Authors: David Cay Johnston
Sarbanes-Oxley also requires
companies to report grants of stock options within two days, not months. That eliminated most of the ability to pick days after the
fact. Gutting that law is now one of the major goals of business lobbyists in Washington. Turn on any of the cable television
programs that tout stocks and guests will denounce it as excessive regulation that is stifling business.
A few chapters back we examined the health care industry and how government policy has made a few very
rich at the expense of the many. One of the biggest players in the stock-option scandals was William McGuire of UnitedHealth
Group, the firm that manages to get around a Minnesota law that prohibits for-profit companies from providing health care. He
made $125 million in 2004 and even more the next year.
McGuire held options valued at almost
$1.8 billion in 2006. That was the result of his demand that company directors give him shares equal to 2 percent of the company.
To approve the grant the directors, at least in theory, had to conclude that paying him this much was less costly to shareholders
than his possible departure for being denied a raise.
It turns out that McGuire's stock options
were exquisitely timed. His 1997, 1999, and 2000 options were given on the days when the company's shares hit their low points for
those years. His 2001 stock grant just missed the bottom.
The Wall Street Journal
reported that the odds of this happening by chance were at best 1 in 200 million.
Before he
resigned in late 2006, McGuire and his board agreed to reprice the options he had yet to exercise. The new strike price was the
highest price at which the company's shares had traded in each year. How differently those on the top floor are treated from those
on the shop floor. Steal a few videos and the Supreme Court says you can rot in prison until you die. Cheat your shareholders on a
grand scale and you just sign a new contract with your employer.
In retirement, McGuire will
collect a pension of more than $5 million annually for life. His employment contract also obligates UnitedHealth to provide him and
his wife with all the health care they need for life at no cost to the couple.
UnitedHealth
provides health care as a fringe benefit to both its 55,000 workers and to retirees. But under both federal and Minnesota law, if
UnitedHealth decides to cut off this benefit the retirees are out of luck. Not so McGuire. His employment contract requires the
company to reimburse him for the full cost of replacement coverage.
Think about that in the
context of what President Bush said in 2002 at a national summit on retirement savings. “What's fair on the top floor should be fair
on the shop floor,” he said.
Fair or not, five years after the president spoke those words
government rules continue to favor the top floor over the shop floor. The administration is proposing to limit the tax break for
health care plans offered by employers. In effect, it would raise taxes on some workers because they have quality health
insurance.
Nothing in the proposal, however, would prevent companies from giving complete
coverage to executives and even paying them the taxes on the value of the coverage if part of it becomes taxable. Anyone who
doubts that companies would do this to get around the limit when it comes to those on the top floor need only read McGuire's
employment contract. He had unlimited personal use of the company jetâand the company paid the taxes he incurred for these
free flights.
Companies in the options backdating scandal reported more than $5 billion in
charges to correct their financial reports, yet hardly any money was recovered from executives. The 2002 Sarbanes-Oxley law had
a provision to recoup improper payments to executives, but the courts say only the federal securities regulators may invoke it, not
shareholders. As of late 2007 the government had not brought charges in a single case.
There
is yet another way that government rules favor executives over the rank and file. The rules allow troubled companies to cheat
workers out of their full pensions despite a 1974 law intended to guarantee retirement income. The economics of funding pensions
are simple, but corporations have persuaded Congress to make them complicated because they gain from complexity that subtly
shifts risks onto workers.
Traditional pensions provide a monthly payment for life based on
earnings and years on the job. The law requires that money be set aside each year to fund these pensions in advance. The safe
and sound way to fund pensions is by investing in a portfolio of bonds that will pay interest on money set aside for the pensions.
That is what insurance companies do when they sell private annuities, which are individual pensions.
Congress has authorized numerous seemingly minor changes to the pension-funding rules since 1974 that
have had the effect of making it likely that too little money will be put aside. These rules limit pension fund contributions in years
when pension assets are high relative to the obligation to pay, which are also the years when companies are likely to enjoy their
best profits. These rules generally require companies to make larger contributions in years when the economy is weak and can
least afford to make contributions. Companies short on cash can ask for permission to delay making contributions. Thus, both the
good years and the bad create opportunities for “contribution holidays” in which little or no money is added to a pension plan,
even as an additional year of work adds to the total eventually due to the workers.
Congress
also allows a large portion of pension fund assets to be invested in risky stocks rather than secure bonds. While over the long haul
stocks will return more, the up-and-down nature of stock values conflicts with the requirement of a pension plan to make monthly
payments to each retiree. The risk is that many workers will enter retirement during a stock market slowdown, or even during the
kind of severe drop in stock prices experienced in 2000, from which the market by 2007 had not fully recovered. Three or four years
of lower stock prices while pension payments continue are a prescription for trouble.
Worse,
Congress lets companies assume they will earn a specific return on their pension plan assets and to record it whether they do or
not. This last technique is called “smoothing,” and its real effect is to let companies put in less money than is needed to properly
fund pensions.
Finally, Congress places artificial limits on pensions. Salaries of more than
$225,000 at age 65 were not eligible for pensions guaranteed by the government in 2007. The result of this rule is to disconnect the
interests of executives from the rank and file, since many executives make far more than that. An executive who makes ten times
that amount, for example, gets a pension that is 10 percent in the system guaranteed by the government and 90 percent outside
that system.
