Skip to main content

Did the Enron Scandal Really Change Executive Compensation?

While it inspired new regulations, executives have found a way around them.

Following a slew of corporate scandals in the early 2000s—most prominently the one involving energy company Enron—the United States government instituted a number of regulatory changes. The largest was the Sarbanes-Oxley Act of 2002, which expanded mandatory financial disclosures, and increased penalties for chief executive officers and chief financial officers who failed to comply. The hope was that, through the impetus of fines and prison time, chief executive officers would change their behavior.

But the new regulations said nothing about limiting executive compensation, despite a growing public outcry over the millions that Enron executives were being paid prior to its collapse. A 2002 piece in the New York Times reported that compensation totaled more than $432 million, paid to 2,000 executives, in the two years leading up to the scandal. But though the outrage soon died, the corporate sphere still decided to tweak payments to executives. Why? They were clearly bad for business.

Executive compensation, after all, is not merely intended to attract the best of the best people to oversee the company, but also to incentivize them to act in a way that benefits the company long-term. When the contracts were having a negative effect on the company's performance (can't get much worse than a scandal followed by bankruptcy), they needed to be tweaked.

But now, more than 15 years later, it's unclear how much things have really changed.

"You definitely see a clear moving away from stock options toward restricted stock," says Edward Carberry, a professor of management at the University of Massachusetts—Boston, who examined the trend for one of his recent studies.

Stock options allow executives to purchase shares at a fixed price at any time in the future, to incentivize them to boost the company's stock price as much as possible over a short term. They sometimes encourage executives to aim for a quick cash-out. Restricted stock, on the other hand, gives executives stocks they can't sell for a set period of time (typically five years), ideally incentivizing them to have a deeper stake in the company's long-term success.

Has any of this worked? It depends on the metric used for evaluation.

Stock prices are higher than ever and productivity is up, but real wages (pay after taking inflation into account) have stagnated since 1979. Businesses are stronger, but workers are not better off. That reality seems obscene, particularly in an era where chief executive officers make 271 times the pay of a typical worker.

Occasionally, this tension has informed how executive compensation is structured. To avoid the outward appearance of executives being better off than ever before while wages stagnate, boards have tried to conceal how they compensate executives through methods such as perks that don't show up on the books, like retirement packages. In the 2004 book Pay Without Performance: The Unfulfilled Promise of Executive Compensation, co-authors Lucian Bebcheck and Jesse Fried called this "camouflage compensation." They suggest it's indicative of executives having a strong hand in developing their own compensation models:

We agree that paying generously to provide desirable incentives can be a good compensation strategy for shareholders. ... Our concern is simply that executives have partly taken over the compensation machine, leading to arrangements that fail to provide managers with desirable incentives.

If executives are in charge of determining what executives should be paid, why would they ever suggest packages in which they're paid less?

"It's a big question how independent these boards are," Carberry says. "The way we do it is very much a closed community of people. A lot of corporate boards are composed of other executives, and often they sit on each other's boards." On top of that, the chief executive officer plays a significant role in choosing who gets to be on the board. "Board members don't have a lot of motivation to oppose a CEO's compensation package."

With a system incentivized to maintain the status quo, will a more equitable system ever rise? None of the corporate governance laws are written in stone, and while they're unlikely to pass in the current political climate, Germany's co-determination laws, Carberry suggests, could work to ease the problem.

In Germany, the government has ensured that workers are represented in the decision-making process. This tends to come in the form of a supervisory board—which must be made up of a certain percentage of employee representatives and has the role of appointing and overseeing the executive board. The whole system is intended to prevent chief executive officers from feeling incentivized to act in ways that negatively impact their workforce.

"It's a debate we should be having: Who should be on a board? And whose interest are they serving?" Carberry says. "If you have a CEO that's rewarded for laying off 5,000 employees, is that how the system should work?"