Independent directors at big public companies need to be tougher

WHERE were they? The rash of corporate scandals over the past few years has produced not only outrage at the greed and shenanigans of top executives, but also incredulity that their boards of directors went along with their misdeeds.

What did directors know and when did they know it? Were they, too, corrupt, or merely incompetent or complacent? These are now the questions being asked in dozens of criminal investigations and scores of lawsuits.

At the same time, regulators in America and Europe have placed new burdens on board directors and, despite the perceived failure of so many directors in the recent past, the favourite remedy for ensuring corporate rectitude in the future is to appoint a new generation of directors who will, next time, be truly independent and ever watchful. What was once often a comfortable, and lucrative, sinecure is beginning to look like the job from hell.

As a result, the behavior of corporate boards has already-begun to change in important ways. But there is still much confusion. What exactly are directors supposed to be doing? The answer seems obvious: representing shareholders. Yet what is the best way to do that? Should directors aim to help the chief executive — who, after all, is also supposed to be acting in the best interests of shareholders—by offering advice on management or strategy? Or is the main task of independent directors to monitor a firm's managers, and make sure they obey the rules, don't pay themselves too much and generally behave? In other words, should directors see their role as that of colleague or cop?

" Both, " would be the ideal answer. And in superbly run firms, playing both roles simultaneously may be possible. But in many big companies, directors have found it impossible to be both effective guard dogs and loyal members of the pack, and most have chosen to be the latter.

This has also been the choice that most bosses want them to make. How much more comfortable it is to work chummily with the clever person who has appointed you, or had a strong say in your selection, than to look continuously over his shoulder and ask awkward or embarrassing questions. It is understandable that so many directors have taken this approach, but it is the wrong one.

The perils of collegiality

The primary function of independent board directors in a large public company is to monitor the firm's managers, not to give strategic or managerial advice, and directors should allow nothing to impair their monitoring role.

Most big firms operate in highly competitive markets, and honest strategic errors will be quickly punished by rivals. Moreover, bosses are not short of advice from consultants, industry experts and management gurus, not to mention their own subordinates. But market competition cannot monitor the internal workings of a firm, check an overweening boss, expose a fraud or simply stop top managers from paying themselves far too much. Only independent directors can perform these essential tasks.

This inevitably will require more of an adversarial stance from directors. Of course, to act as effective monitors directors need to know enough about a company's operations to ask the right questions, and they will form views on its strategy. If they think a firm is headed in the wrong direction, they should say so.

But they must remember that their first duty is to speak for shareholders, and that the firm's boss works for them, as the shareholders' representatives, not the other way around.

Despite encouraging steps in this direction, there is a long way to go.

Warren Buffett, the world's most successful investor and an acute observer of corporate America, has no doubt about this. For him the " acid test" of directorial independence is chief executives' pay, which has continued to soar, at least in America, through good times and bad. And he has no doubt about why this " piracy, " as he calls it, has succeeded. Too often, he has written, " boardroom atmosphere" means that collegiality trumps independence. Whenever it does, millions of shareholders are the losers.

The Economist

UNIT 11

• Text 1.

UNDER WATER

The downturn is making companies think anew about how to tie managers' compensation to performance

IТ HAS been a remarkable experiment. Reward top executives according to the performance of their companies, and their interests will be more closely aligned with those of shareholders. So far has the experiment gone, particularly in America, that William M. Mercer, a pay consultancy, says that only 18% of the compensation of American chief executives (and 40% of that of British chief executives) came from fixed salaries last year. The rest came from variable sources such as stock options and other performance-related bonuses.

As corporate profits and share prices soared in the late 1990s, so did these rewards. With the fall in the stockmarket this year, however, many executives' stock options have become almost worthless. Ira Kay of Watson Wyatt, another pay consultancy, reckons that 90% of American quoted companies have some options " under water" — i.e., the share price is below that at which the options were issued. At perhaps half of these companies, he reckons, all the options are under water.

At Harvard Business School, Brian Hall and Thomas Knox have done more detailed sums, studying a sample of top executives in large and small companies. In some 40% of the companies they looked at, the top cadre of executives had near-valueless options.

This is not the only way in which performance-related pay is being whacked. Other measures on which executive bonuses are based, such as hitting budget targets, are doing badly. Richard Bednarek, a director of the Hay Group, a remuneration consultancy, says that for executive directors of FTSE 100 companies in Britain last year, the median bonus was 50% of basic salary. Some got well over 100%. These figures will be far lower this year.

