Friday, May 19, 2006

The Worth of Executive Leadership

With regulatory action pending, executive compensation is receiving considerable scrutiny. Just what is a chief executive officer worth? Is the pay scale different for a small cap company than a large cap company? When the SEC finalizes its compensation reporting requirements and investors begin to see the full scope of executive recompense, how will we conclude if the pay is fair?

Several years ago I appeared as a panelist at an investor symposium with Marc Robbins, founder and editor of the small cap publication, The Red Chip Review. Mr. Robbins related that it was his practice to search company parking lots to determine what kind of cars management was driving. An old clunker or a modest sedan in the CEO’s parking spot suggested wise and frugal management. Conversely, a luxury model pointed to greed and rapacity in the executive suite.

While that reasoning played well with the audience, which was packed with senior citizens, I was a bit skeptical of Robbins’ paradigm. Maybe the old clunker means the CEO lacks vision or ambition. If the CEO is the frugal sort, maybe he or she will forego investing in new equipment that creates cost savings or new technologies that protect competitive position. It makes sense to drive profits with a lean cost structure, but sales could dwindle if a company loses market share. Perhaps the CEO with a fancy car has the kind of charisma that attracts top personnel and inspires excellence in performance. Both drive sales growth and profits, which are at the heart of investment returns.

What is the best litmus test for executive performance and compensation? I am not certain there is a single formula. It seems though that when we see excellence, we know it is worth a good measure and, when we see finally see greed, we have already paid for it. The latter truth has been playing out in the last few months in a Houston courtroom as Kenneth Lay and Jeffrey Skilling face charges for their role in the failure of Enron Corporation.

The Enron scandal is one of the driving motivations behind the SEC’s executive compensation disclosure reforms. Kurt Eichenwald’s book, Conspiracy of Fools, published this year by Broadway Books of New York, is an excellent compendium of the facts in this watershed business collapse. Kenneth Lay, Chairman of the Board and serial CEO, is the central "fool" in the book start to finish, as if Eichenwald was drawn to Lay’s incongruous self-image as both shrewd leader and victim of fraud. Eichenwald offers dizzying detail of the company’s collapse, including an interesting discussion of the short selling activities that Lay blames for Enron’s demise.

Eichenwald is a New York Times reporter with a knack for stringing words together in a way that makes simple reading of the arcane accounting issues at stake in Enron’s final months of business. One quote on the back cover describes the book as “riveting like a John Grisham novel.” I think the book is worthwhile reading while the jury deliberates. Make it a race to see if you can digest all 675 pages before a verdict is announced.

If Enron defines greed, what defines excellence? Two Harvard University professors, Anthony Mayo and Nitin Nohria, tried to answer that question in their book, In Their Time: The Greatest Business Leaders of the Twentieth Century, published this year by Harvard Business School Press of Boston, MA. The pair surveyed 1,000 business executives and analyzed the data by decade to put each in a historical context. They came up with one hundred top executives.

Not surprisingly, Wal-Mart’s Sam Walton tops the list. We do not know what kind of car he drove. Walt Disney is second runner up. He was known to live a fairly simple lifestyle. Bill Gates, Henry Ford and J.P. Morgan follow in the next three slots. Estee Lauder, the make-up maven, and Elizabeth Claiborne, the women’s clothing designer, are on the list. However, “everyday living” gal and convicted felon, Martha Stewart, is not. Ted Turner of Turner Broadcasting is in. Sumner Redstone of Viacom is not. Another very conspicuous missing person is Opray Winfrey, founder of HARPO Entertainment Group, although Martha Graham of the Washington Post won a spot.

Popularity or notoriety was apparently not enough to get high marks in the Harvard test. Mayo and Nohria measured their pool of candidates against contextual factors such as technology advances, demographic trends or government intervention that might have presented challenges or opportunities for leadership. They concluded that the top executives generally followed three paths to greatness: entrepreneurial innovation, savvy management or transformational leadership.

Although my list might have a few different names than the Harvard 100, I recommend the book as a guide for scrutinizing management qualifications and performance along lines that relate directly to company success. In Their Time does not provide a standard compensation scale, but its dimensions for greatness beats cruising parking lots.

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