Friday, August 29, 2008

Executive Compensation

Shareholder groups, a number of politicians, financial analysts and many members of the media have justifiably been criticizing what's felt to be excessive executive compensation for several years. The criticism is especially understandable at a time when millions of average middle-class working Americans have lost their jobs, the economy has been weak, hundreds of thousands have or are about to lose their homes, are struggling to pay their bills, and are very worried about financing their retirement. Why is this an issue worthy of debate? It's because it's usually harmful and not fair to the other shareholders, and can be harmful to the company. Also it looks bad, can damage morale among the other employees and can bring negative publicity to the company, as well as potentially adverse attention by regulators and legislators.

Supporting information is that the median CEO compensation in 2005 was a total of $13.5 million, compared to something like $50,000 for the average worker. In 1991 the average large company CEO earned 140 times the average worker, whereas in 2003 the average CEO received 500 times what the average worker made. Does that sound reasonable and fair, a step in the right direction?

I was reminded about this issue when I read an article in the L. A. Times this morning about the $72 million compensation package awarded to CEO Larry Ellison of Oracle Corporation, the $18 billion revenue Redwood City, California headquartered multinational company specializing in business software products, especially database management systems. As is quite common for CEO compensation packages, a high percentage of the Ellison package, about $59 million, was represented by the value of stock options granted. What was a little unusual, perhaps, was that Ellison requested this package from his company's three person board of directors' compensation committee. Officially they approved it because they thought it was reasonable and justified. However, I'm sure they didn't want Ellison to be unhappy, given his strong control of the company and their likely happiness with their own compensation arrangements, which Ellison is undoubtedly in a position to change.

Notable examples of past excessive compensation packages include the $141 million received by Reuben Mark, the CEO of Colgate-Palmolive some years ago; the $139.5 million retirement package awarded to Dick Grasso, the Chairman & CEO of the New York Stock Exchange back in 2003; the $153.8 million awarded to James Kilts, CEO of Gilette, for supporting the big merger with Procter & Gamble; and the $570 million by Michael Eisner, CEO of Walt Disney, earned in 1998 through exercise of millions of stock options granted him.

One of the challenges facing critics is clearly defining what is excessive when to comes to CEO compensation packages. As a benchmark I would submit that any amount above $10 million annually, except in some rare extraordinary circumstances, should at least tentatively be termed excessive. Another thing is that the government doesn't have any authority to approve or disapprove compensation packages in the private sector. It's up to the the company's board of directors or its compensation committee in the case of CEO's and to the CEO and his fellow executives in the case of workers, unless a union contract governs worker salaries and benefits.

What's happened recently? Since the many, widely publicized compensation scandals over the past ten years, the SEC has mandated much more disclosure of compensation packages for the top executives. That development, plus embarrassment of board members at the negative publicity, and increasing pressure by larger shareholder groups, has led to a great deal more sensitivity by boards and their compensation committees to work towards curbing blatant excesses. One type of generally unjustifiable excess has been the practice in many cases of approving bonuses and salary increases even when a company has reported operating losses and had had a poor year or barely broke even in a mediocre year.

Another development was the passage in the House of Representatives in April 2007 of H. R. 1257, the Shareholder Vote on Executive Compensation Act. This mandates that public companies must ensure that shareholders are allowed an annual nonbinding advisory vote on executive compensation plans. This also applies now to a situation where a company awards what's called a "golden parachute" package (a great deal) when negotiating the purchase or sale of the company.

What else is being discussed, or could be done to limit excessive compensation, aside from more pressure from larger shareholder groups and the media? One thing, quite likely under an Obama Administration and a Democrat controlled Congress, is higher tax rates, perhaps including an alternative minimum amount, and higher capital gains taxes, for peole earning more than, say, $250,000 annually. Another significant development would be legislation limiting the compensation amounts that would be deductible as an expense for the employer for corporate income tax purposes.

Democratic Convention

There can be little doubt that almost every Democrat, and the majority of objective Republicans and Independents, would agree that the Democratic Party put on a very good show and had a highly successful convention in Denver these past several days.
Of course, the key factor was probably the unqualified and effective endorsements of Barack Obama and Joe Beiden by Hillary Clinton and former president Bill Clinton, which should have the impact of convincing most of Mrs. Clinton' supporters to vote for this ticket in November. A second key factor was Obama's expected dynamic and compelling acceptance speech at the end.

