If you were interested in finding a culprit for the deluge of bad news that has engulfed American business and brought the stock market crashing down, the name of Lee Iacocca would probably not be high on your list of suspects. But if it weren’t for Iacocca, it is unlikely that we would be talking about Enron and WorldCom today.
In the early 1980s, as chief executive officer of Chrysler, Iacocca helped rescue that company from bankruptcy. He starred in a series of legendary (as these things go) TV ads, each of which ended with him gazing earnestly into the camera and saying: “If you can find a better car, buy it.” His marketing pizazz, coupled with a not-so-subtle appeal to nationalist sentiment (who wanted to let the Japanese kill off one of the Big Three?) revitalized Chrysler’s image and got the company off its deathbed.
The resurrection of Chrysler turned Iacocca into the symbol of a resurgent U.S. capitalism. This was rather ironic—Chrysler only survived, after all, because of a government bailout and some well-timed intervention against Japanese imports. But Iacocca’s combination of tough-guy individualism and earnest Americanism fit the country’s mood in the Reagan years. He appeared on the cover of Time magazine, he bandied about the idea of running for president, and his autobiography became one of the best-selling books of the decade.
Iacocca’s ascent signaled a dramatic change in American culture. Prior to him, the popular image of the CEO had been of a buttoned-down organization man, pampered and well paid, but essentially bland and characterless. The idea of the businessman as an outsized, even heroic, figure seemed like the legacy of a long-forgotten past when men like J.P. Morgan and William Randolph Hearst were still around. In fact, in 1982, Forbes magazine wrote, “Tycoons are fairly rare birds in today’s business world. We seldom hear of moguls.” Within just a few years, that had all changed, with business journalists turning every clever executive with a good idea into the next Henry Ford, and with the Rupert Murdochs, Sumner Redstones, and Donald Trumps of the world actively cultivating the “mogul” label.
By the time of the ‘90s boom, CEOs had become superheroes, accorded celebrity treatment and followed with a kind of slavish scrutiny that Alfred P. Sloan could never have imagined. Dennis Kozlowski and Bernie Ebbers reaped what Iacocca had sown. “In the 1980s, there was a sea change in the way the media and the culture at large responded to CEOs,” says Jim Collins, author of the seminal studies of business history Built to Last and Good to Great. “And you can pinpoint that change to one single event: the publication of the Iacocca book. That was the moment when it became clear that everything was different.”
The shift in Main Street’s perception of CEOs would not have mattered so much had the people in the boardrooms not also bought into the myth of the CEO as superhero. But they did. Companies everywhere wanted their own Iacocca. They didn’t just want someone who knew his industry and was good at nuts-and-bolts execution. They wanted someone who was good on television, who had a touch of glamour, who could sell the company’s story on Wall Street, who had a handle on the vision thing (and who was good at nuts-and-bolts execution, too).
This was a futile quest. Although it may be hard to believe after a decade and a half of CEO worship, all the available evidence suggests that most chief executives have only a negligible impact on the performance of the companies they run. There are, of course, exceptions. But corporate performance depends far more on what industry a company is in, what proprietary advantages it has, and the general quality of its work force, than it does on who’s at the very top.
And in those cases where leadership does make a difference, the successful leaders don’t fit the corporate-savior model. In Collins’ book Good to Great, for instance, all the “great” companies he studied were led by CEOs whose attitude toward fame and attention was more like that of Thomas Pynchon than Tom Cruise. “They were, by design, not celebrities,” Collins said. “They did not attribute the company’s success to their own genius. And they shunned the spotlight.” By contrast, the executives who were constantly making star turns—who included men such as “Chainsaw” Al Dunlap and, yes, Iacocca—did a bad job of making their companies stronger.
No matter, though. Boards of directors were convinced that the CEO was the key to greatness (perhaps in part because so many directors were themselves CEOs), and they were willing to pay accordingly—after all, you don’t treat a new messiah the way you would an ordinary mortal. So CEO pay packages skyrocketed, rising from 42 times the average worker’s salary in 1980 to 531 times the average worker’s salary in 2000.
And it wasn’t just the very best CEOs who were rolling in filthy lucre, either. Since what one executive makes tends to depend on what other executives make—a typical corporate proxy statement will include a line such as “we want our compensation package to be competitive with the industry as a whole”—there was an irresistible ratcheting-upward effect. Then, too, in the 1980s and early 1990s, compensation committees were often made up of other CEOs. Who, really, was going to vote for what would have been an indirect pay cut for himself?
