Enron Corp. is a case study in shady accounting, weak auditors, incompetent directors, and shallow work by stock analysts who, with few exceptions, missed it. All of those things contributed to the greatest corporate bankruptcy in U.S. history. But none explains it. Why were Enron's executives able to act so recklessly and run the company into the ground? How could they take such huge risks, to the detriment of long-term shareholders?
The short answer is: because they were not long-term shareholders themselves. Not really.
Fundamentally, this is same reason John Roth and his acquisition-happy band of executives were able to drive Nortel Networks Corp. to the brink of financial disaster. Through the magic of stock options, all of them became fabulously rich running public companies, regardless of how well their shareholders did in the long run.
It's fine and good to promote an independent board, and other niceties of good corporate governance. But even Brian Gibson, senior vice-president of active equities at the governance-obsessed Ontario Teachers' Pension Plan Board, says there isn't a single study that proves good corporate governance leads a company's shares to outperform. The only reliable link indicator, says Mr. Gibson, is management ownership.
When the CEO and his key executives own plenty of stock, and hold on to it, companies tend to outperform. It's a proven fact. When the CEO and his key executives get thousands or even millions of options handed to them on a silver platter, no strings attached, which they can cash at anytime ... well, what's the quickest way for them to get rich? To make the stock pop.
The only way to do that quickly is to create the illusion your company is a fast-growth play. Nortel did it through hasty, overpriced acquisitions. Enron did it through accounting sleight-of-hand. In the both cases, the result was similar. Shareholders got creamed; the CEO bought a giant house and is now gardening full-time (or, in Mr. Lay's case, dodging prosecution).
It would be wildly optimistic to say that future Enrons can be avoided just by changing CEO option plans. But reforming them is as good a place as any to start. Let's say Enron executives had been given compensation packages in which they were given millions of options -- but only after Enron met certain earnings targets over, say, five to 10 years. Would they have destroyed the company?
The basic problem with so many options schemes is they lack any kind of performance conditions for executives. Nor do they require them to hold the stock of a company for the long term. Mr. Roth once exercised options and then sold the underlying stock the same day for a $54-million profit. This rich reward was his, not because Nortel was generating profits, but because Nortel happened to get caught in a wave of enthusiasm for tech stocks.
Fortunately, the major pension funds are getting fed up enough to do something about this. Last month, the $35-billion Ontario Municipal Employees Retirement System called for companies to give options "to reward the achievement of predetermined performance benchmarks, and not to reward mediocrity or failure."
Translation: pull a Nortel, and we'll embarrass you by voting against your shareholder plan at your next annual meeting. "We have no issue with management being paid once," said Tom Gunn, senior vice-president of investments at OMERS. "We have lots of issues with management being paid three or four times. And we have huge issues when management is paid and shareholders lose."
OMERS, as one of Canada's largest pension funds, can throw its weight around. Individual investors have no such influence. What they can do, if they're smart, is sell the stock of any company that, like Enron, gives its management an irresistible reason to juice short-term returns at the expense of the future.
http://www.nationalpost.com/financialpost/fpcomment/columnists/story.html?f=/stories/20020208/1373934.html
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