CEOs and Debt

We have all become rather accustomed to the fact that executives of a company are often compensated for their services in part by equity in the corporation -- or, in the alternative, by options to buy equity.

Not only does this seem normal, there is a superficially plausible case to be made that it aligns incentives properly. A CEO with stock in the company has "skin in the game," as the saying goes.

There are two sides to that, though. As Roger Lowenstein wrote in ORIGINS OF THE CRASH (2004), "For an incentive to functiom properly, there must be a prospect of pain as well as gain" and the the 1990s dotcom bubble with which Lowenstein was concerned in that book, the very possibility of CEO pain was "trivialized."

Another common complaint about reimbursement through equity is that if executives see themselves as equity holders, they have an incentive to shift wealth away from debt holders, toward themselves and their fellow stockholders. How might they do this? By over-paying dividends, most obviously. If a company is in trouble (in the "zone of insolvency" as lawyers sometimes say, although not across that line yet) and it pays its shareholders a generous dividend anyway, then the company is essentially making sure the shareholders get cash while the 'gettin' is good.' That cash will never be available to pay off the bondholders should the company default and either voluntarily file bankruptcy or be pushed in that direction by debtor action.

So: if executives are compensated in stock, they may have a commonality of interests with their fellow shareholders, but this may express itself not in productive dcisions, but in beggaring other stakeholder groups.

What, then, about compensation in bonds? Perhaps a CEO who really wants to show us that he has skin in the game will load up on debt instruments issued by his company. Here is the recent discussion of that point that has gotten me thinking.

Marks & Spencer

Marks & Spencer, the big Brit retailer, (clothing, food, furniture, etc.) holds its annual shareholders meeting in July.

The key thing to know about M&S in the run-up to that meeting is that its chief executive, Stuart Ross, is also the chairman of the board.

The idea of one person holding both of those titles is customary enough in the United States, but unusual in the Mother Country, and that is what one of the institutional shareholders of M&S is challenging.

In fact, at last year's meeting, 22% of investors voted against Ross as chairman, an extraordinary degree of shareholder rebellion.

The Local Authority Pension Fund Forum, which claims to control more than 1% of M&S equity, said today that it is offering a resolution at this year's meeting to appoint an independent chairman by July 2010. Such a resolution would need the support of 75% of M&S shares to pass.

This sounds a bit quixotic but .... hey, who am I to deny the appeal of the knight of doleful countenance.

“The separation of powers at the head of a company is a fundamental governance principle, and one that is accepted by the rest of the market,” said the LAPFF Chairman in a statement.

Proxy access

Another round in the proxy access debate coming our way?

In late 2007 I was blogging here about proxy access rules then under considerationby the Securities and Exchange Commission.

At that time, the SEC adopted the narrowest of the access rules it had under consideration, making life more difficult for shareholder activists seeking change in the election procedures.

It now appears (judging from a story Reuters carried Friday, while Congress continued its struggles with a stimulus bill) that with the new administration we might get a revival of this argument with special emphasis on "sharehlder democracy" as a tool for limiting CEO pay.

Charming Shoppes and a paradox

The president and chief executive of women's clothing marketer Charming Shoppes (best known for its Lane Bryant brand) resigned on July 9, effective immediately.

As Dorrit Bern headed out the door, the chairman of the board, Alan Rosskaum, said what one is expected to say at such times, "We just came to an agreement that Dorrit built a wonderful platform for the company, but this was an apropriate time for the leadership change."

Ms Bern may have helped stimulate this leadership change with some of her recent cost-savings measures. She's closed 150 underperforming stores.

Also, dissident shareholders waged a successful proxy fight in recent months -- successful in the sense that forced a settlement that put two of the dissidents' nominees on the eleven-seat board.

Here's where things get a bit paradoxical. During the peak of that proxy campaign, Ms Bern was also chairwoman of the board, as well as CEO and prez. The dissidents made a point of this and of their desire to separate the roles (a common bone of contention in proxy fights these days -- we've discussed it in this blog before).

In late June, soon after the settlement, the company seemed to have conceded that point. It did separate those roles. Ms Bern stepped down as chairwoman, and Mr. Rosskaum became the chairman.

But was that point made or unmade? The separation lasted only two weeks. Then Ms Bern left, as aforesaid, and the chairman, Mr. Rosskaum, announced that he is the "interim" chief executive, pending a search. So those two posts are re-united. An "interim" position, after all, can last a long time.

And perhaps as Peaches and Herb would say, "it feels so good."

Sullivan out at AIG

This weekend, the board of directors at AIG fired its CEO, Martin Sullivan, and replaced him with its chairman, Robert Willumstad.

This runs counter to the general trend in "good corporate governance" these days. The trend is to separate the two posts of chairman and CEO, on the theory (as it is often expressed) that the same person shouldn't be quarterback and head coach.

This particular team has just fired its quarterback and the head coach, with the consent of the other coaches, has just sent himself in to QB. We'll see how the team does.

Stockholders are probably happy to think that there is a strong hand at the helm, though (and yes, I'm aware of the abruptness of my switch to a nautical metaphor) because AIG has been caught in some pretty nasty seas.

On Friday, a story in the Wall Street Journal said that AIG is under investigation at both the SEC and the Department of Justice on the possibility that the financial products division may have intentionally overstated the value of contracts linked to subprime mortgages.

This comes in addition to the litigation by private plaintiffs I've discussed in earlier posts, and it comes at a time when the price of a share of AIG stock is near its 11-year nadir.

For the record, AIG is saying nice things about Mr. Sullivan while he is on his way out the door. Board member George Miles said, "On behalf of the board and the entire organization, I want to thank Martin Sullivan for his extraordinary dedication and service to AIG for over 35 years."

Bye bye.

CSX and CEO Pay

Two different hearings on Capitol Hill last week pointed in two very different directions.

On Wednesday, the subcommittee on railroads -- a panel of the Transportation Committee -- held a hearing chiefly for the purpose of excoriating activist investors, especially the UK based fund TCI, who have lately been agitating for management changes at CSX. The general attitude of the solons doing the questioning (especially the subcommittee's chairwoman, whose district includes CSX's headquarters) was that the railroad has been doing a fine job, employs a lot of people, and how dare these Londoners come into this picture to mess things up.

On Friday, another house committee -- this time a full committee, Oversight and Government Reform -- held a hearing about CEO salaries. It turns out they're shockingly high. The general attitude of these solons was that managements get out of control, grant themselves salaries not checked by market forces, and it would be good to have some more activist investors holding them in check.

Do these two sets of committee members never even talk to each other?