The Conference Board 2004 Executive Compensation Seminar Keynote Address by Thomas J. Donohue

On: Corporate Governance Reforms: Have We Gone Too Far?
To: The Conference Board 2004 Executive Compensation Seminar Keynote Address
From: Thomas J. Donohue
Date: September 28, 2004

"Corporate Governance Reforms: Have We Gone Too Far?"

New York, New York
September 28, 2004

Thank you, David. I appreciate the opportunity to be here. I come wearing two hats. One is as head of the largest business organization in the world, representing business interests before the White House, Congress, federal agencies, the courts of law, and the court of public opinion.

In this role, I talk to CEOs and directors everyday about the challenges and opportunities they face in a highly competitive global economy—taxes, lawsuits, trade barriers, and government regulations.

I'm also a director on four public company boards—so I have come to understand the issues related to compensation, corporate governance and accounting from that perspective as well.

What I'd like to do today, before getting into some discussion, is first, make just a few comments about the compensation issue.

Then, I'll speak more broadly about the impact that new corporate governance and accounting rules have had on our economy and the risks ahead should we fail to strike the right balance between regulations and free markets.

What I've learned during countless hours in boardrooms discussing executive compensation comes down to this: CEO pay is fundamentally a reflection of the marketplace.

The responsibilities that come with the job of CEO are immense; the right blend of skills and leadership qualities needed is very hard to find; and the number of people who can fill these roles is limited. The marketplace establishes the value of CEOs accordingly.

In the case of major Fortune 500 corporations, pay that might seem exorbitant to the average American reflects the growing complexity that comes with running huge organizations, where decisions at the top impact hundreds of thousands, perhaps millions, of lives.

In the case of smaller, start-up organizations, their prospects for success and growth often depend on the managerial skills and reputation of the CEO—and so investors are willing to pay top dollar to get the best talent.

The CEO's job is riskier than ever before, due in large part to the broader corporate governance issues I will discuss in a moment. And if job security and longevity are what you are after, you probably don't want to be a CEO!

All of these factors work together in the marketplace to set the price for executive talent. And to those who believe that marketplace is working improperly, they might want to look at top executives in the context of major figures in entertainment and sports.

I don't recall a lot of outrage when it was learned that in the final season of the TV sitcom "Friends," each cast member received a salary of a million dollars per episode. Or that Tiger Woods makes $80 million a year, most of it in endorsements.

Are there cases in which executive pay exceeds the value of the person receiving it? Or where a CEO's performance does not justify a high level of compensation? I'm sure there are.

Have there been examples where total compensation has not been adequately disclosed, and subjected to vigorous review by boards and shareholders? I'm sure there have been.

Today we are seeing greater vigilance on the part of boards and shareholders. Annual salary increases for CEOs are no longer a sure thing—according to one survey, one-third of companies did not give their CEOs a raise last year.

Typically, the lion's share of a CEO package is tied to company performance. Only a portion of it is base salary.

The bottom line is that strong, creative, knowledgeable, and visionary executive leadership is a scarce and virtually priceless commodity in today's highly competitive and immensely complex and risky environment. You get what you pay for. It's that simple.

But of course, nothing is really that simple because we are in the middle of a highly-contested, highly-emotional political season.

The issue of CEO pay is easy to exploit, and business opponents readily do so as they attack our best companies on the broader issues of corporate governance, accounting, and who sits on boards of directors.

In my remaining comments, I'd like to address the question of whether in fact lawmakers and regulators have gone too far in reacting to a few cases of serious wrongdoing in the corporate suite.

And if they have gone too far, why is this happening and what is at stake for our capital markets and our free enterprise system?

The Chamber was one of the first business organizations to publicly condemn misconduct at Enron, WorldCom and others, and we've been very clear from the start that businesspeople that intentionally break the law and violate the public trust should be prosecuted and severely punished.

But at the same time, we have urged the public and lawmakers to consider that of the 17,000 public companies in the United States, we're talking about allegations of misconduct at perhaps a couple dozen of them.

The perception that criminal activity is widespread in the business community is simply wrong, and that must be pointed out.

The Chamber supported many provisions contained in Sarbanes-Oxley because we believed then and still do today that they will produce greater transparency, restore investor confidence, and head off future criminal activities.

Because of these reforms, boards are more independent, they meet more often, and they've improved communications with shareholders. Almost everyone would agree that these developments have improved our capital markets system.

But the pendulum has swung too far. Good intentions have produced unintended consequences. The SEC and state attorneys general—including the one from this state—are engaged in a competitive game of "gotcha," instead of helping corporate executives understand and comply with the new rules.

And the class action trial bar is following on their heels with a new mountain of lawsuits.

Groups such as Institutional Shareholder Services are piling on, even though their own practices are far from above board.

ISS has set itself up as judge and jury of corporate behavior – this from an organization that is riddled with conflicts of interest because it sells services to public companies, institutional investors, the class action trial bar, AND union pension funds that seek to advance a social agenda.