Executive pay was, on its own terms, scandalous. But what made it the engine of the kind of shenanigans we’ve seen at Enron and WorldCom was the fact that most CEO pay packages relied heavily on stock options. Options were not new—read any business history dating back to the 1950s, and it is clear that option packages were an important part of any CEO’s compensation. But the nature of the options grants in the 1990s was qualitatively different.
In 1995, Congress passed a law limiting the tax-deductibility of corporate salaries of more than $1 million. But it allowed an exemption for any pay that was incentive-related. So options were a way of paying executives without forgoing tax benefits. (Daniel Gross explained the dismal impact of the $1 million limit in this “Moneybox.”) The bull market made options seem relatively costless. (If everyone was winning, did we really need to worry if the CEO was clearing an extra $30 million-$40 million a year?) And there was the one intellectually sound argument for options—they aligned the interests of the CEO with the people he was supposedly representing, the shareholders. Put all these things together, and you had stock-option grants on an unprecedented—and indeed practically unimaginable—scale.
In 2000, Steve Jobs of Apple was given a package that would be worth $550 million if Apple’s stock rose just 5 percent a year over the next decade. In the same year, Larry Ellison of Oracle was given 20 million options worth around $400 million, even though he already owned 700 million shares in the company. (Were the extra 20 million options really going to make him work harder?) The idea of the CEO as superhero was radically misconceived, and the idea that stock options were free money was senseless. Together, they created an environment in which one of corporate capitalism’s perennial problems—self-dealing—could flourish.
Self-dealing, essentially, occurs when managers run companies to line their own pockets instead of those of the companies’ owners. It’s been a perennial problem in American capitalism and became a real dilemma when America moved toward a model in which corporations would be run by professional managers who had only small ownership stakes.
One of the answers to that dilemma, ironically, was stock options. But in practice, option packages actually turned out to facilitate—rather than curb—self-dealing. As economist David Yermack of New York University has shown, stock option grants tended to be issued just before good news was released (thereby locking in a lower price for the option). Issuing more options didn’t increase executives’ stake in companies. They just cashed in existing options. And the way options were awarded encouraged executives to adopt risky strategies. If stock prices skyrocketed, they got massive options grants as a reward; if stock prices plummeted, they got massive options grants as an incentive, or they had their options repriced. Either way, executives couldn’t really lose.
Finally, the sheer size of the grants exacerbated the problem. In the past, one check on managers’ greed was that they stood to gain more from staying with a company for a long time than they did by playing fast and loose and cashing out early. But when you give CEOs the chance to make $300 million in a year by stretching the rules a little bit, it’s not surprising that some of them will take you up on it. So, if in the old days investors worried about executives paying themselves high salaries, lavishing perks on themselves, and spending money to redecorate the executive dining room, now they have to worry about executives using deceptive numbers to jack up the stock price in order to dump their stakes and put hundreds of millions in the bank before anyone can figure out what’s wrong. (It is true, of course, that if you’re a visionary investor, you could dump your stock too, and piggyback on the executives’ malfeasance. But that’s not exactly easy to do.)
In the past couple of months, it has become fashionable to say that what led to the scandals was that favorite mantra of every 1990s CEO: “shareholder value.” But this is a red herring. Of course, investors brought much of this on themselves by blissfully ignoring the real cost of options and buying wholeheartedly into the myth that superhuman CEOs deserved superhuman pay packages. (One stunning Burson Marsteller survey from the late 1990s said that 95 percent of investors would buy a stock based on what they thought of the company’s CEO.) And there were few investor complaints when the Nasdaq rose 273 percent in three years. Only after the crash did everyone get religion.
But it’s nonetheless true that shareholders paid the price, rather than reaped the benefits, of corporate corruption. And although CEOs were obsessively concerned with their companies’ stock price, at companies such as Enron and Tyco, top executives were less concerned with the performance of the company’s stock over time than they were with getting out of the stock as quickly as possible. That’s not exactly what the emphasis on shareholder value was supposed to mean. In fact, if you look at the hundreds of billions of dollars of debt that corporations took on in the 1990s in order to pay for the cost of issuing options, and you look at how little stock prices ended up rising over that same period, it now appears as if the past decade witnessed the greatest transfer of wealth from shareholders to workers in the history of the U.S. economy. Unfortunately, the workers were almost all ensconced in the executive suite.