In theory, the government-guaranteed pension should be safer, more likely to
actually produce income in old age. But executives outside the guarantees often are at far less risk than the rank and file. First, the
government guarantee was $49,500 for someone who worked to age 65 and qualified for a pension plan that ultimately failed and
had to be taken over by the government. Those who retired early, or were in pension plans that failed before they reached
retirement age, typically get far less than they anticipated.
Executives are at less risk. Often
when they leave they are allowed to take their benefit as a lump sum, especially the part above the government guarantee. John
Snow did this at CSX, for example.
If the company files for bankruptcy protection, the portion
of executive pensions not guaranteed by the government can be wiped out. That rarely happens. Instead, the executives demand
that the creditors trying to rehabilitate the company guarantee their pensions as a condition of their staying on to keep the
company going. In a few cases executives have gotten their executive pensions doubled in bankruptcy proceedings. The rank and
file, and executives who have already retired, get no such benefits. Thus do government rules favor executives over
Everyman.
Two decades of economic churning in the airline industry also demonstrate how
government rules can enrich executives while devastating the retirement incomes of rank-and-file workers. Many pilots lost all of
their pensions above the government guarantee. Because the guarantee applies at age 65, while by law pilots must retire at age 60,
they cannot collect even the full, supposedly guaranteed amount of their pensions. Some pilots who had expected to collect
$10,000 a month in their old age now get a third or less.
But the airline executives got rich.
When Northwest emerged from bankruptcy in 2007, its chief executive, Douglas Steenland, was given $26.6 million in restricted
stock and stock options. Glenn Tilton of United got almost $40 million when its parent exited bankruptcy proceedings. Doug Parker
at US Airways got $6 million.
Back in 1998, before its first of two trips to bankruptcy court, the
parent of US Airways paid its two top executives, Stephen M. Wolf and Rakesh Gangwal, more than the combined pay of the 25 top
executives at the corporate parents of American, Continental, Delta, Northwest, and United. Wolf was paid $34.2 million and
Gangwal $36 million. That same year it put very little into its pension plans, because government rules allowed the executives to get
rich even as the pension plans were being shortchanged.
That any American who forgoes
wages today for the promise of a pension tomorrow is not paid in full is a scandal. He has been robbed as surely as if a burglar
broke into his or her home.
One of the great lies being spread in our time is that at big
companies like General Motors and Ford there are not enough workers on the job today to sustain the pension benefits of those
already retired. Current workers are not supposed to benefit those who came before. Each worker forgoes part of his or her current
pay for a benefit in the future. Federal law requires that a pension be funded in advance by setting aside money for that benefit.
Thus, over the life cycle of a company, as it grows from a single worker to a giant enterprise, and then passes into history, the
number of workers on the payroll at any moment is not relevant to whether each worker collects the benefits deferred until old
age.
All Congress needs to do to correct this problem is require sound financing of these
plans. That means setting aside enough money each year for the benefit each worker earned and then investing that money in
high-quality bonds. The problem for representatives and senators is that the simplicity of sound financing would mean a loss of
fees for investment advisers and others who get rich off the current system. In turn, that would mean a reduction in the flow of
campaign contributions to members of Congress. To business owners and executives, the cost of campaign contributions is
chump change compared to the benefits of shortchanging pension plans.
Government rules
permit and encourage a vicious cycle. To the extent that pensions are not fully funded, that their true costs are not paid each year,
it means that corporate profits are inflated. Inflated profits mean that share prices for company stock are inflated, because they
should represent the profitability of companies. And inflated stock prices mean, in turn, that executives cash in their options for
more than they should get.
Stock options are just one part of a bigger scandal about how
executives of publicly traded companies are paid. Congress and the courts have made it harder and harder for unions to organize,
which inherently reduces the bargaining power of workers to get more for their labor. But Congress and agencies like the SEC
have allowed the compensation of executives to become a rigged game. Among other abuses, directors who sit on the committees
that decide how much to pay a chief executive often have indirect interests. And, of course, they have a direct interest in keeping
their seat on the board.
Because of lax rules, the very top executives at companies are now
paid with little regard for their performance. Just look at the mediocre to disastrous performances put in by the top acolytes of Jack
Welch, the retired chairman of General Electric, when they moved to other companies. The poster boy for being overpaid for
negative performance is Bob Nardelli. He left GE for the Home Depot, which turned out to be the best thing that could have
happened for its major competitor, Lowe's.
Nardelli, like many executives, paid attention to
numbers, not people. For a while the numbers like total sales and profits improved, but that is not sustainable without good people.
Those helpful Home Depot workers who can show you tricks, and warn you about do-it-yourself mistakes that can ruin your new
fixture, felt no respect once Nardelli came. To make the bottom line look better, Nardelli cut many of them from full-time to part-time.
The best of them migrated over to the competition. Nardelli felt no need to restrain his own pay. He made $38.1 million in 2005. And
his contract guaranteed him a $3 million bonus no matter what.
The annual meeting for Home
Depot shareholders in 2006 proved a turning point. It was held in Delaware, not Atlanta where the company is headquartered. No
one from the board attended. Nardelli treated the owners brusquely. In less than a year he was out, but he left with a stunning
packageâ$210 million.
What was stunning was not so much the amount, but how he got it. It
was negotiated up front when he joined the company six years earlier. Basically, Nardelli stood to walk away richer than rich no
matter how he managed the company. Government rules on the pay of chief executives are so lax that even mismanagement can
be worth a fortune. On the other hand, Nardelli could have made much more. “If Nardelli had been successful, he would have made
$800 million,” said Ira T. Kay, a leading executive pay consultant.