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Emerald Group Publishing Limited
Copyright © 2004, Emerald Group Publishing Limited
Raiding the cookie jar
Catherine M. DailyCatherine M. Daily is the David H. Jacobs Chair of Strategic Management, Kelley School of Business, Indiana University (email@example.com).
Dan R. DaltonDan R. Dalton is Dean and Harold A. Poling Chair of Strategic Management, Kelley School of Business, Indiana University (firstname.lastname@example.org)
With another proxy season upon us, corporate observers' thoughts turn to what has become a perennial lightning rod and bane of chief executive officers (CEOs) and board members – executive compensation. Consider the generous compensation and retirement package Dick Grasso, former CEO/Chairperson of the New York Stock Exchange (NYSE), amassed. For many, Mr. Grasso's $139.5 million compensation package (not including $48 million in deferred compensation to which he was entitled) is nothing short of unconscionable. Was this a case of an executive being caught with his proverbial hand in the cookie jar? Perhaps, but it also illustrates substantive issues that continue to surround executive compensation and effective corporate governance practice.
What lessons, then, can be learned from a situation such as that at the NYSE?
Ignorance is not bliss. Incredibly, when Mr. Grasso's pay was publicly revealed, several NYSE board members claimed shock and surprise. Their defense of the compensation/retirement package was that they were unaware of the particulars of Mr. Grasso's compensation. As a non-public company, the NYSE was not subject to publicly disclosing matters of governance. NYSE directors used this lack of disclosure, in part, as a reason for their ignorance of Mr. Grasso's mounting bounty. How is it that the very individuals responsible for setting and approving executive compensation were unaware of the elements of the compensation package?Lesson: all board members are responsible for decisions at the board and board committee levels. There is no excuse for being an uninformed board member.
Coloring in the line: making industry comparisons. Another element of Mr. Grasso's compensation that garnered considerable attention was that his salary and bonus in 2002 – $1.4 million in salary and $7.1 million in bonus – constitute an astronomical level of compensation for a not-for-profit executive. Even comparisons with public company CEOs in the financial services industry revealed that his salary was 40 percent higher than the comparison group and his bonus exceeded that of more than a dozen CEOs with whom his compensation was compared. Here, too, however, compensation committee members claimed that they were unaware that Mr. Grasso's compensation dwarfed that of comparison executives. Other board members disclaimed any knowledge at all of certain elements of the compensation package. This paints a picture of board members who minimally failed to adequately benchmark the CEO's compensation, and who clearly failed to discharge their duty to adequately monitor and evaluate, yet alone appropriately reward the CEO.Lesson: defensible benchmarks must be established in setting compensation – whether at the executive level or otherwise.
Independence in structure and action. Much of what occurred at the NYSE can be attributed to lack of board independence. For example, though a widely criticized structure, the positions of CEO and board chairperson are held in tandem at the NYSE. This structure is believed to compromise the desired independence between the board and management. The director nomination process at the NYSE is illustrative. Mr. Grasso personally selected director nominees by providing the nominating committee with an annual list from which the committee chose new members. Moreover, as a not-for-profit organization chartered in New York, removal of directors is guided by state law that stipulates that board members can be removed only "for cause" and with a majority vote of board members. This results in further entrenchment of current board members. Most damning, however, is the board interlock between Mr. Grasso and the NYSE's compensation committee chairperson, Kenneth Langone, co-founder and board member of Home Depot, Inc. Brother can you spare a dime?Lesson: structural independence is believed to be an essential precursor to behavioral independence. With board structure an easy target for shareholder activists, the conservative position for firms to adopt is adherence to board independence guidelines in order to avoid even the perception of having a captured board.
Sometimes bigger is not better. The 27-member NYSE board demonstrates that the maxim, "bigger is better" is not always true. It appears that the shear size of the board – three "big board" officials, 12 securities industry representatives, and 12 public representatives – may have contributed to the relative inattention to significant board decisions such as Mr. Grasso's compensation. A classic problem with large decision-making groups is that it provides an environment whereby members can "free ride" on other members' efforts. In smaller groups, it is more difficult to become lost in the crowd, as non-performance is more directly visible.Lesson: boards should be structured for maximum efficiency and effectiveness in decision-making processes. Boards need sufficient breadth to provide for diversity in background experiences, perspectives, gender, race, skill sets, etc., while at the same time not becoming unwieldy or redundant in terms of membership.
Two central questions emanating from the furor over Mr. Grasso's pay are whether the compensation was excessive and whether it is reasonable and fair that Mr. Grasso's 36-year tenure at the NYSE was cut short as a function of the disclosure of his compensation package. To the first question we would respond that the ultimate litmus test for any compensation package, at any level in an organization, is whether the pay is appropriately tied to performance goals. To the second, we are sympathetic to the charges that given his active involvement in the myriad of corporate governance practices and issues at the NYSE, Mr. Grasso's hand was probably a bit too entrenched in the cookie jar. It is hard to sustain an argument that he was a disinterested party in the determination of his pay, despite his protestations to the contrary. But we are also intrigued by the furor directed almost exclusively at Mr. Grasso as the recipient of the board's largesse. It is the board that determined and approved the compensation and retirement package. Directors, then, would seem more deserving of remonstrance than Mr. Grasso.