It seems that “Neutron Jack” Welch is not only back in the news but also is making the monologues of late night talk shows.
The retired chairman of General Electric is being pilloried for the perquisites he reportedly receives, including access to the company’s private 737, membership in four country clubs and rent-free use of a GE-owned luxury apartment. Welch has decided to reimburse GE for the perks.
A few years ago, such delayed compensation would have aroused little comment. But since Enron, Tyco and other corporate scandals in which executives fattened themselves, any new evidence of undeserved compensation of executives can easily outrage the public.
Some members of Congress assert that current systems of corporate governance — especially in regard to executive compensation — are broken and that new laws are needed to protect the public from the effects of fraud and gouging.
Other voices argue that executive pay and perks are a private matter between owners of a company’s stock, their representatives on the board of directors and the managers themselves. Some note that if any executive did well for shareholders in the past decade, it was Jack Welch.
While Welch was richly compensated, they argue, his pay was well worth it to anyone who owned GE stock during the years he ran the company. If multimillion dollar compensation packages are the going market rate for exceptional managers, who is to argue with that?
Both positions have an element of truth. There is a broad national public interest in ensuring the transparency and integrity of corporate governance. A productive economy depends on capital being channeled from savers to firms in an efficient manner.
U.S. financial markets have been some of the most efficient in the world. But if the investing public — and that includes people who own stock only through a 401(k) plan or mutual fund –- lose confidence in the underlying fairness of the system, the system will break down and our economy will produce fewer goods and services to meet the needs of households.
It also is true that stockholders have a more direct and compelling interest in good corporate governance than the public at-large, and we are more likely to have good outcomes if they act rather than defer to government.
The traditional solution to problems of managerial abuse is for the shareholders to press their representatives, the boards of directors, to straighten things out.
But the last 10 years and reams of scholarly research papers demonstrate that board members often are “captured” by the executives they are supposed to supervise.
Economists refer to this phenomenon as a “principal-agent” problem. It is one way in which markets can fail and produce outcomes that are not good for society. And it is pretty clear there are many firms in which the “agents,” or hired management, have not acted in the interest of the “principals” or stockholders.
The crucial problem is how to fix this failure.
The significant change in financial markets in the last four decades has been the rising importance of institutional investors. Historically, individuals owned most of the stocks and bonds. Now most are held by public or private retirement funds or by mutual funds acting on behalf of clients.
Some institutional investors have taken an active stance with regard to management. CALPERS, the California state employees retirement system, has frequently challenged corporate actions it deemed imprudent. And Warren Buffett’s Berkshire Hathaway fund is famed for keeping a close eye on the store at firms in which it owns stock.
But many such institutional investors are not doing all they could to protect their interests and that of their members or clients. The Minnesota State Board of Investment is suing AOL Time Warner, alleging that firm made fraudulently misleading statements about its finances.
That may be a good move on the board’s part, but the horse is well out of the barn. It would be far more useful if the Minnesota board got together with its counterparts in other states and with large private pension plans, such as TIAA-CREF, to devise new institutional arrangements to protect investor interests.
The mistakes of the 1990s demonstrate how traditional external auditors, hired by management, no longer are an effective check to ensure prudent management. And, the incestuous relationships between corporate boards and managers are unlikely to disentangle soon.
There is nothing, however, to prevent TIAA, CALPERS, the Minnesota State Retirement System, and other institutional investors from banding together to set up a surveillance system. Such a system might offer something between a traditional external audit and the kind of work done by rating agencies such as Moody’s or Standard and Poor’s.
One thing is clear. If state and private sector institutions do not act, the federal government likely will. And the history of financial reforms instituted hastily by the government after periodic scandals shows that such action often is not as effective or equitable as more- thoughtful reforms by direct participants. Let’s hope some institutional investors see the light.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.