Tenured Tyrants in Corporate America

The U.S. economic outlook remains bleak. Unemployment still hovers around the uncomfortably high 9% level it's occupied for almost two years now. However, one exclusive group retains suspiciously airtight job security in these difficult times: chief executive officers.

Like tenured professors, CEOs seem to sit around collecting pay, their lofty and well-paid position guaranteed with little consideration for their merit or performance. But this year, the age of executive tenure may be coming to an end. Shareholders have begun to speak out against outrageous pay for lackluster performance. Whether that results in more CEO pink slips, however, remains to be seen.

Foreshadowing fury
Earlier this month, 53.7%  of Beazer Homes (NYSE: BZH  ) shareholders opposed management's executive compensation practices at the homebuilder's annual meeting.

Corporate governance watchers RiskMetrics pointed out that Beazer's stock has delivered substantial losses to shareholders in recent years. Yet longtime CEO Ian McCarthy enjoyed a 350% boost in total direct compensation last year.

I dug into the Manhattan Institute's Proxy Monitor database, searching for the results of shareholder votes on executive compensation last year. Some companies' vote tallies revealed significantly high percentages of shareholder unhappiness with the status quo. The following examples might be just the tip of a looming iceberg:

  • 62.8% of WellPoint (NYSE: WLP  ) shareholders supported holding an advisory vote on executive compensation. 49.4% of Target (NYSE: TGT  ) shareholders and 46% of shareholders at UnitedHealth Group (NYSE: UNH  ) backed similar votes.
  • 46.1% of Cardinal Health (NYSE: CAH  ) shareholders favored a requirement that stock option grants be performance-based.
  • 42.9% of Coca-Cola Enterprises' (NYSE: CCE  ) investors approved of a proposal to seek shareholder approval for future severance agreements that pay senior executives more than 2.99 times their base salary plus bonus.
  • 42.7% of Verizon (NYSE: VZ  ) shareholders supported ending "golden coffin" death payments.

The high cost of entrenchment
Clearly, many shareholders aren't happy with executive pay policies, and many managers and boards must be all too aware of their displeasure. But expecting high-profile CEOs with low-quality performance to actually get shown the door may be too optimistic for now.

Underperforming CEOs, whose paychecks often represent millions or even billions in squandered shareholder capital, rarely get the axe. On average, only about 2% of Fortune 500 CEOs lose their jobs every year. Wharton finance professor Luke Taylor wanted to know why so few top executives got fired, and a December article in The Journal of Finance revealed the results of his research.

Taylor constructed a financial model of the costs related to firing a CEO. First, he crunched dollar considerations on direct costs like severance payments. Next, he quantified intangible "entrenchment costs," like friendly or comfortable relationships, or a sense of business alliances between CEOs and directors. 

His sober conclusion: While direct costs averaged $300 million, "entrenchment costs" weighed in at a whopping $1 billion. If corporations could somehow abolish those latter intangibles, CEO firings might jump from just 2% a year to a more substantial 13%.

Buddy systems aren't shareholder-friendly
Wharton's article concerning entrenchment costs is fascinating, and well worth the read. It supports the argument that overly chummy relationships between managers and boards make it difficult to clear away dead wood in a corporation's upper echelons.

However, Taylor's data did reveal some surprising factors: Entrenchment costs diminished to zero, or even negative, at larger companies -- likely because higher profile directors' reputations are more publicly on the line. Also, entrenchment has dwindled in recent years, probably thanks to increased shareholder activism.

Taylor admits that if the rate of CEO firings surged, it really might bring about the worst fears of high CEO pay's staunchest defenders: Talented people could stop aiming to be chief executives. Even those brave enough to accept the jobs might be reluctant to take the kind of risks necessary to secure long-term growth and performance.

On the whole, though, whether we're talking about reining in unjustifiably fat paychecks, axing tenured tyrants, or both, one thing does have to change. Corporate managements and boards need a greater sense of accountability, and at least some negative repercussions for poor job performance. This year more than ever, shareholders are watching.

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

UnitedHealth Group and WellPoint are Motley Fool Inside Value selections. Motley Fool Options has recommended a diagonal call position on UnitedHealth Group, which is also a Motley Fool Stock Advisor pick. The Fool owns shares of UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax does not own shares of any of the companies mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On February 17, 2011, at 1:09 PM, rgugliotti wrote:

    I don't buy the statement that talented people will stop wanting to be CEOs as long as they do not take foolish risks or go out buy $6000 shower curtains went the company is underperforming.

    The compensation packages seem overly sufficient to attract top talent.

    Ron

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