not much here to talk about on stock performance depending on how long you look. I would never suggest Mr. Buffet is a bad investor, he is not but he too is subject to the winds of chance as economies wane and rise. As for him taking a $1 pay package, his office has some substantial perks so if you add those back I sure the numbers dont look quite so compelling. Secondly, Mr. Buffet has figured out how to rob the tax man, don't sell anything or if you do make sure you sell something that lost value in the period as well. He is a master of the tax trade as well as valuation.

    Now for entitlement. Who is entitled, the average stay of a CEO is less than 7 years, roughly the same as a major league baseball player, football player and basketball player. Are there not enough examples in sports where the college ball player goes to the pros and is found to be wanting? In business, the bold are celebrated because society loves a good story, but for every good story there a hundred others that did not turn out so well. So entitlement in the terms you set out seems to be reticence that you are not there. Mark Hurd got massive benefits from Carly Fiorinas decision to buy Compaq, who gets better press. But in the end it was Mr. Hurd who did the final steps of the integration and execution. Bill Clinton gets kudos for balancing the federal budget, but is that right when Ronald Reagan laid the groundwork by bankrupting the Soviets into submission and George Bush surrendered himself with a tax increase. Not to mention the republican backlash against healthcare in 1994 which prevented Mr.Clinton from committing entitlement hari kari. The point of this missive is too say you hire peole with the best intentions, some will turn out to be turkeys others will turn out to be heros...but many times it is the hard fought land that the turkeys win that provide the fodder for the hero to crow over.

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