At any time, ISS can be profiting from helping companies improve their corporate governance score, selling research to the trial bar to help them file securities class action suits, and helping CalPERS advance its special-interest agenda!

CalPERS, as you probably know, withheld its votes to re-elect corporate board directors at 2,700 public companies, claiming poor corporate governance.

Not coincidentally, the CalPERS board is dominated by labor union interests.

Safeway was one of the companies targeted by CalPERS, and the timing was suspicious to say the least. The grocery store chain had been involved in a protracted dispute with its union, and it just so happens that the chairman of the board of CalPERS is a top official in that union.

Talk about conflict of interest!

The actions taken by CalPERS, ISS, and the class action trial bar are not really about corporate governance. They are about advancing their own political agendas, settling scores with companies, and going after deep pockets.

The cumulative effect of their actions and of new regulations coming from Congress and the agencies is extremely troublesome.

Talented people are turning down board roles, and CEOs are finding it harder to get good advice from their lawyers and accountants.

Companies with the most innovative business models—the next Microsofts—are finding it harder to attract the most experienced auditors and the most qualified directors.

What we see is a business environment in which CEOs are reluctant to take risks, take companies public, or acquire other companies—all of the things that characterize our free enterprise system, grow our economy, and create jobs.

For example, a leading CFO told us that his company is now reluctant to acquire privately held companies because of the short deadlines for certifying the books of the acquired company.

Executives at smaller public companies tell us that the escalating costs of doing business as a public company have caused them to question the benefits of being public at all.

The number of European companies listing on the New York Stock Exchange is down sharply the last two years, and the CEOs of some European companies already listed tell us that they are trying to pull their companies off our exchanges because the maze of governance rules and regulations has become too burdensome.

All of these developments raise serious questions about American innovation, capital formation, entrepreneurship, and global competitiveness.

The Unites States has always been known for offering business owners and entrepreneurs the freedom and flexibility to start and grow their enterprises.

That's the American way. If you have a good idea and are willing to work hard at it, the rest—including gaining access to capital—usually takes care of itself.

But now when a company wants go public or an entrepreneur wants to bring to life a new idea, they might think twice about going to U.S. capital markets.

They might instead think about opportunities in Europe or China, or anyplace where the rules and regulations aren't as forbidding.

Our challenge is to build a transparent, rules-based system without forfeiting freedom and flexibility…

To have strong enforcement of existing laws without creating enforcement competition in which even an investigation deflates market capitalization, destroying good companies along with the bad…

To have predictable enforcement regimes as well as predictable rules…

And to stop special interests, such as labor unions and trial lawyers, from using corporate governance as a vehicle to attack business and advance their own agendas.

Roles and responsibilities are changing in this era of reform. The stock exchanges, the SEC, state attorneys general, and secretaries of state are all getting into the act, trying to exercise their influence on how rules are made and enforced.

The business community has a choice – it can either defer to the regulators and lawmakers, or it can take a seat at the table and fight for sensible action that will restore confidence and end uncertainty without damaging our economy's productivity and competitiveness.

The U.S. Chamber has chosen to do the latter – through advocacy, original research and, yes, even through lawsuits.

Last month, the Chamber sued the Securities and Exchange Commission for its rule requiring mutual fund boards of directors to have an independent chair and that 75% of the directors be independent as well.

We argued that the SEC exceeded both its authority and the intent of Congress. And we argued that the SEC failed to provide empirical evidence that its proposal was a reasonable solution to a well-defined problem.

But that is not the only issue we have with the SEC. The Chamber is also vigorously opposing the SEC's proposal that would allow, in some situations, a small group of shareholders to put its own board of nominees alongside management's choices on a company's official ballot.

We've told the SEC in written comments and in oral testimony that this proposal would give special-interest directors a vehicle to push their own social and political agendas, creating disruption on boards and weakening their ability to function.

It's another tactic by labor unions and other anti-business interests to sabotage profitable businesses that don't do as they say.

These are just a couple of the corporate governance issues the Chamber is addressing. We are also challenging FASB's mandatory stock option expensing proposal, the SEC's proposed rules governing hedge fund advisors, and proposed additional restrictions on tax services by audit firms for their audit clients.

Speaking of which, in the spring, the Chamber will release the results of a landmark study assessing the future of the auditing profession.

Finally, we're working to preserve securities litigation reforms in Congress and in the courts.

We will continue to work with Congress, the SEC, the Public Corporate Accounting Oversight Board, and the stock exchanges to ensure that good intentions don't produce bad results…that "solutions" to problems that don't exist are not implemented.

I've been around long enough and know enough CEOs to know that an overwhelming majority of them perform their jobs with the utmost integrity.

And I have great concern for the future of this country when they tell me that they are reluctant to take risks out of fear of running afoul of new rules and regulations that place tremendous restrictions on how they run their companies.

Remember, part of the reason CEOs are paid so well is because they are willing to take calculated risks.

Flexibility in our free market system and the rewards that come from taking a risk…these are the principles that have made our economy, our capital markets, and our way of life the strongest in the world, and it's these principles we must fight to protect.

Thank you very much.