Seated before him were three employees from the accounting firm—a 40-something woman with an MBA from Harvard, a younger fellow, also an MBA, and Oliver Dulles, a gray-haired man with many years of experience as a certified public accountant. “We have a historic challenge before us,” said Johnston after only the briefest of introductions. “To reach our goals, we must cease looking at UCBS shares strictly as ‘stock in a company we want to sell.’ Instead, we must view them as something much grander than that. We have to think of them as a new currency—a new kind of dollar or pound or yen. We must make UCBS’s shares one of the most valuable currencies on earth. We want to see UCBS shares soar to the stratosphere, creating still more wealth. We want to use that strong currency, our stock, to purchase even larger companies.
The CEO paused briefly, and in the second of silence that ensued, he thought to himself, Plus, we must goose up the value of my own shares and options. They’ve already made me a rich man. Now, I will be even richer.
The Harvard consultant responded as if she had heard his last thought telepathically. “The first item on our agenda,” she said, “is the overhaul we’re proposing in your management team’s compensation packages. We think they—you—need to be rewarded and given incentives to achieve even more rapid growth than you’re currently experiencing. Right now, even including all your stock and stock options, you’ll personally take home no more than $14 million this year. But based on our comparative analysis of executive comp in your peer group of companies, we figure you should get at least 5 times that much, maybe 10 times. Needless to say, the only vehicle that has the potential to make that possible is options. So we are proposing to dramatically upgrade your options plan.”
The CEO nodded knowingly. Options were the new elixir of corporate America. They gave CEOs the chance to make the killing of a thousand lifetimes, and they never once had to be recorded as an expense or be deducted from the profits that were reported to shareholders. Options made it possible for CEOs to plunder a company and pull out a king’s ransom, yet keep shareholders in the dark almost indefinitely.
This CEO already owned a batch of options that gave him the right to buy shares more cheaply than the going price: UCBS shares were selling for $12, and his options gave him the right to buy 1 million shares for an average of $10 each, or $2 less than their worth. If he wanted to cash them in right now, he could effectively buy the 1 million shares for $10 and then sell them immediately at $12, pocketing a profit of $2 per share, or $2 million total.
Not too shabby, he thought to himself, but still not good enough. What disturbed him most, however, was the key point the consultants were finally trying to address right now: The growing gap between his own compensation package and those of others at the helm of companies in the same size category.
Johnston knew, for example, that Enron, a company in the forefront of this new field of “creative accounting,” was especially generous with its executives. Enron’s chairman Kenneth Lay received a base salary of $1.3 million and a bonus of $7 million. Plus, in March 2000, he exercised options worth $123 million. Meanwhile, Enron’s CEO Jeffrey Skilling received $850,000, a bonus of $5.6 million, and exercised options in 2000 worth $62 million. Around the same time, Andrew Fastow, Enron’s CFO, made off with over $30 million for managing two of Enron’s “special-purpose entities.”
Meanwhile, WorldCom was quickly on its way to becoming the largest telecommunications giant in the world, driven mostly by an aggressive acquisition program like the one at UCBS. Johnston suspected, correctly so, that its executive compensation packages were among the richest of all. Indeed, Bernard Ebbers, president and CEO of WorldCom, received a salary of $41 million in 2000, along with a bonus of $10 million. Plus, he was granted over one million options in WorldCom stock, which at the time were worth as much as $53.4 million. In 2000, Mr. Ebbers exercised over a million WorldCom options on shares worth $23.4 million. Later, by the time he quit, he would also have a loan from the company for an astounding $408 million—not to mention a guaranteed salary of $1.5 million for life.
What Johnston didn’t know was that the Enron empire would later collapse in a cesspool of fraud. Nor did he have any inkling of the coming troubles at WorldCom, a fraud and bankruptcy that would make Enron’s look like a friendly game of gin rummy.
That outcome was not even conceivable. Instead, the conversation at UCBS focused on the options portion of the executive compensation package, which was pivotal. If you held options to buy your company’s shares, known as call options, you would have the right—but not the obligation—to purchase the shares at a relatively low price and then immediately sell them at a much higher level. If the company’s stock failed to go up, you would lose nothing except the option itself. If the stock soared, the options alone could be worth more than 10 years’ base salary.
It didn’t take a rocket scientist to figure out what would happen if the company’s stock dropped, for instance, by 30 percent: The big cheeses would lose one-third, one-half, or even two-thirds of their personal wealth. Depending on the company, that percentage could translate into hundreds of millions of dollars.
These corporate CEOs weren’t dumb. They knew that there was nothing better than a positive earnings report to goose up their stock prices. Hence, once each quarter, unscrupulous CEOs massaged the numbers, hid losses in any way they could, artificially inflated revenues, and when all else failed, looked investors squarely in the eye and lied their rich, well-tailored fannies off.
Later, when these stocks crashed and millions of people were burned, the public and the U.S. Congress would bitterly deplore the CEOs who walked away scot-free with Beverly Hills mansions, ocean-faring yachts, and eight-digit bank accounts. Now, however, few people questioned the standard Wall Street rationale for the superfat paychecks and enormous bonuses commonly earned by CEOs. “As long as these managers are making you rich,” rationalized the analysts, “why should you give a damn how big their paychecks are?”
Thus, at UCBS, size was no issue as the woman with the Harvard MBA handed Johnston a spreadsheet with proposed revisions to management compensation packages. On the spreadsheet, his name—plus the names of four other top officers in the company— appeared at the top of each column, while along the left side were various scenarios for UCBS shares, starting from $10 all the way up to $100. “This is a summary sheet showing how much you and the rest of senior management can make with our new proposal, depending on what happens to UCBS share prices,” she declared.
Johnston stared down at the spreadsheet while hiding a narrow smile. The bottom-line number for his total compensation was $360 million at $100 a share. Even if the stock made it just half that far—to $50 a share—he could waltz away with a fat $160 million. Now you’re talking! he thought.
The woman waited for the full impact of the numbers to sink in and then proceeded to explain the underlying basis for the calculations. “First, we are proposing that the total number of options granted to executives should be quadrupled. Second, we are narrowing the program to be weighted more toward you and your top officers—less to middle management and nothing to rank and file.
Needless to say,” she added parenthetically, “it’s not up to me or you to decide on all this—it’s up to UCBS’s board of directors.” The CEO had little concern about this aspect. He knew the members of the board would rubber-stamp the changes in a heartbeat. Why? For the simple reason that they themselves were invariably granted miniature versions of the same compensation packages granted to top executives. They’d be richly rewarded for their “yes” votes.
“Now,” concluded the woman, “the management team will have a truly powerful incentive to do everything humanly possible to boost UCBS shares in the stock market, which leads us to the second item on our agenda—your bottom line. Oliver will pick up from here.”
She nodded to the CPA, who pulled out a yellow pad on which he had scribbled several bullet points.
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