Business: Top Cats

Score one for the lowly corporate shareholder.

After years of watching top executives collect fat pay raises and multimillion-dollar bonuses bearing little or no relation to profits, shareholders were finally able to convince the Securities and Exchange Commission that enough is enough. In February, with public outrage reaching the boiling point, the SEC promised shareholders a greater say in determining how much executives are paid.

The ruling is a major victory for America's 51 million shareholders. For the first time, the owners of public companies will have the right to vote on specific pay proposals. Although the proposals won't be binding (by law, only a vote by corporate directors is binding), their very presence on a proxy ballot will send a forceful message to companies that it's time to curb the excesses. And while boards of directors will be free to ignore such messages, chances are they won't—unless they want to risk public exposure and embarrassment.

But, promising though the ruling is, some shareholder groups think it doesn't go far enough.

"This whole executive pay issue is just a symptom of a much larger infection we have in corporate America—the lack of accountability," says Ralph Whitworth, president of United Shareholders Association. "It's the smoking gun, if you will. These executives…have virtual autonomy over their own private fiefdoms."

Indeed, the top echelon of the corporate world has long enjoyed a freedom from scrutiny that few people in the public arena have. Shareholders are generally powerless to curb that freedom.

In theory, shareholders aren't powerless at all. If you ask corporate lawyers and executives about corporate accountability, you'll get a nice tidy dissertation on how shareholders elect a board of directors, which, in turn, selects and supervises a company's top officers and can fire them if they fail to perform.

"People say this so often it has become like a mantra," says Robert Monks, president of Institutional Shareholder Partners Inc. and co-author of a new book, Power and Accountability. "The fact is, it's untrue, and everyone knows it's untrue."

What is true? Simply this: Management appoints the board members and asks shareholders to approve its choices. The vote is a formality only; it has little real meaning because shareholders are not presented with a choice of candidates. The outcome of the proxy election is thus preordained.

Anyone who hopes to challenge management's monopoly—and give shareholders a real choice—must launch a proxy fight. But such battles can be expensive (one at Lockheed Corp. cost more than $10 million), time-consuming, and difficult, demanding extensive SEC filings and a lengthy SEC review. And mutineers must be prepared for a hostile counterattack from management.

Last spring, Monks mounted such a challenge, running for a seat on the board of Sears. Monks is no gadfly: A Harvard Law School graduate, he headed a money-management firm in Boston, twice ran for the U.S. Senate, and served as a Labor Department official under President Reagan. Monks says he decided to target Sears because of its financial troubles—earnings in its U.S. retail division had plummeted to $47 million, less than 6 percent of its 1984 peak—and because when Fortune asked corporate executives to rank the top 500 companies according to their respect for each, Sears finished a miserable 497.

Sears reacted to the challenge with predictable vigor. The company sued to block access to its shareholder list, shrank its board from 15 members to 10, and altogether spent more than $5 million of shareholder funds on the fight, arguing that Monks's presence on the board would prevent it from boosting its profits. Although Monks managed to win over some of Sears's largest institutional holders, he fell short of the 25 percent needed to win.

"It's like a club," Monks says soberly. "You have to be invited to join."

In fact, most corporate boardrooms do operate like exclusive private clubs, with the chief executive officer serving as membership director. He stacks his board with friendly colleagues who are unlikely to challenge him, and he makes sure they are pampered and well-paid.

Consider the following:

• Two-thirds of board seats are filled by the chief executives of other companies. Take Ford Motor Co., for example. Six of its 17 board seats are filled by the CEOs of major corporations: Coca-Cola, Hallmark Cards, Wells Fargo & Co., Digital Equipment Co., Union Pacific Corp., and Nabisco Biscuit, a division of RJR-Nabisco. Of the remaining 11 seats, company officers fill eight.

• People from outside the corporate world fill only 7 percent of corporate board seats. A close look, though, reveals that many of these directors have strong ties to the company they direct—as attorneys, consultants, and suppliers of goods and services.

• Directors earn handsome fees—in 1990 the average total director's pay at the top 100 companies was $45,650—for what is seldom more than a few weeks' worth of work a year. Many directors continue to collect as much as 60 percent of their fee for 10 years after retirement. Benefits such as life and health insurance are routine, while stock options—the "incentive pay" that executives routinely get—are increasingly used to spur directors on, too.

• Companies treat directors to lavish perks. At G.M. and Ford, directors enjoy free use of new cars; American Airlines and United Airlines offer directors free unlimited first-class travel.

Is it any wonder, given this system of "I'll scratch your back if you scratch mine," that corporate salaries are out of whack with profits, that such protections as golden parachutes and poison pills go unchallenged, and that executives at lackluster companies seldom lose their jobs?

Changing this system of entrenchment won't be easy. Corporate executives wield tremendous power and when threatened go on the offensive. Last summer, for example, when the SEC announced it was mulling new rules to loosen restrictions on shareholder communication, the Business Roundtable, a group of the top 200 CEOs, met privately with Bush administration officials in hope of preventing enactment. In the following few weeks, the SEC received hundreds of letters from Roundtable companies denouncing the plan. There are signs, too, that the Roundtable is preparing for a major showdown on the executive-pay issue.

Nevertheless, inroads are being made. For one thing, the public furor over runaway executive pay has focused an unusual amount of attention on the issue, pushing it into the political arena. As a result, Congress is considering several bills on the matter, including one by Sen. Carl Levin (D–Mich.) to give shareholders the power to rewrite a company's pay policies and one by Rep. Martin O. Sabo (D–Minn.) to essentially cap top-level pay at 25 times that of the lowest-paid worker.

Neither bill, however, fully attacks the underlying lack of accountability in the corporate system, nor do they go far enough to restore the balance of power between company owners and their paid managers. And the Sabo legislation, particularly, robs shareholders of control—by forbidding shareholders who do want to reward an executive for a job well done from making that decision.

What the bills do accomplish, however, is to put pressure on the SEC to act quickly. Since the issue erupted last fall, the SEC has taken several steps to restrain executive power. In its February announcement, the agency proposed rule changes that would force companies to spell out on their proxy statements exactly what top executives make—no more hiding such information under pages of obfuscating legalese. If the SEC adopts the changes, companies would also have to explain to shareholders what performance goals must be met before top managers can earn incentive pay.

Meanwhile, a number of shareholders' groups and institutional investors are pushing the SEC to embrace sweeping reforms. The California Public Employee Retirement System (CALPERS), the nation's largest public fund, is calling for 48 changes in the proxy process. Among the suggestions: Give shareholders greater access to the company's proxy so they can nominate candidates, make the shareholder list available upon demand, and require confidential proxy voting.

"The rules were written back in the days when institutions were not major holders," says Kayla Gilliam, assistant general counsel for CALPERS. "It's like fitting square pegs in round holes: They no longer match with reality."

However it shapes up, the battle between shareholders and managers is far from over. And it is likely to get uglier as shareholders claim more victories. That the battle had to be waged at all should serve as a reminder to those who would seek a high-level corporate position: Despite the fancy pay, perks, and power, they're still only hired help.

Deborah Hallberg is a San Francisco-based writer.