Because most bonuses are at least partly related to such fuzzy things as " personal goals, " some companies will (if they so wish) be able to massage them back up a bit. For many industries, though, that will be impossible. Wall Street bankers' bonuses are likely to be down by as much as 70% this year. Several airlines, including Delta, have already ditched bonuses for their top managers; so have Ford.

For many, this year's bonus is being allowed to keep the same salary. British Airways and CSFB are among a number of companies seeking to cut their executives' nominal salaries. Others, says Steven Hall of Pearl Meyer, a company that monitors top pay, are giving no salary increases but raising possible bonus pay-outs, so that high-fliers have a chance to earn a little more if things go well.

With options drowning and bonuses shredded, how will companies reward their stars'? No longer will the likes of Enron, a toppled American energy company, be able to pay less than the industry average by relying heavily on options. " Cash is king, " says Charles Wardell of Korn/Ferry International, a big headhunting firm. The star candidates he sees want a basic salary and a cash bonus. That is bad news for many companies: cash is a scarce commodity these days.

New options add to the overhang of allocated but unclaimed corporate equity, something that shareholders dislike. But they hate it more when companies " reprice" options (cancel them and reissue them at a lower, more favourable price).

Pay consultants therefore sweat through the night to concoct ingenious ways to issue options that will motivate and retain talent without annoying shareholders. One device that minimises overhang, popular on America's west coast, is the " stub option" - a short-term option that " vests" (becomes available for an employee to exercise) within 12 months but expires after 13. Most options vest within four years and expire after ten.

On both sides of the Atlantic, the fast-growing fad in remuneration packages is " deferred bonuses." A company will, typically, pay a cash bonus of 40% of salary up-front, and another 40% in shares (not, note, options) which become available only at some future date. " Restricted" stock of this sort has become an increasingly popular part of top executives' pay packages in America over the past couple of years. When the share price falls, options become worthless — but restricted stock is merely worth much less than before.

The longer-term question, however, is how to link pay better to sound performance. Some academics, such as Sendhil Mullainathan of MIT, have criticised stock-related pay on the ground that it rewards good luck as much as good performance. The rising stockmarket tide of the past did wonders for a host of leaky boats (and their top executives).

Now that options are so drenched, even some of the compensation consultants who once helped to design them wonder about their worth. " Options were given to too many people, " reflects Scott Olsen, who specialises in executive compensation at Towers Perrin. " Many sold as soon as they could. So they did not build a sense of ownership."

Moreover, a relentless focus on some performance measures can skew corporate policy. In the latest issue of the Harvard Business Review, Michael Jensen, a professor at Harvard Business School, criticises the ties that exist in most companies between a manager's budget and his pay. These, he says, " distort decisions, and turn honest managers into schemers." Mr. Jensen argues that compensation should reward actual performance, independent of budget targets.

At root, though, badly designed rewards often reflect bad corporate governance. Board remuneration committees too often indulge in a form of high-level back-scratching. Nell Minow, an expert on corporate governance, says that decisions on pay are " best made by capable, expert, vitally involved directors, and until our boards meet that standard, companies and their shareholders will break out with bad pay the way that sufferers of poison ivy break out in an itchy rash." The rash developed in the 1990s has not yet subsided; it has merely changed colour a bit.

The Economist

Vocabulary

Notes

1. FTSE [ futsi] 100 companies - Financial Times Stock Exchange index of 100 companies

2. CSFB - Credit Swiss First Boston banking group

3. MIT - Massachusetts Institute of Technology

4.poison ivy - бот. сумах ядоносный; ядовитый плющ, вызывающий при контакте сильнейший зуд и высыпания на коже

Exercise 1. Suggest the Russian for the following.

to align top executives' interests with those of the shareholders; to claim compensation for damages; fixed salaries; performance-related bonuses; stock-related pay; stock options; high-fliers; cash bonus; to indulge in high-level back-scratching; restricted stock; pay package; compensation consultants; deferred bonuses; deferred demand; to hit budget targets

Exercise 2. Suggest the English for the following.

увязывать вознаграждение менеджеров с результатами деятельности компании; требовать возмещения убытков; возвращать стоимость купленной вещи; возмещать кому-либо, понесенные расходы; вознаграждать руководителей; выплаты премиальных; достигать намеченных показателей; искажать стратегически важные решения; цена исполнения опциона; пола­гаться в значительной степени на вознаграждение в виде опционов