Ceos Enjoy New Salary Security

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A few months ago, I went to Washington to watch members of the House Committee on Oversight and Government Reform question Prince, Mozilo, and O’Neal about their roles in the subprime blowup. Sitting there facing the television cameras, the three looked like fish on a dock. John Finnegan, the chief executive of Chubb, who heads Merrill’s compensation committee, told the committee that of the $162 million O’Neal received on his departure, $130 million was in the form of stock awards that had been granted years earlier and hadn’t yet vested. To keep those options away from him, the board would have had to terminate O’Neal for cause. And the provisions for that, Finnegan explained, “are very specific and basically cover misconduct, not unsatisfactory future financial performance.”

Henry Waxman, the California Democrat who chairs the committee, wasn’t satisfied with this explanation. He reminded Finnegan that Merrill lost $2.4 billion in the third quarter of 2007 and $10.3 billion in the fourth quarter, and that its stock price fell by almost half. “What was the rationale for letting Mr. O’Neal retire with $131 million in unvested stock instead of terminating him and recouping this money for the shareholders?” Waxman demanded. Finnegan repeated that the provisions in O’Neal’s contract having to do with dismissing the C.E.O. cover only misconduct and have nothing to do with poor financial results.

After listening to this exchange, I went in search of the legal language at issue. I found it in a Merrill contract provided to Waxman’s staff. It said “cause” for being fired existed only for “(a) any violation of Merrill Lynch’s rules, regulations, policies, practices, and/or procedures; (b) any violation of the laws, rules, or regulations of any governmental entity or regulatory or self-regulatory organization, applicable to Merrill Lynch; or (c) criminal, illegal, dishonest, immoral, or unethical conduct reasonably related to your employment.”

Finnegan was right. There was nothing about poor decisionmaking in exposing the firm to unnecessary risks or anything else relating to job performance.

I dwell on this example not to single out O’Neal but to show that the terms of employment he enjoyed are increasingly common. “Cause, as you and I understand it, has been redefined to mean something completely different,” says Nell Minow, the editor and co-founder of the Corporate Library, a research group that campaigns for better corporate governance. “If an ordinary person does a bad job, he or she gets fired. For a C.E.O. to be dismissed for cause, it now requires the committing of a felony, and sometimes even a felony conviction isn’t enough.”

The privileges afforded to C.E.O.’s are increasingly enshrined in their employment contracts. A decade ago, Minow says, less than a third of C.E.O.’s signed such contracts; now it is the norm. A 2001 study that examined about a hundred of these agreements found that in more than 90 percent of them, the C.E.O. couldn’t be fired for doing a bad job unless he or she received a big payoff; nearly half the time, even a felony conviction couldn’t deprive the C.E.O. of a severance payment. “We are unable to understand how such provisions could be in the interests of the firm,” Michael Jensen, of Harvard Business School, and Kevin Murphy, of the University of Southern California, wrote in a 2005 working paper, which they are currently turning into a book. “Employment contracts for C.E.O.’s and top managers should be discouraged, and when they do exist they should not provide for compensation when a manager is terminated for incompetence or cause.”

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