I'll now mention some other things I liked that were quite effective, in my opinion, and then I'll point out a few things that could have been handled better.

One of the well-known, heavy and understandable emphases in John McCain's campaign has been on the apparent differences between the two principal presidential contenders in the area of national security expertise, military experience, and presumed competence to serve as commander-in-chief. It was therefore effective that the convention organizers arranged for about two dozen retired generals and admirals to come on stage in full support of Obama. Their spokesman, a retired general, mentioned that he had traveled extensively recently with Obama to several countries in Africa and the Middle East, meeting national leaders, and he was highly impressed. Another symbolic positive, from the Democrats's perspective, was that Susan Eisenhower, granddaughter of former Republican five star general and U. S. president Dwight D. Eisenhower, a highly regarded business consultant noted for her expertise on the Soviet Union and the energy industry, came out to confirm her personal support of Obama.

One of the things that bothered me with almost all the speakers, including Obama, was the definite impression that the great many things he would do as president to put the country "on the right track," were virtual promises of actions, as if he didn't need the approval of Congress or, with some issues perhaps, support in the Supreme Court. I know that most voters know that Congress has to approve all federal legislation, and that their needed support may be implied, but it still bothers me and the concern could so easily have been covered in very few words. I also know that this implicit exaggeration of presidential authorities is not at all unique to Democrats. It seems it's a pattern followed by almost all politicians in this country.

Another thing that bothered me, and probably the majority of Republicans and Independents, as well as many Democrats, was that no mention was made, as I recall, of any pledge to balance the federal budget, and there was only limited clarity on how Obama and Beiden would pay for all their many policy positions. Again, this seems to be a common situation with politicians, especially presidential candidates.

Of course, one of the ways Obama will try to pay for his programs is to end the war in Iraq, costing at least $10 billion monthly, and bring our troops home as soon as possible. However, he acknowledged firmly that he plans to add a lot of troops in Afghanistan and spend much more to pursue and find Bin Laden and his lieutenants. He also plans to spend a lot of money to rebuild our military, provide tax credits for alternative energy development, hire and increase pay for teachers, and provide universal health care, among many other expensive programs. When one factors in a tax cut for the bulk of our 305 million population, it's an important question how this will be paid for without adding to our annual deficit and the federal debt. It's not viable to expect that a tax increase for the very rich will cover the shortfall. They have very smart tax attorneys who will figure out how to minimize their larger tax bites.

This reminds me, it also bothered me that I don't recall any of the speakers, including Obama, talk about the need to greatly reform our current ridiculous, expensive, and overly complicated federal tax system. It could be that I just missed hearing it, but I don't think so. Certainly Obama didn't mention it. I find this amazing. The complete reform our tax system, which affects everybody, is a genuine no-brainer. Well, it will be interesting now to see how the Republican Convention in Minneapolis goes. Certainly it was quite surprising to me that McCain has just picked Alaska Governor Sarah Palin as his choice for Vice President.

Monday, August 4, 2008

California Budget Impasse

Under the California Constitution the State Legislature is obliged to approve the annual state budget for the period July 1st to June 30th by a minimum two-thirds vote of its members by June 30th. It is now about five weeks past the deadline and a budget has not yet been passed! In the last twenty years the budget has only been passed on time four times! Critical state services cannot be funded without an approved budget. The state will run out of money by the end of September at the latest, if no budget is passed. Folks, this is serious, ridiculous and unacceptable!

The most recent budget draft calls for general Fund expenditures of roughly $101 billion and total state funds expenditures of roughly $141 billion. As a reminder, the three largest categories of expenditures are K-12 Education, Health and Human Services, and Higher Education. Right now, based on projected state revenues, it looks like we will have a budget shortfall of between $14.5 billion and $15.2 billion!

Somehow the budget shortfall must be eliminated in the next week on a bipartisan, reasonable and pragmatic basis, and the final balanced budget must be approved by a two-thirds majority. Then the governor must sign off.

