Enron ain't the problem. (Compensation Committee).
The unremarked gut issue today is that over the past decade there was a landslide transfer of wealth from public shareholders to corporate managers.
Enron was just the tip of the iceberg ready to happen. Process the salaries, all the $10 million annual bonuses, the issuance of zero-cost stock and tens of million of options to top management. It adds up to hundreds of billions. It wasn't just high-tech properties, but financial services and media largesse that created a new crop of billionaires ranging from Jack Welch to Michael Eisner and Sandy Weill.
High-octane managers like Weill and Eisner did not go unnoticed by other corporate managers. Options programs covering 10% to 15% of the outstanding capitalization of public companies became the norm, everywhere: Merrill Lynch, Morgan Stanley, Time Warner...you name it. They have the full package! Apple Computer's board gave Steve Jobs a Gulfstream V for masterminding the turnaround.
I know the rejoinder -- "Yes, but these headmen created tens of billions of shareholder value during their reign." Granted, but they took no financial risk and tapped other people's equity money. Professional athletes command $10 million paychecks, but Derek Jeter won't end up owning the New York Yankees; Derek goes to the Hall of Fame in Cooperstown, N.Y., in his sunset years.
The big issue of the transfer of hundreds of billions in wealth from shareholders to corporate managers is percolating but not yet boiling over. Enron's management has done our country a big favor. They speculated with their shareholders' and employees' capital, enriched themselves and then lost it all -- tens of billions in credit instruments and $70 billion in equity market value. The public's awareness of this scam hopefully will end the passivity of audit committee board members and put a lid on compensation committee handouts.
Normally, billionaire status is reserved for entrepreneurial success, as in Bill Gates, Michael Dell, Sumner Redstone, and John Kluge. Gates doesn't need options in Microsoft Sadly, Michael Dell, who owns 12% of Dell Computer, piggishly takes 19 million options worth about $200 million.
Who should we blame for the Enron flimflam? Well, let's lay it at the feet of Jack Welch and see how it shapes up. Keep in mind that Enron started out as a stodgy gas pipeline, almost a utility construct, from which sprouted its onshore and offshore trading operations. Enron leveraged its pipeline credit rating to get things rolling. Michael Armstrong of AT&T years later used this model to leverage Ma Bell into the cable television business, which in turn is a fully leveraged balance sheet construct Chuck Dolan, founder of Cablevision, has run his company for decades with a debt to EBITDA ratio of 6-7 to 1. In a stable industry this is an optimum balance sheet It works. When you trade energy futures or warehouse junk bonds, it's trouble. Ask Drexel.
Jack Welch's financial genius was leveraging the prime credit rating of General Electric. Bread-and-butter acquisitions of stable properties selling at half the 30-plus multiple of GE's stock boosted earnings. Welch also commanded the management depth to choose well and upgrade what he bought.
Tyco is a good example of a GE clone except it controls no primary industry like power generation. Tyco bought companies for 12 times earnings and hoped the market would pay north of 20 for the parent. It wrote off a lot of inventory and R&D and pared wage rolls. It showed mid-teens earnings growth at least for a couple of years. Federal-Mogul tried this construct in the cyclical auto-parts sector and promptly sank into bankruptcy.
Remember the heady days of the mid-eighties when Mike Milken was dragging down $500 million in salary at Drexel Burnham? The concept was the same. Buy companies with bank debt and high-yield debentures, but make sure you can cover your fixed charges at least twice aver. Milken anointed his share of billionaires, including Redstone, Kluge, Richard Lindner, and even Ron Perelman. The combination of poor management and an outrageously generous salary package cashiered Saul Steinberg. Wall Street lost patience with Steve Wynn's grandiosity, and he lost his gaming enterprise to Kirk Kerkorian, who keeps a low profile but knows how to execute a lethal bear hug.
When Mike Milken was defrocked by Rudy Giuliani as the high priest of high yield, many of the eastern seaboard senators I talked with thought the biggest financial industry problem was insider trading. But shady traders like Ivan Boesky just made some money. Boesky controlled nothing and had no power. The major financial issue in the mid-eighties was the excessive leveraging of corporate America to do deals and transfer ownership to deal makers who ended up owning 20% or more of the companies they took over.
Corporate largesse is only respectable if you show good numbers. The back half of the nineties, what Alan Greenspan has characterized as the great surge in productivity gains, is now being called into question. After you make adjustments for too liberal assumptions on pension fund rates of return, factor in take-a-bath plant closings, the capitalization of R&D and huge inventory write-offs, and low salaries to balance the options substitution, it looks as if earnings for the S&P 500 Index grew at their long-term pace of 5%, not the 10% that was reported.
This is a very sobering revision of financial history. Most dividend discount models today incorporate much higher earnings growth rates -- 8% to 9%. If you use 5%, the market is at least 10% overvalued, even if 10-year Treasuries yield under 5%. Sadly, the SEC, Congress, the FASB and even the New York Stock Exchange have remained passive observers of all this corporate earnings mufti-pufti that has developed over the past 15 years.
The late Senator Jacob Javits spearheaded the ERISA Act in the 1970s. ERISA was aimed at protecting pension fund holders from the outrageous acts of money managers who flouted the Prudent Man Rule. ERISA came under the Department of Labor's control (in my experience a bureaucratic snakepit). Nobody in government ever spoke up and said you can't put 30% or 40% of pension and profit-sharing funds in one stock, that that's not prudent.
Wall Street is rapidly adjusting to the new realities. Corporations that are highly leveraged are being marked down. Any property with credit risk in retailing, banking, credit cards or communications is losing followers--JP Morgan Chase and Tyco are examples, as understandably are Kmart and Providian, but sound properties like Sprint PCS and AOL Time Warner are losing cachet. There's too much debt and not enough free cash flow an the horizon. The accounting conventions of GE, IBM, American International Group, and Citigroup are now generating "complexity discounts" among money managers.
The country needs a swelling populist rage against managements' venality comparable with the vilification of the trusts, typified by John D. Rockefeller Sr. There were days when Rockefeller dared not leave his house. Where's the Teddy Roosevelt in the wings holding a big stick and ready to pounce?
The President needs to gather his moral energy and set things right. Nowadays, our presidents leave office, join a dozen corporate boards, sign up for $100,000 speaking engagements at Morgan Stanley, take tax write-offs on their presidential papers and sign $7 million book contracts. It's not the right message.
Shareholders should dump all those puff-piece four-color annual reports and shine a spotlight on 10Ks and 10Q SEC filings. Read the proxy statement word by word. If the pay packages smell fishy, check yourself out at 9:30 a.m.
Martin T. Sosnoff is chairman and founder of Atalanta/Sosnoff Capital Corp., an investment management company listed on the NYSE. He began his career on Wall Street almost 40 years ago as a securities analyst, and for the past 20 years has also served as chief investment officer of Atalanta/Sosnoff. Headquartered in New York, the firm manages approximately $2.5 billion in assets for institutions and individuals.
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|Title Annotation:||excessive executive compensation|
|Author:||Sosnoff, Martin T.|
|Publication:||Directors & Boards|
|Date:||Mar 22, 2002|
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