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The Harvard Law School Forum on Corporate Governance and Financial Regulation, March 26, 2010 posting



Curbing Excessive CEO Pay by Disentangling Wall Street and Corporate America

Posted by John Wilcox, Sodali, on Friday March 26, 2010 at 9:07 am

Editor’s Note: John Wilcox is Chairman of Sodali, a director of, and former Head of Corporate Governance at TIAA-CREF.

Peter Drucker, the revered management guru, deplored excessive CEO pay. He argued that CEOs should not be paid more than 20 to 25 times the average salary of company employees. While his approach is schematic, Drucker’s reasons for opposing high executive compensation resonate today even more than during his lifetime. Essentially, Drucker believed that the leadership, motivation and teamwork needed for a successful business are undermined when the CEO is overpaid. He maintained that business leaders should set an example of responsibility, not privilege. He defined the CEO’s role in terms of stewardship, not self-interest.

The financial crisis certainly validated Drucker’s concerns. A Who’s-Who of respected global business leaders have recently gone on record advocating changes in executive compensation. The list includes Paul Volcker, Bill Gates, George Soros, Warren Buffett, Jeff Immelt, Mervyn King — even Allen Greenspan.

Conspicuously absent from the list have been the leaders of Wall Street, and herein lies an important clue to what went wrong, what should be done and why the task is so difficult.

A case can be made for tracing the roots of both CEO pay abuses and the broader financial crisis all the way back to 1976 and the decision to end fixed commissions on Wall Street. That change triggered a chain of events that altered relations between Wall Street and corporate America, ultimately damaging both.

In a nutshell: During the 1970s, ‘80s and ‘90s investment banking devolved from a relationship business into one driven by transaction fees. Mutual trust between companies and bankers gave way to arm’s-length dealings. Hostile takeovers proliferated. Shareholder demographics changed. Relations between companies and activist institutions became increasingly adversarial. Independent sell-side analysts were displaced by captive research often in service of deals and underwriting. A further cascade of negative developments followed repeal of the Glass-Steagall Act in 1999: deregulation, construction of financial oligarchies, IPOs of Wall Street firms and stock exchanges, conflicted credit rating agencies, opaque derivatives trading, distorted accounting – all contributed to the now-familiar story of over-the-top executive pay, market volatility, speculative bubbles, fraud, Ponzi schemes, the debt crisis and financial system collapse.

One of the least-noted effects of these systemic changes was to unleash Wall Street’s specialized money culture and pay practices, which ultimately migrated to corporate America, infecting businesses via their boardrooms and ratcheting up CEO pay. The Enron Corp scandal showed us where the infusion of Wall Street practices into corporate America can ultimately lead. With its board asleep to the dangers, Enron decided to become a trading company and make money the same way Wall Street does. In so doing, it earned fortunes for its top executives while defrauding its employees, customers and investors.

The lesson: What makes sense for Wall Street can be problematic for corporate America. The converse is also true: Governance and pay standards appropriate for public companies don’t suit Wall Street’s high-risk, competitive environment. Recent post-TARP concessions limiting top investment bankers’ salaries and bonuses may represent a step toward best practice from a corporate governance perspective, but surely they are only temporary. Before long, competitive forces will compel investment banks to return to incentives and pay levels that match private equity firms, hedge funds and other private entities.

How can we bring rationality back to executive compensation at America’s public companies (and, for that matter, to Wall Street)? The answer ultimately depends on our ability to tackle the bigger problem: How can we restructure the U.S. financial system to disentangle Wall Street, corporate America and the federal government?

As Congress continues to grapple with these questions, here are five steps that should be considered:

  1. Wall Street firms should voluntarily segregate speculation and proprietary trading and convert these activities back into private ownership structures, thereby reducing the risk exposure of long-term investors and keeping investment bankers’ compensation out of the public record.

  2. Too-big-to-fail financial institutions should be restructured or broken up to reduce both systemic risk and moral hazard.

  3. Congress should enact new legislation, building on the principles of Glass-Steagall, to segregate commercial and investment banking and to clarify fiduciary standards governing investment of long-term assets.

  4. Regulatory and accounting reforms should compel both corporations and financial intermediaries to increase transparency.

  5. Corporate boards should strengthen oversight of risk management and executive compensation and be fully accountable to shareholders.

These reforms would help reign in corporate pay, take some of the pressure off Wall Street and stabilize our financial system.

Even if these steps are taken, the U.S. must also face up to its underlying cultural and governance issues – the entitlement and celebrity status of CEOs, a tradition of boardroom acquiescence, flawed governance of institutional investors, truculence between companies and shareholders, pervasive short-term focus in investment and business management.

The solution to these long-term problems is not just a matter of legislation or public policy. Corporate CEOs and boards of directors will have to take a leadership role. As Peter Drucker might say, corporate America needs fewer overpaid managers and more responsible stewards.


© 2010 The President and Fellows of Harvard College




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