Governor Schwarzenegger and legislative leaders met in his office yesterday to try to settle the stalemate we now have without success. To deal with the impending crisis and put more public pressure on the legislature, the Governor laid off more than 10,000 state employees and issued another executive order to temporarily cut the wages of other employees to the federal minimum wage of $6.55 an hour. This was probably not entirely fair, but might have been necessary as a needed wake-up call.

The media, the voters and the Governor need to urgently and loudly make it clear to the legislative leaders that, to correct this major problem, we all favor a constitutional amendment requiring a budget to be balanced annually and on time. If this is not accomplished, the amendment will mandate that legislative members will receive no salary at all until the budget is balanced and approved. Reinstatement of salaries will not be retroactive. Lists of those not voting in favor of the final majority will be widely published and voters will be encouraged to make every effort not to reelect any of them. We can work to have the amendment on the ballot in November, if need be. Another step to be considered for the future is changing the requirement for budget approval to a majority vote, rather than the current two-thirds.

Carried out effectively, the above actions ought to get the attention of the party leaders and their colleagues. We are accountable for our actions. We are paying for their high salaries and benefit packages. They are our public servants. Finally, they need to be accountable for their actions and inactions! This is a no brainer!

Sunday, August 3, 2008

Energy Policy Actions

We have many well-known quite serious problems facing our country right now as well as the majority of individual American families. Of high importance among these are very high energy prices for such basic and vital products as gas for our cars, diesel for some cars and most of our trucks and buses, jet fuel for the plane fleets of our airlines, and heating oil and natural gas for our homes. Of course, the high energy costs are also serving to produce much higher food prices, due to their impact on manufacturing and distribution costs. All of these induce consumers to reduce spending, save less, and worry more being able to pay their bills, keep their homes, and adequately prepare for retirement.

At the same time the major oil companies are reporting huge, record earnings. The largest of all, Exxon, reported an incredible $11.68 billion for the recently concluded second quarter! That's after paying all their expenses, including taxes. BP earned $9.47 billion, Royal Dutch Shell earned $8.6 billion. Chevron, America's second largest oil firm, earned over $5 billion for their last fiscal quarter. Many find these profits "obscene," given what's going on.

What to do? As I said in my posting on energy policy back in December 2007, government, businesses and individual families all have an important role to play, and this is a critical issue to be given high priority by the next Administration. This is especially so when one also takes into account such related important issues as energy independence, national security, increasing world-wide pollution, and global warming.

The federal government needs to put together a well thought-out, comprehensive national strategic plan for energy that will get strong bipartisan support in the Congress. But that will probably take at least six to twelve months and will have insignificant impact in the short run. The federal government can also approve limited environmentally sensitive oil drilling in ANWR in northern Alaska and off our coasts, especially in the Gulf, the states permitting. The government can also try to induce the oil companies to drill more onshore under existing federal land leases. However, these steps, which I would support, are only likely to impact supply and prices over the intermediate or longer term.

The federal government could also try to get approval for a windfall profit tax on the oil companies, but it's not clear that would serve to lower energy prices. In fact, it might lead oil companies to increase prices. Senator McCain supports a one-time suspension of the 18.4% federal tax on gas sales. That likely would temporarily reduce retail gas and diesel prices, but it would only save average drivers no more than an estimated $10-15, and also reduce badly needing funding for our highways and bridges. Further, according to many leading economists, it would add to oil company profits, because many drivers would buy more gas.

In the short run, only individual families can realistically take steps to help lower gas prices and directly reduce the amounts they themselves are spending on gas and other energy products. And this is already happening. It's not rocket science. The laws of supply and demand many of us learned in Economics 101 generally work fairly well. More and more drivers are driving and flying less than they used to when prices for gas were much lower. They are car pooling more when commuting to and from work. They are not buying poor mileage SUV's and pick-up trucks, but choosing instead good mileage hybrids and economy sedans. Many people are also working with their electric power and gas utility firms to get tips on reducing expenses for heating and cooling their homes.

