Crime, Punishment, Compensation, and CEOs

Crime, Punishment, Compensation, and CEOs BDO Dunwoody/Chamber Weekly CEO/Business Leader Poll by COMPAS in the Financial Post for Publication June 27, 2005 COMPAS Inc. Public Opinion and Customer Research June 27, 2005

1.0. Introduction This week s web-poll of CEOs and business leaders explored the legal system s treatment of corporate crime and the separate issue of the appropriate compensation for the CEOs of public corporations. In the wake of the 15 and 20 year sentences given the founding father and son of Adelphia Communications, Canada s CEOs and business leaders believe that the U.S. legal system is dealing effectively and justly with corporate crime. Virtually none believe that the American authorities are over-reacting; some believe that the American authorities are not going far enough. Canada should be following suit. The vast majority of the panel (83) feel that it is vital for Canadian authorities to learn from the U.S. example and treat corporate crime with greater seriousness. On the matter of executive compensation, the business leaders and largely private company CEOs on the panel believe that public corporation CEOs tend to be overpaid. They welcome the Sarbanes-Oxley requirement for independent directors deciding CEO compensation but are not convinced that this obligation provides adequate protection against avaricious executives. Furthermore, they perceive CEO compensation to be driven by the wrong considerations the compensation paid to other public company CEOs and board friendships rather than the CEO s performance in providing strategic positioning, acquiring executive talent, and delivering profitability. These are some of the key findings from this week s web poll of business leaders and CEOs, sponsored by BDO Dunwoody LLP and the Canadian Chamber of Commerce. 2.0. U.S. Doing It Right, Canada Should Follow The panel takes a tough line on corporate corruption. The majority of panellists (63) believe the U.S. conviction and sentencing of the founder and son of Adelphia 2

Communications was appropriate (table 1). Meanwhile, 11 of respondents still believe the sentence was somewhat too light. An overwhelming number of respondents (83) believe that it is vital for Canadian authorities to learn from and emulate the U.S. leadership in dealing with corporate fraud (table 2). Panel members want Canada to follow in American foot steps in part because they do not believe that the American legal authorities are over-reacting. Only 2 take the view that some of the recent convictions and sentences were excessive, as shown in table 3. Without suggesting the sentences were disproportionate to the magnitudes of the frauds, some respondents are puzzled by the harshness of penalties for business fraud as compared to the consequences for personal violence. As one respondent asked rhetorically, We put child molesters in jail for 5 years and corporate criminals for 20? Whatever their feelings about particular sentences, the panel has an overwhelming sense that Canada should imitate the U.S. This near consensus emerges not only in responses to specific questions, as mentioned above, but also in volunteered opinions: I believe that the CEO of Nortel got away with murder. Nothing was done to prosecute as he lost a lot of money for many people including me. How can I feel about crooked CEOs? Crime pays at this level in Canada. It must stop! I would like to see more aggressive Canadian prosecution and punishment of corporate fraud and market manipulations a deterrence. The issue of executive accountability is huge. CEOs should be held to the highest standards for ethical behaviour, and those that are found to be guilty of misconduct, negligence etc. should face penalties, including possible jail sentences (for criminal acts) and fines. Panellists tend to believe that the U.S. legal system may be missing some culprits. In practice, 63 believe that the American authorities are either overlooking some miscreants (43) or that recent convictions are only the tip of the iceberg (20). 3

Table 1: (Q1) As you know, the leaders of Tyco International and Adelphia Communications were just convicted of wrong-doing with the Adelphia founder and son given jail sentences of 15 and 20 years, respectively, for misappropriating millions of dollars. So far as you can tell, are these sentences [ROTATE POLES] Far too severe for the magnitude of the crimes 3 Somewhat too severe 11 About right 63 Somewhat too light 12 Far too light 5 Don t know/refused 7 Table 2: (Q3) To this point, the trials and convictions of top executives have been in the U.S. Which of the following opinions is closest to your own? [RANDOMIZE] It is vital for Canadian authorities to learn from the U.S. example and treat corporate crime with the seriousness that it deserves 83 The situation is as it should be Executive misconduct is far greater in the U.S. than in Canada 12 American legal and securities authorities are excessive in their zeal and should back off 4 Don t know/refused 1 4

Table 3: (Q2) Thinking of the behaviour of senior executives in public corporations in general, which of the following opinions is closest to your own: [RANDOMIZE] The convictions of the last couple of years probably understate somewhat the degree of corruption among CEOs, some of whom 43 will get away with serious wrongdoing Recent convictions probably nabbed most of the most serious offenders; the vast majority of CEOs conduct themselves well 34 within the law These convictions are the tip of the iceberg; there are many more senior executives guilty of serious misconduct who may never be 20 brought to trial Some of the recent convictions and sentences were excessive 2 Don t know/refused 1 3.0. CEOs Overpaid, SOX Provision for Independent Directors Good But Not Necessarily Adequate The majority of Canadian business leaders (70) believe that CEOs of public corporations are either greatly or somewhat overpaid (table 4) whereas only 2 believe they are underpaid at all. Most panellists (88) embrace the Sarbanes-Oxley (SOX) requirement for compensation to be determined by a committee of independent directors but are divided about the provision s ultimate effectiveness (table 5). Some respondents (43) believe that it will protect shareholders against compensation-hungry CEOs while others (46) believe it is not sufficient on its own to fully protect shareholders. In their verbatim comments, some respondents expressed concern that boards do not carry out their duties to protect shareholders with sufficient attentiveness and that some smaller public corporations are not actually implementing the SOX requirement. 5

