Paul Krugman: Incentives for the Dead

Paul Krugman on "the growing scandal involving backdated stock options" as a reflection of our failure to "come to grips with the epidemic of corporate misgovernance":

Incentives for the Dead, by Paul Krugman, Stock Options Commentry, NY Times: I don’t know about you, but I need a break from political scandals. So let’s talk about private-sector scandals instead — specifically, the growing scandal involving backdated stock options...

To understand the issue, we need to go back to the original ideological justification for giant executive paychecks. In the 1960’s and 1970’s, C.E.O.’s of the largest firms were paid, on average, about 40 times as much as the average worker. But executives wanted more — and professors at business schools provided a theory that justified much higher pay.

They argued that a chief executive who expects to receive the same salary if his company is highly profitable that he will receive if it just muddles along won’t be willing to take risks and make hard decisions. ...

The claim, then, was that executives had to be given more of a stake in their companies’ success. And so corporate boards began giving C.E.O.’s lots of stock options... If the stock went up, these options would pay off; if the stock went down, they would lose their value. And so, the theory went, executives would have the incentive to do whatever it took to push the stock price up.

In the 1990’s, executive stock options proliferated — and executive pay soared, rising to 367 times the average worker’s pay by the early years of this decade. But the truth was that in many — perhaps most — cases, executive pay still had little to do with performance. For one thing, the great bull market of the 1990’s meant that even companies that didn’t do especially well saw their stock prices rise.

Then there were the tricks that companies used... For example, after a downward move in the stock price, ... the price at which the executive had the right to buy stocks would be reduced to the new market price. Heads the C.E.O. wins, tails he gets another chance to flip the coin.

What the backdating scandal reveals is that for many executives even that wasn’t enough. To ensure that executives profited from newly issued options, companies would pretend that the options had in fact been issued at an earlier date, when the stock price was lower. ...

What’s wrong with backdating stock options? There’s a tax evasion aspect, but the main point is the bait-and-switch. The public was told that gigantic executive paychecks were rewards for exceptional performance, but in practice executives were lavishly paid simply for showing up at the office.

And in some cases even that wasn’t required. Cablevision Systems gave options to a deceased executive (in other words, to his heirs), backdating them to make it appear that he had received them while still alive.

The moral of the story is that we still haven’t come to grips with the epidemic of corporate misgovernance revealed four years ago by the Enron and WorldCom scandals, then drowned out as a political issue by the clamor for war with Iraq. Even now, we’re still learning how deep the rot went.

And there’s no reason to believe that the problem has been solved. ...[E]xecutive compensation, which fell briefly after the Enron and WorldCom scandals, has shot right back up.

So we’re still waiting for serious corporate reform. And don’t tell me that everything must be O.K. because stocks have been rising lately. Remember, they rose even faster in the 1990’s — and the 1920’s.

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