There’s no escaping it. Enron and other corporate scandals remain in the news. One story had Warren Buffett
saying that Wall Street loves crooks. A friend of mine propounded that it was the ultimate pinnacle of the Peter
Principle. My own speculations have gone more toward the idea that the whole corporate structure is flawed.
In the long run it all comes back to the old Latin question, “Qui custodiet custodies?” At the highest levels of
corporate America, there is nobody paying attention. In some ways it is like the U. S. Government. There are
supposed to be checks and balances, including elections by the people, but it rarely works out as well as theories
dictate. For instance, incumbents usually have the advantage, and things slip past the voters when they aren’t
watching. Also, over time what seems acceptable by government officers has changed. In corporations, the board is
supposed to serve the stockholders, but how often does that really happen? Are the stockholders watching the
board and the executives or just the stock price? Are the board members managing the executives? Do they even
know how? Do they truly even care? Do they know what is going on?
The answers to questions about the board are often found in the board selection process. Are they professionals
with good experience on boards? Are they executives who let the CEO get away with things, hoping they will be
given the same latitude? Are they friends of the CEO or Chairman? Are they selected for apparent diversity? How
are the board members compensated for their time? Has their compensation been analyzed in light of the law of
unintended consequences? Does it encourage shenanigans? How long have they served? Has it been long enough to
understand what is going on?
If a board is well selected, they will know what a board is supposed to do and how to do it. The board steers the
long-term vision of the corporation and ensures that the executives are following that path with no financial
irregularities. If a board is composed of friends of the CEO, it cannot function properly because of an inherent
conflict of interest. I was on a board where the executive did everything in his power to keep information from
the board and to stock the board with his friends and the clueless. When accusations were leveled against this
executive, the charge led by two of his buddies, it seemed natural to take action. When it became clear that the
only actions the board had available were to cut his salary or fire the executive, his friends retreated. It was
one thing to moan about the problems, but quite another to hurt their buddy who was using them. Even though it put
those board members in jeopardy of liability suits and criminal prosecution, they were unwilling to act. If the
executive can influence who gets onto the board nothing is safe except the executive’s job. This is very common
with non-profit organizations.
Likewise, if the board is compensated for their time in ways that encourage short-term manipulations, they will
look the other way when the CEO manipulates. An example of this is compensation via stock options. Stock options
encourage manipulation of the stock price for short-term gain. Any bad news will be held or swept under the rug
for as long as possible. If board members are paid via a per meeting stipend, it encourages them to keep the
meetings short, possibly to the detriment of the business. If they are compensated on an hourly basis, it
encourages long meetings. If they are compensated based on profit, long-term investment and maintenance may go by
the wayside to reduce expenses. If they are compensated on gross revenues, they might allow churning that ups
apparent sales. For instance, the Enron contracts that traded energy to other suppliers leaving Enron to buy back
at a higher price. As can be seen, there are pitfalls no matter what basis a board member or executive is
compensated. The best way is a mixed compensation structure that encourages a long-term view. For example,
immediate compensation as a small percentage of profits with stock options with a long investiture period, say ten
to twenty years. Getting boards to know what is going on, control it, and take the long view is what is needed in
America today.
I can do that. Anyone need a new board member? I’ll do it for a few million in stock options.
F. B. Knight is Curmudgeon-in-Residence at the Attila the Hun School of Management. He can be reached for questions
at
fbk@attilathehunschool.net.
