Return to Virginia Business - July 2002

Related stories:
-Barbarians at the gate
-How not to run a company

by John Rubino

Corporate boards of directors have traditionally operated in the background, meeting in private and making decisions that were explained, if at all, in arcane 10(K) footnotes and proxies which few investors ever read. But as the governance scandal widens and the public realizes that boards are both the problem and the solution, they're under greater scrutiny than perhaps ever before.

Generally made up of a mix of company executives and independent outsiders, boards usually meet monthly or quarterly to review corporate actions and vote on major initiatives. For the really big decisions-like who gets hired and fired and how much they're paid-most boards break down into committees.

The compensation committee, which sets executive pay, must by law be composed of independent outside directors. At Owens & Minor, for instance, the committee is chaired by James Rogers, president of SCI, a private investment firm, and includes Anne Marie Whittemore, a partner at the Richmond law firm of McGuire Woods, and James Ukrop, chairman of Ukrop's Super Markets. Like the rest of O&M's directors, they're paid $12,500 a year, plus $12,500 in company stock and $1,200 per meeting. At bigger companies in larger cities, directors can make as much as $100,000 a year, plus options and other perks.

Independent or not, compensation committees haven't done much to restrain executive pay. In the 1990s, the income of the average CEO rose by 500 percent, versus 35 percent for the average factory worker. CEOs now make an average of about 500 times as much as the average factory worker. Abominations like golden parachutes and poison pills, meanwhile, have become increasingly common.

But this isn't a new problem, notes Michael Dooley, a University of Virginia law school professor. "The IRS tried to put the breaks [on executive pay increases] in the early 1990s by limiting the amount of compensation that could be deducted as expense." But stock options, since they have value only if the stock price increases, weren't part of this calculation. And since they didn't appear in the income statement as a cost, companies soon discovered that they could hand them out like candy. "You can pay your CEO a dollar in salary but in reality can pay him $100 million a year through options," says Dooley.

The solution? Index the options, says Dooley. That is, design them so they only rise in value if the company outperforms the overall market or its peer group. And force companies to account for option grants as an expense, says legendary investor Warren Buffett. Poison pills and golden parachutes, meanwhile, should be either banned or severely restricted.

Also in the spotlight is the audit committee, which signs off on accounting methods and chooses an outside auditor. Its members are required to have financial and/or accounting expertise. At Owens & Minor, this committee includes, among other local heavyweights, A. Marshall Acuff, former managing director of Salomon Smith Barney, and Vernard Henley, former CEO of Richmond-based Consolidated Bank and Trust Company. By keeping auditing separate from consulting, O&M has avoided messy entanglements. Not so for many other companies, where accounting firms often have auditing and consulting arms working at cross purposes. Enron, for instance, paid Arthur Andersen $27 million in consulting fees in 2000. Overall, the big accounting firms earn about three times as much from consulting as auditing.

Here again, the rules are changing. The major stock exchanges recently required that audit committees of listed companies be independent of management. And in June the New York Stock Exchange proposed additional rules that would provide more checks and balances for shareholders. For instance, each year company CEOs would have to certify that information provided to shareholders is accurate and complete. Audit committees would have to be chaired by directors with financial expertise. Failure to abide by the new rules could result in a company being delisted. Still, the market is ahead of the regulators, says Moon Capital's David Moon. "Just look at all the people who have fired Andersen in the past few months."