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When CEOs fail successfully

C. Gopinath

A LOT of noise is usually made over the high pay given to CEOs in the US (see this column dated May 3, 1999). It is certainly many times the wages of the entry-level worker in the same company, and also many times that paid to their counterparts in other developed economies in Europe and Japan. The CEO, of course, justifies the high salary because he (or increasingly, she) feels that the contribution to the shareholders' wealth from the CEO's astute decision-making deserves a large compensation.

When analysts pointed out that there seemed to be no relation between the CEO's pay and the performance of the company being managed, we saw a new trend of `pay for performance.' The idea here was to tie the compensation to the performance of the enterpr ise. However, rather than choose an index such as ROS or ROA, the compensation consultants managed to anchor the pay to stock price.

Thus, the charm of stock options shot up and CEOs strove hard to push up the stock price by their actions. But what if the CEO does not perform and the profitability goes down or the share price sinks? You would argue that the CEO needs to take some of t he blame. Quite often, the CEO can point to the environment as being turbulent, or decide on major downsizing, lay off employees, and hope that the share price responds. When that does not happen, it is time to call the bluff.

More generally, investors and creditors are left to bear the burden as the company slides, and ultimately collapses through liquidation, or some savior acquires it for a song. Then what happens to the CEO who led their companies down this path? Is the CE O's pay cut? In the past, he usually faded into obscurity; while he did not proceed to the poor house, he did not emerge richer either.

How times have changed. CEOs, and they are usually a smart lot, have learnt from the experiences of their less fortunate brethren. CEOs today negotiate packages usually termed a `golden parachute.' It keeps their nests feathered, even if the company and other employees are suffering from the consequences of their decisions.

Jill Barad headed the popular division of Barbie Dolls, the $6 billions (Rs. 25,800 crores) Mattel Inc. A 17-year veteran with the company, she was promoted CEO three years ago. Unfortunately, the fortunes of the company began taking a dive under her lea dership. A particularly disastrous decision was the acquisition of Learning Co., a software maker, for $3.5 billions (Rs. 15,050 crores) last year. Losses began mounting and the board suggested that it was time for her to leave.

My guess is that she jumped at the chance because her severance package, it is now revealed, amounted to $50 millions (Rs. 215 crores). This included a cash payment of about $26.4 millions (Rs. 114 crores, and five times her last drawn salary), and a bon us under the company's incentive plan. It also included a retirement plan, forgiveness of a $3-million (Rs. 13-crore) loan the company gave her to buy a house in 1994, forgiveness of another loan given to her to prevent her from selling company stock, an d so on.

The company told shareholders that the severance payments to Ms. Barad and another executive were going to cost them about nine cents (Rs. 4) a share. Mattel also revealed that it was going to get rid of the recently-acquired software company at less tha n a third of the acquisition price. As you would expect, several shareholders have sued the company alleging mismanagement.

Another recent case is equally heartwarming. Conseco Inc. is a $9-billion (Rs. 38,700-crore) insurance company founded 21 years ago by Stephen Hilbert, who also headed it. The company was built largely through acquisitions and was the toast of the stock market for several years, although there was always a suspicion that accounting manoeuvres were partly responsible for the stellar results _ a rumour Mr. Hilbert denied. However, the recent acquisition of a financial services firm drew the company away from its traditional insurance business. Results soured and began dragging the whole organisation. Last month, a worried board decided to sack Mr. Hilbert. The details of his severance package are not public yet, but is expected to be about five times hi s salary and bonus, amounting to about $72 millions (Rs. 310 crores).

By the way, the Mattel story is not over. The Mattel board has appointed a new CEO, Mr. Robert A. Eckert, to replace Ms. Barad. He began his job at the end of May. He has a three-year contract and his compensation will be largely similar to that of his p redecessor. In the event of his termination, he will receive a slightly less lucrative deal compared to Ms. Barad. The company clearly does not believe in learning its lesson. You would now be wondering if Mr. Eckert will be actively involved in raising shareholder value as he claimed, or, perhaps, in trying to get fired and collect on his dues!

Let me, for a moment, remove my cynical hat and look at the reasons rationally. CEOs can fail for several reasons. There may be a poor fit between the individual and the needs of the environment _ both the firm and the situation it is in. Al Dunlap, who shot to fame as a turnaround CEO, met his Waterloo when he was found to have misled the board about the results and the prospects of the company. He was shown the door at Sunbeam. He is suing the company for compensation he claims was promised. (CEOs do not go quietly.)

In other cases, Peter's Principle may be working. Recall the author, Peter who propounded that an individual rises to his level of incompetence, and stays there with no further growth. But there is no further growth once you become a CEO, other than to r etire in comfort, without paying the price for incompetent decisions! CEOs can be fallible, but then, should they not pay the price for it?

One reason advanced for providing CEOs the security of a lavish severance package is that it encourages risk-taking. Now, there is a contradiction in terms. The CEO is expected to take risks for the company without fear of personal loss. So doesn't it ma tter that several thousands of employees may have to pay a price? On the one hand if stock options are given as incentives for reaching goals, then providing security in case of failure detracts from risk-taking and creates an imbalance in the rewards sy stem. This is not the management I like to teach.

Finally, we should look at the bright side. In two cases, although the CEOs made bad decisions and managed to escape paying a personal price, we should compliment the boards for their decisions. If the company had to pay a heavy price to get rid of these chieftains, it is probably worth it for the company over the long run, for these CEOs could have done more damage.

(The author is a professor of international business and strategic management at Suffolk University, Boston, US. His Internet address is: cgopinat@suffolk.edu).