Shareholders must stand up to lawyers

I have never had much sympathy for shareholders who complain that chief executives who leave with massive pay-offs are being “rewarded for failure”. Nobody is giving them money because they screwed up and drove down shareholder value – they are being compensated precisely in line with the agreement to which shareholders signed up. The alternative is simple: contracts that offer huge potential rewards for the upside of executive performance, but that offer next to nothing in the event of failure and/or dismissal.

There will be those who argue that top companies can’t attract top management unless they offer the most attractive packages. But this seems to me to be the most specious argument. It is self-evidently the case that the most generous packages don’t attract the best candidates, who must surely be those who demand remuneration as a proportion of the wealth they create – and nothing in the way of severance payment if they fail.

My attention has been turned to these matters by a report published this week which shows that European chief executives are more likely to get sacked for poor performance than their counterparts in the US. Management consultants Booz Allen Hamilton commissioned a study which demonstrates that some 9.5 per cent of the world’s 2,500 largest companies lost their chief executives in 2003 – the lowest proportion of change since 1998.

This could be a sign of an improving economy. The rising number of top departures between 1998 and 2000 must have had not a little to do with pony-tailed, dot-com entrepreneurs going “post-economic”, as making a shed-load of money was known in those days. The new stability in top jobs these days must have something to do with an improving economy that doesn’t look like a casino in which the croupiers have sided with the punters.

According to the report, the main reason behind the rising rates of top-job retention is the drop in the number of chief executives being fired for poor performance. Only some three per cent of the companies surveyed fired their chief executives in 2003, compared to 4.2 per cent in 2002. This could plausibly be viewed as an indicator of an improving world economy.

But the devil is in the detail. Some of the most high-profile departures have been in Europe recently – Jürgen Sengera left WestLB in Germany, while in the UK we said goodbye to Brendan O’Neill at ICI and Steve Russell of Boots, to name a few. Germany was the worst place to be a chief executive last year – 8.1 per cent of the leaders of major companies there lost their jobs, while the proportion in the UK was 6.5 per cent. By contrast, 5.1 per cent of business leaders from North America were allowed to choose their time of departure.

This may indicate that the engine of the world economy in the US is beginning to pick up speed again. That would be a reason to be cheerful, but I’m afraid there may be something more prosaic and depressing about these comparisons. Maybe I’m an old cynic, but I’m afraid we may be back to those watertight remunerative contracts that shareholders allow their appointed managements to have signed on their behalves. And, as ever, it’s the lawyers who are cleaning up.

I believe these figures have very little to do with relative performance and even less to do with economic indication. And they have everything to do with the awesome power of litigation in the US to act as a disincentive to the removal of top executives. For me, the scene was most notably set back in 2001, when some high-profile American executives set legal precedents for a veritable industry of pay-offs – for an industry is what it has become, supporting entire sectors of the legal profession and career-planning.

It was in that year it emerged that Richard McGinn had quit Lucent Technologies after less than three years with compensation of some $13m (£7.4m). His chief financial officer, Deborah Hopkins, had to make do with $5m (£2.8m). Meanwhile, Michael Bonsignore took some $9m (£5.1m), plus handsome perks, out of Honeywell International for the two years during which the company had failed to merge with GE. There are plenty of other examples – and all accompanied by legal claims that could be published as small books and that take many seasons to settle.

So don’t let anyone imply that job security in top companies indicates an improvement of the economic climate, far less an improvement in standards of executive performance. The bald fact is that shareholders are intimidated by the prospect of enormous legal claims. Shareholders only have themselves to blame for allowing the legal eagles to do this to them. And nothing will change until shareholders learn to stand up to the lawyers.

George Pitcher is a partner at communications management consultancy Luther Pendragon