The watchdog that did not bark: can corporate directors regain their reputations as reliable guardians?

• Author: Horton, Tom
• Position: Some Things Considered

IN THE ROILING AFTERMATH of the recent corporate scandals, two questions persist: Exactly what happened, and who permitted it to happen?

There is no shortage of villains: the accounting industry, which for years had been slipping megabucks to Congress in an effort to maintain its conflicted roles; its trade association, also seriously compromised; brokerage firms that shamelessly touted whatever they needed to unload; investment banks that abetted their clients in hiding debt; compensation consultants whose collusion with CEOs secured their future business; and lawyers corrupted by large fees.

These were among the institutional gatekeepers, the professional advisers whom the investing public thought, all too wrongly, that it could trust. Sadly, the ultimate watchdog, the board of directors, too often failed as well.

How could this have happened, and why? It happened partly because of certain well-established myths that had been swallowed whole by many corporate directors and had become unquestioned beliefs.

Myth: It is essential that the board design a compensation package that will "align" the interests of the CEO with those of the company. There used to be a time when there was some perceived fairness to CEO compensation in the minds of employees and the public. In 1980 the average chief executive earned 42 times that of the average worker. By 2001 this factor had risen to 531. But even if this ratio had not escalated to such an unprecedented peak, why would any CEO's interest not be "aligned" with the success of the enterprise? What kind of CEO would want his or her organization to fail? Yet this myth has served for years as a rationale for ratcheting up executive pay to previously unimaginable heights.

Myth: The compensation package should be designed to keep the CEO from "walking." This imaginary imperative justifies the relatively new retention bonus as well as otherwise inflated pay packages. Yet I am unaware of any exodus of CEOs. Each year those who leave one company to lead another can be counted on one hand. The truth is that challenge and opportunity anchor competent CEOs to their jobs, not just pay. More than 10 years ago a letter to Business Week asked rhetorically, "Who would try to hire away John Akers of IBM or Lawrence Rawl of Exxon or Rand Araskog of ITT?" Myths like this have led to such examples as Citigroup CEO Sandy Weill's compensation over the past 10 years exceeding $1 billion. Is this what compensation committee...