When demand is reduced and supply is unchanged, prices tend to fall. Of course, because there is a global market for oil, and demand in recent years has grown dramatically in large developing countries like China, India, and Brazil, falling domestic demand doesn't always reduce prices. Rising foreign demand can have more impact than falling domestic demand. This factor will likely be with us for the indefinite future. Nevertheless, even if prices do remain high or go higher, consumers can help themselves by buying lesser quantities.

I will readily acknowledge, however, that this will increasingly be very difficult for airlines, trucking firms, cab drivers and others like them for whom fuel is such a critical and large expense. Unfortunately, many of these will go out of business. Others in these industries, who are very well managed and innovative, will find ways to survive and even prosper. Southwest Airlines, who successfully hedged their projected fuel expenses, is a good example of this.

The above said, I think the oil companies could do a better job in communicating with the media and the public about this whole subject. Perhaps the media and the public could work together to try to convince them to give consumers a break for the next six months or so by lowering their prices voluntarily. However, such pressure would probably be more effective if it were supported by larger shareholder groups, like pension funds, mutual fund families, and major insurance companies.

Saturday, August 2, 2008

U. S. Foreign Policy, Part II

The Bush Administration is continuing to make what I view as major foreign policy blunders and the presumptive Republican Party nominee, Senator John McCain, seems to be prepared to make another related big one, should he be elected President in November. The issues for this posting primarily relate to the U. S. sponsored eastern European missile defense system, NATO expansion and the G8 countries, and concerns our relationships with Russia and China.

In April of this year I published a posting on U. S. foreign policy, emphasizing that our relationships with Russia and China should, in the area of foreign affairs, rank among the top priorities for the country's next president. Very few foreign policy experts would disagree with this. It's therefore hard to understand what the Administration has been doing recently and what Senator McCain is apparently urging.

Like it or not, Russia and China are already, or will be in the near future, among the world's super powers, together with the U. S. Russia must be considered a super power because of their large and powerful military establishment, their vast energy production and reserve levels, and their sizeable nuclear weapons arsenal. China should be considered because of their fast growing military might, their leading manufacturing prowess, their very large economy with incredibly strong financial muscles, and the world's largest population at 1.3 billion.

The U. S. badly needs their ongoing strong support in dealing effectively with many of the world's most important issues. These include, among others, combatting world-wide terrorism, containing Iran and North Korea, nuclear non-proliferation, global warming, international pollution, trade, providing aid to poor countries, population control, and energy conservation and independence.

Why then has the Administration knowingly greatly angered and provoked the Russian government by negotiating with Poland and the Czech Republic to build missile defense system shields in those countries. Arguing that the shields are necessary to repel potential missile attacks from North Korea and Iran is not very credible.

The same goes for plans to continue to expand NATO from its current nineteen members to add a greater number of countries from the former Soviet Union, including the sensitive country of Ukraine. NATO was established in 1949 among countries primarily bordering the north Atlantic as a international security alliance against the threat of the old Soviet Union. The Soviet Union fell apart in 1991, and most of the recent new member countries and those now short-listed for membership lie many hundreds of miles from the Atlantic.

Senator McCain has recently made it clear in his campaign for president that he favors expelling Russia from the exclusive club of G8 countries which includes, besides Russia, Canada, the U. S., the U. K., France, Germany, Italy, and Japan, in addition to the European Union. The reported reason for his view is that he wants to penalize them for "poor behavior," including the several autocratic steps taken in recent years by Russia's dominant leader, Vladimir Putin. While we have reason to be unhappy with some of the steps he has taken, we're not going to have a good chance to get their needed cooperation on the above more important issues if we were to work towards expelling Russia from the G8. Isn't this a no-brainer?

A number of foreign policy experts, including noted author and columnist Fareed Zakaria, have stated they strongly disagree with Senator McCain's position on Russia and even propose that China be seriously considered for G8 membership. Given China's virtual super power status, I agree with them, though the G8 countries were intended at the outset of the group's formation in 1973 to be reserved for major industrialized democracies. While China certainly qualifies as a major industrialized country, it clearly is not a democracy. Nevertheless, given the importance of the global issues that currently face us, China should definitely be considered for membership. It's a matter of realism and pragmatism over ideology.