Crisis in the corner office

Sustainable or not, the increasing role that options play in executive pay produces a strong motivation to show ever rising profits so that share prices climb.

"By increasing shares a few dollars [in price], you can make a very large sum of money," notes Peter Peterson. "As you get near the chalk line of what is proper or improper, licit or illicit, right or wrong, it probably gets a little more tempting" when the executive in question has millions of options at stake.

Critics charge that options are misused when corporate boards either make massive options grants not tied to stellar performance or reprice options so a CEO collects even when the price of the stock falls. They also argue that options should be counted as an expense for the corporation, which is not now the case.

"The abuse of stock options has been enormous," says Paul Volcker. "An instrument that was rationalized as aligning the interests of management with the stockholder has, in my opinion, too often become an instrument for aligning the stockholder with the interests of management."

Goldman CEO Paulson takes a different view of the scale of problems with CEO compensation. "There are a number of situations – nothing like the majority – where compensation is out of line with performance or there is clearly over compensation." He adds that "most of the CEOs I have worked with ... are driven by wanting to do well, a sense of honor and purpose. They don't need huge megapackages."

In a widely noted speech last month to the National Press Club in Washington, Paulson argued that shares a CEO receives should be held for a significant period of time and that CEOs who sell before their company goes bankrupt should have their profits clawed back for up to one year.

Paulson's extensive reform proposals are among a wide number of plans being developed by industry groups like the New York Stock Exchange, by regulators like the SEC, and by Congress.

Thus the framework in which CEOs work is likely to change significantly in the months ahead.

"Changes will probably come from both the government and the private sector," says Timothy Smucker, co-CEO of the J.M. Smucker Co. "I would venture that ones from the private sector – self-policing – will be the ones that will be more lasting."

Already, the business press is reporting that companies looking for new executives are asking search firms to pay special attention to candidates' ethics. And corporate directors now feel new pressure to scrutinize CEO pay more closely.

"Behavior is already changing without rules," contends former SEC Chairman Levitt. "Humiliation and embarrassment tend to change behavior faster than rules and legislation. Legislation and rule making can be effective in prolonging changes in behavior."

In the end, though, external regulations are not what matters, observes Citicorp veteran Walter Wriston. "None of this stuff will work. Only integrity will work. You can't do good business with bad people. Period."

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