Executive Compensation: Time for a Reality Check

Shareholder activists and regulators have for years sought to regulate or control executive compensation practices, with little success. That changed with the current financial crisis, and compensation practices, rules and claims will continue along the road of change. In this Emerging Issues Analysis, author Dan Bailey surveys the legal landscape of executive compensation and argues that directors should be more prudent in their executive compensation decisions and should confirm that their D&O insurance program provides the protection they need.

Mr. Bailey writes: The current financial crisis has dramatically changed the visibility of and emotions surrounding executive compensation issues. CEOs of many of the high profile financial institutions which contributed to the current financial crisis received huge compensation packages shortly before their companies' horrible financial conditions were disclosed. For example, during 2007:

• Bear Stearns' CEO, James Cayne, received $38 million;

• Lehman Brothers' CEO, Richard Fuld, received $34 million;

• Citigroup's CEO, Charles Prince, received $15 million;

• Countrywide Financial's CEO, Angelo Mozilo, received $21 million.

More recently, the huge bonus awards to lower level executives at many Wall Street firms and other financial institutions have been well documented. But, these compensation excesses are not limited just to the financial services industry. The average public company's CEO compensation today is reportedly 400 times that of the average employee. By contrast, the ratio of CEO pay to the average employee pay is reportedly about 22 in Britain, 20 in Canada, and 11 in Japan.

The issue of executive compensation is now at the forefront of any discussion relating to current problems with corporate America. There is a widespread perception that too many executives are being paid too much without regard to their performance. By adopting compensation practices which either ignore performance or focus only on short term performance, many believe that executives have been incentivized to make important company decisions based upon short term benefits or self-interest rather than based upon the long term goals of the company and the best interests of society. In other words, it appears that compensation arrangements for many executives encourage those executives to take large risks for short term gains without concern for the long term ramifications to the company and its constituents.

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