Executive compensation and internal controls in public companies

Internal Control Analysis

Publicly owned and operated businesses have always been flashed an evil eye of suspicion by many corners of society but the depth and breadth of the scrutiny now bestowed is not a higher pitch than ever, and for two major reasons. The first reason is that the blogosphere, social media and the Internet and general has made it much easier to share and disseminate salacious information as well as engage in legal malfeasance. The other reason is that there was a wave of scandals or other major situations in the last decade or so that rocked the corporate world to its core at the time, those being the tech bubble, the wave of corporate scandals that included Enron, Tyco and MCI WorldCom and then there was the aftermath of the global recession vis-a-vis the housing market and other businesses that either had to be bailed out (e.g. AIG, Citi, General Motors, etc.) or just completely imploded and/or were acquired (e.g. Merrill Lynch, Lehman Brothers, etc.). In light of this high visibility and the massive scale of bad actors in the publicly traded business sectors, it is certainly worthwhile to see how well internal controls are functioning in a post-Enron social media universe.

Executive Compensation

The topic of executive compensation is not new to the forefront of publicly traded companies and the ethics of the same but it's become more of an issue because executive salaries are climbing much faster than the rank and file employee salaries over the same time horizon. Complicating things even more is that the recent job recovery figures have favored the upper and lower classes while the middle class jobs are coming back much more slowly, as noted in the attached appendix (Plumer, 2013). While this may seem unfair on its face, many businesses make the point that attracting top talent requires top dollar and this means throwing money the best and the brightest.

The shareholders and decision-makers usually fall in line with this line of thought because they are mostly (but not always entirely) focused less on perceptions about what their executive is being paid and why and more on the results that the executive has or could bring to the firm in question. While some may call this greed, others would call it preventing a brain drain. It's a battle between people saying that the deck is stacked in favor of money-rich executives and companies and against the rank and file who often live paycheck to paycheck. Both sides have merit but neither is completely right or wrong.

The supply and demand dynamic that exists with attracting and retaining of executives cannot be denied but there is also the idea of not doing things that look bad. Paying bonuses, especially those related to supposedly good performance, is a very bad idea and even bonuses NOT contingent on performance (e.g. retention payments) can raise the ire of government and advocacy groups in a hot minute, as AIG quickly found out circa 2007/2008. There is nothing wrong with following industry-accepted and logic-based frameworks but timing is everything and it behooves businesses to keep themselves as unconstrained contractually as possible.

Concealment of Losses

One of the major transgressions at Enron was the use of shell companies and other nefarious means to conceal the fact that they were losing money hand over fist. That is certainly not the only thing they were doing that was illegal or unethical, but it certainly was a major thing. The aforementioned use of independent board members and auditors is a great first step but keeping internal people, executives and money-trackers in general, in line in terms of ethics and procedure is key. It is the whole "garbage in, garbage out" thing come to life. Even if it's unwitting or the act of a scant few isolated people, the effects can be much the same.

In terms of that, most firms are unwilling to lie about losses and/or they are unable to get away with it due to strong independent board/auditor activity. For sure, if a firm like KPMG catches a whiff that a client of theirs is doing something obtuse as it relates to information reporting, they are generally not going to go along with the dog and pony show because they will get messy just like their client if it comes out from anyone other than them when they could have or should have known what was going on before the eventual, and usually inevitable, revelation of bad behavior.

Social/Corporate Responsibility

Social and corporate responsibility can be a tricky thing because how different people define those terms in terms of real-life business and cultural situations can vary quite a bit. For example, the aforementioned AIG bonuses that got a lot of people's dander up, including that of President Obama and the United States Congress, was so sweeping and so white-hot that talk of pitchforks was tossed around by the President himself and Congress tried to tax the bonuses at a rate specific only to those bonuses and specific only to AIG.

Lost in the fray is the fact is that the bonuses were retention bonuses for people that knew they were eventually going to be cut loose but were being retained to wrap things up before they left. Beyond that, the payments were contractually obligated and the idea of taxing a single group of bonuses at a single firm when the bonuses for a legitimate business purpose is staggering to most constitutional scholars. What made this even sicker is that the same exact thing happened at Fannie Mae and Freddie Mac a scant year or two later and the amount of the bailouts for those two government-service entities (GSE's) dwarfs the money that AIG got (and paid back).

On the whole, most firms do a great job but when pandering politicians and otherwise insipidly-thinking people get a cause without thinking through what is going on (or otherwise not giving a rip what the facts are even if they are known), a firm can still get slimed and denigrated. This perfect storm of scrutiny usually passes, as evidenced by firms like AIG that are still standing and now doing much better. However, the withering blast of attention, even if it's entirely unfair, is too much to bear for a lot of firms. The best thing to do is avoid the media spotlight at all costs but take extensive measures if and when the attention comes.

Something that some firms do, sometimes at their extreme peril, is either confront or blatantly ignore some of the catcalls that are lobbed against them. Depending on the issue, this can be prescient or extremely unwise. For example, Yahoo CEO Marissa Mayer banning all telecommuting, on its face a perplexing move in and of itself, was made even more odd by the fact that Ms. Mayer has an in-office nursery for her child. There is such a thing as "rank has its privilege" but those two facts being what they are at the same time is a big aggravating to some people, that's all (Guynn, 2013).

Another major issue is that politicians tend to greatly overshoot in terms of reacting to public firm scandals, as many critics of Sarbanes-Oxley will tell you if you ask them. Per a recent survey by a firm that tracks opinions about the cost/benefit ratios for Sarbanes-Oxley, many firms have endured a net loss and sometimes the loss is quite major. This despite the fact that most firms probably did not need Sarbanes to get to them to comply in the first place (Protiviti, 2013).

Conclusion

In conclusion, a lot of the examples and dynamics above are greatly polluted, or at least controversial, due to very disparate viewpoints and ethical mindsets as it relates to what business should do, what they must do and why. Firms must (and should) be ethical and behave within the constraints of the law but the field of play is often not level and there is little to nothing that can be done about it. However, it must be endured nonetheless.