Table 4: (Q4) So far as you can tell, are the CEOs of public corporations [ROTATE POLES] Greatly overpaid for what they do 25 Somewhat overpaid 45 Paid about right 25 Somewhat underpaid 2 Greatly underpaid 1 Don t know/refused 2 Table 5: (Q5) Under Sarbanes-Oxley requirements, CEO compensation should be determined by a committee of independent directors. Which of the following opinions about this requirement is closest to your own: [RANDOMIZE] A good innovation but not sufficient on its own to fully protect shareholders against compensation-hungry CEOs 47 A good innovation that will protect shareholders against compensation-hungry CEOs 41 A poor innovation that is inadequate to address the problem of inflated compensation 9 Don t know/refused 3 4.0. Compensation Driven by CEO Market and Board Friendships, But Should Be Driven by CEO Strategic Leadership, Profitability, and Talent Acquisition According to Canada s CEOs and business leaders, there is a gulf between the factors that actually drive CEO compensation in public companies and the factors that ought to be the compensation drivers. Respondents believe that CEO compensation is determined above all by the compensation paid to other CEOs (79) and by board 6

friendships (68), as shown in table 6. By contrast, members of the panel would prefer compensation to be driven by the CEO s strategic leadership (87), role in acquiring strong executive talent (82), and company profitability (78) (table 7). Most respondents (66) believe that CEO compensation should be a combination of salary and equity or stock options (table 8). The minority (23) who favour mainly salary based compensation greatly outnumber the few (6) who favour mainly equitybased compensation. From these numbers, it is fair to infer to some panellists are concerned that an undue emphasis on equity-based compensation might contribute to artificial financial statements and share valuations but most are not especially concerned. A number of respondents, including CEOs of public companies, commented on some of the complexities associated with compensation: My struggle is the balance between making quarterly numbers for the markets and truly building the business for the long-term health of the organization. Too many short-sighted decisions are being made for the sake of reporting. There is a disconnect between executive compensation and long-term business objectives. More attention is needed by shareholders directed at long term goals, not short term profit. Strategic positioning will be the future way to success, not tactical wins. Usually short term gains are achieved by some sacrifice of long term odds of survival. Some equity is an incentive to make the company stronger, but perhaps a deferred ability to collect on exit. Perhaps a trust fund that can be accessed after a few years [is a solution 7

Table 6: (Q6) From what you can tell, to what extent is CEO compensation driven in practice by each of the following factors? Please use a 5 point scale where means not a factor and 5, a strong factor. [RANDOMIZE] Mean 5 4 3 2 1 DNK The compensation paid to other CEOs 4.2 42 37 9 6 2 3 The CEO s interpersonal influence at the Board 3.9 33 35 20 5 3 4 The CEO s role in strategic positioning of the firm 3.8 25 41 21 9 0 3 Current company profitability 3.6 32 23 19 16 6 3 The CEO s role as marketer/public face 3.6 17 39 28 9 3 5 The CEO s role in acquiring strong executive talent 3.3 11 31 34 15 3 5 Table 7: (Q7) To what extent ought CEO compensation to be driven by these factors? Please use a 5 point scale where 1 means it should not be and 5, that compensation should be strongly influenced by the factor. [RANDOMIZE] Mean 5 4 3 2 1 DNK The CEO s role in strategic positioning of the firm 4.5 55 32 7 2 0 4 Current company profitability 4.3 53 25 13 4 1 4 The CEO s role in acquiring strong executive talent 4.3 41 41 11 3 0 4 The CEO s role as marketer/public face 3.4 14 31 38 9 4 4 The compensation paid to other CEOs 3.0 9 25 33 17 12 4 The CEO s interpersonal influence at the Board 2.3 5 10 23 25 31 5 8

Table 8: (Q8) Some people say that CEO compensation should be salarybased to deprive the CEO of an incentive to create short-term profits, real or imaginary. Other people say that CEO compensation should be equitybased because CEOs are hired, after all, to increase shareholder value. Should CEO compensation [ROTATE POLES] A combination of salary and equity or stock options 66 Mainly salary based 23 Mainly equity-based 6 Be entirely salary based 1 Entirely equity-based 1 Don t know/refused 4 5.0. Methodology The National Post/COMPAS web-survey of CEOs and leaders of small, medium, and large corporations and among executives of the local and national Chambers of Commerce was conducted June 22-24, 2005. Respondents constitute an essentially hand-picked panel with a higher numerical representation of small and medium-sized firms. Because of the small population of CEOs and business leaders from which the sample was drawn, the study can be considered more accurate than comparably sized general public studies. In studies of the general public, surveys of 150 are deemed accurate to within approximately 8.0 percentage points 19 times out of 20. The principal and co-investigator on this study are Conrad Winn, Ph.D and Tamara Gottlieb. 9