CEOs reap big rewards from big failures

"It is the confidence that speculators have in their own bad judgment that inspires confidence in others. So the speculators join those whom they have inspired in hope and avarice and are there with them holding the bag at the end. Then they are revealed for what they always were, which is not much."

The Toronto Star
February 9, 2002

CEOs reap big rewards from big failures
David Olive

JOHN KENNETH GALBRAITH was thinking of the farcical Hunt brothers of Texas, who went bust trying to corner the silver market in the early 1980s, when he argued that con men always end up conning themselves.

"The blind do not, in fact, lead the blind, but the gullible do gull the gullible," the economist said.

"It is the confidence that speculators have in their own bad judgment that inspires confidence in others. So the speculators join those whom they have inspired in hope and avarice and are there with them holding the bag at the end. Then they are revealed for what they always were, which is not much."

Well, that's how the system used to work, back in the days when a penniless Henry Pellatt, ruined by his own stock promotions, was reduced to auctioning off his household chattels on the front lawn of Casa Loma when the city seized his palatial home for back taxes.

But today there's no sackcloth and ashes for humbled masters of the universe. Capitalism now rewards schemers who think big, act big and fail big.

In his glib testimony before a congressional subcommittee Thursday, Jeffrey Skilling, former CEO of the collapsed Enron Corp., allowed that he shared in the misery of ordinary investors holding massively devalued Enron stock.

Why, at the moment of his abrupt departure from the Houston-based energy trading firm last summer, the unfortunate Skilling himself was still clinging to more than 900,000 shares of the doomed company — stock that is now practically worthless. What Skilling neglected to mention was that like so many fallen heroes of the late-1990s boom, he had taken the precaution of unloading $30 million (U.S.) worth of Enron stock before Enron cratered.

When stock options became all the rage in the 1990s, they were heralded as a device for "aligning management's interests with those of the stock holders." Uh-huh. Skilling's failed strategy at Enron ultimately wiped out $60 billion in shareholder value.

But Skilling, one of the great wealth destroyers of all time, still lives in grand style in a $2.5 million Spanish-style villa in Houston's tony River Oaks district. He's not alone. His mentor and predecessor as CEO, Kenneth Lay, judiciously took more than $100 million in stock-option winnings off the table before the Enron meltdown, and is in no immediate danger of being evicted from his $7.1 million residence occupying an entire floor of a luxury condominium tower.

Closer to home, Jozef Straus, CEO of former Ottawa high-flier JDS Uniphase Corp., reaped $152 million (U.S.) from exercising stock options before his fibre-optics company went into a tailspin, losing 85 per cent of its value. When John Roth was still CEO at Nortel Networks Corp., he pocketed $135.2 million (Canadian) by cashing in options.

Another tarnished telecom evangelist, John Chambers of California-based Cisco Systems Inc., took the prudent step of exercising options on $156 million (U.S.) worth of stock before Cisco nose-dived in the great tech wreck of 2001.

Financially speaking, it's tough to find any trailblazing CEOs of the New Economy who have gone down with their ships. To be sure, Roth and many of the Enron top brass who collectively reaped $1.1 billion from pre-collapse stock sales have relinquished, or been stripped of, their corporate duties, and are now languidly "pursuing outside interests." But their plight doesn't bear comparison with the 45,000 workers laid off at Nortel, or the Enron pensioner who cancelled elective surgery when his pension plan, consisting of Enron stock, essentially disappeared.

Gary Winnick isn't suffering. He's the Michael Milken protégé whose Global Crossing Ltd. fibre-optics empire tumbled into bankruptcy protection last week. Winnock locked in $600 million in stock-sale winnings before his wildly over-leveraged company bit the dust, erasing $80 billion in share value.
Winnick has since retreated to comfortable seclusion at his $60 million Malibu estate.

But for chutzpah, there's no topping Dennis Kozlowski, CEO of the troubled U.S. conglomerate Tyco International Ltd. He and his chief financial officer, Mark Swartz, have always insisted that they rarely if ever sold company stock. A ringing endorsement of Tyco's prospects, that. Even as they were uttering such assurances, however, the duo quietly sold more than $100 million worth of Tyco stock, which has since lost more than half its value.

It's curious, then, that Paul O'Neill, the U.S. treasury secretary, would salute Enron as an example of how the free market system has a marvelous way of punishing inept corporate strategists.

"Part of the genius of capitalism," he said a few weeks ago, "is people get to make good decisions or bad decisions, and they get to pay the consequences or to enjoy the fruits of their decisions. That's the way the system works."

Actually, the way the system works is that cowboy CEOs take their rewards up front long before it's clear whether their exhortations to "think outside the box" will lead to triumph or disaster. Thanks to the wretched excess of stock options — the almighty motivator of CEOs for whom a seven-figure salary is no longer sufficient incentive — there is no "downside risk" for CEOs who think big, act big and fail big. That's fine for failure-tolerating Texans, who still venerate the foolhardy defenders of the Alamo, and for the fecund founders of drive-by startups in Silicon Valley, where a string of calamities is a badge of honour.

But the free pass for visionaries who enrich themselves from handiwork that disrupts the economy, the lives of ordinary workers and the retirement plans of Main Street investors has become pandemic, infecting every sector of the Old and New Economies. In the 1980s, the most abusive aspect of executive compensation schemes was that they rewarded mediocrity and incompetence. Now they reward outright alchemy, enriching CEOs like Skilling whose firms specialized in accounting tricks that turned loans into assets and expenditures into profits.

If O'Neill is out of touch with the new reality, neither does Galbraith's observation still hold. In retrospect, we see that the mavericks who laid waste more than $1 trillion (U.S.) in shareholder value over the past 18 months were not, in fact, conned by their own Power Point presentations and frequent assertions that the stock market was mistaken when it finally started to turn against their companies. They knew better. The ordinary investor did not. Or it didn't register with the average investor that there was a contradiction between what CEOs were saying about the bright future for their companies and the furious, publicly reported, insider selling by those same CEOs.

In the spring of last year, Roth of Nortel explained why he was compelled to dump a big whack of stock in 2000.

"When the price-earnings ratio [of Nortel stock] was 110, that's when I sold — it was an astounding number." (The "p/e" of the average industrial company is normally in the range of 10 to 30.)

Did Roth have anything to say to investors who held on to the stock, and were burned?

Roth shrugged. "I sold at the peak," he said. "And that was in the papers, it's public record. And I think actions speak louder than words."


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