My latest TCS column tackles perquisites (I don't write the damn headlines, BTW):
Remember ex-Tyco CEO Dennis Kozlowski's $2.1 million birthday trip for his wife, Karen, and their $6000 gold-and-burgundy floral patterned shower curtain? Well, Kozlowski's in jail, but lavish corporate spending on executive perks hasn't gone away.
As the SEC readies its package of new executive compensation disclosure rules (about which I wrote in When Less Really Is More), executive perquisites are once again getting a close look. Back in January, the SEC provided guidance for companies preparing executive compensation disclosures under which a benefit must be disclosed as a perquisite if it gives the executive has any personal aspect, regardless of whether there is a business reason for the benefit or even if it is provided for the convenience of the company, unless the benefit is available on a non-discriminatory basis to all employees. Only items integrally and directly tied to the performance of the executive's duties are exempt, and the SEC takes a very narrow view of what items qualify under that standard. The traditional income tax rules that perks are not income if they are provided with a business purpose or for the company's convenience, for example, are not enough.
Reportedly, as the SEC has been reviewing the executive disclosures filed since the January guidance was issued, the Commission and its staff have been dissatisfied with the quality of those disclosures. Apparently, the SEC thinks corporate disclosures still are not providing enough clear information for shareholders to assess executive pay and perks. It's widely expected that the forthcoming rules will revisit the question of perks to insist upon greater transparency.
The problem is that the SEC and shareholder activists are painting with far too broad a brush. Nobody seriously defends Kozlowski's show curtain, but many so-called perks are perfectly appropriate forms of compensation.
A study by economists Raghuram Rajan and Julie Wulf, examined the provision of perks by large companies over an extended period of time (1986-1999). As they explain:
"A widespread view in the corporate finance literature is that executive perks are a form of agency or private benefit and a way for managers to misappropriate some of the surplus the firm generates. According to this view, firms with plenty of free cash flow that operate in industries with limited investment prospects should typically offer perks. The theory also suggests that firms that are subject to more external monitoring should have fewer perks."
Their findings provided, "at best, mixed evidence" for the conventional wisdom. Instead, as The Economist explained, their findings supported two alternative hypotheses:
"First, firms in the sample with more hierarchical organizations lavished more perks on their executives than firms with flatter structures. Why? Perks are a cheap way to demonstrate status. Just as the armed forces ration medals, firms ration the distribution of conspicuous symbols of corporate status.
Second, perks are a cheap way to boost executive productivity. Firms based in places where it takes a long time to commute are more likely to give the boss a chauffeured limousine. Firms located far from large airports are likelier to lay on a corporate jet."
In other words, Rajan and Wulf's results indicate that executive perks are generally set with shareholder interests in mind.
Additional support for that proposition is provided by Todd Henderson and James Spindler's analysis of a number of controversial compensation practices, including perquisites, corporate loans, and encouragement of conspicuous consumption by top management. In brief, they hypothesize that firms seek to discourage top employees from saving so as to avoid the final period problem that arises when such employees accumulate sufficient wealth to fund a luxurious retirement. Reduced savings by such employees encourages them to seek continued employment, which vitiates the final period problem and provides ongoing incentives against shirking. By encouraging current consumption, the oft-decried practices of providing top employees with munificent perks and loans in fact maximize the joint welfare of managers and shareholders.
Even some of the insufferable Dennis Kozlowski's perks arguably could be justified as advancing shareholder interests. Reportedly, for example, many of the guests at his wife's lavish birthday party represented Tyco customers and suppliers. Building interpersonal relationships with the top management of key stakeholders could well redound to the benefit of shareholders.
As the Kozlowski story illustrates, even with additional disclosure, shareholders still will have only crude tools with which to assess executive perks. At best, they can compare the size of perks to firm returns, but little more. Detailed analysis of whether particular perks are appropriate or not requires the kind of detailed information and regular supervision available only to the board of directors. It's thus hard to see the point of extensive new disclosures.
In any case, the SEC's approach is overbroad. By refusing to take into consideration whether there is a legitimate business purpose for the perk or whether the perk is provided for the convenience of the company, the SEC itself is the one who is misleading investors.
