Executive compensation practices have recently drawn attention from both the public and the government. Bailed-out insurer AIG depends on taxpayers for its survival, yet it has chosen to spend millions on retention bonuses.

Why are struggling companies – including the bailed-out, and even the bankrupt – rewarding some employees? “Greed” is a popular answer, but an insufficient explanation. In a March 20 column at CNN.com, The Corporate Library’s Nell Minow argues that compensation practices are symptoms of a broader corporate governance crisis.

It’s Not Just AIG

John Carney at The Business Insider has reviewed the actual AIG employee retention agreement. He notes that “employees were guaranteed a minimum bonus regardless of performance.” And the bailed-out insurer is not the only company where compensation has uncoupled from performance:

- Nortel, a Canadian telecommunications firm, is paying retention bonuses to eight top executives. Nortel is bankrupt. It also faces a lawsuit from 60 laid-off employees who, despite recent protests about the inviolability of contracts, were denied severance under the terms of Nortel’s bankruptcy.

- The Washington Post has reported that, rather than denying bonuses to executives, “Firms Move Performance Goalposts.” Among other examples, the Post’s Tomoeh Murakami Tse writes that “FBR Capital Markets failed to reach its performance goals in 2008. But the board of the Arlington [VA] investment bank awarded six-figure payouts to its executives anyway.”

Where was the Board?

Nell Minow asks why corporate boards haven’t attracted more attention - and blame:

“Why haven’t we learned that it is the boards who are responsible for the massive failures of strategy and risk management at these companies? Regulators, journalists, securities analysts and investors routinely ignore the most obvious indicators of investment risk that are presented by bad boards of directors.

“This is particularly obvious in the case of AIG, which has been a serial offender in corporate governance, especially in executive compensation.”

Compensation is a key factor in environmental, social and governance (ESG) investment analysis, and Ms. Minow justifies investors’ concern with corporate governance. While many observers have faulted compensation practices at individual companies, she cites “overboarding” as a common failing of many “troubled” firms:

“The Corporate Library released a report in February about the boards of the bailout companies, many of which were outliers in their governance and compensation practices. … In several cases, we found individuals who not only sat on more than four corporate boards but also sat on more than one of these particularly troubled boards during this period….

“We call the phenomenon of directors who serve on four or more corporate boards ‘overboarding.’

“In all, 11 of the 27 companies we identified as “troubled” had at least one overboarded director. Six had more than one; at Merrill Lynch, there were five. By comparison, fewer than 30 percent of S&P 500 companies have even a single overboarded director, and fewer than 5 percent have more than one.” [Emphasis added.]

Weak Governance is a Measurable Risk

Such ESG metrics helped some investors steer clear of these companies – before they were visibly “troubled.” Could better analysis of governance and other investment risks help prevent future crises? Sustainable/SRI investors believe so, and there are signs that governance risk is now a mainstream concern.

Here is an excerpt from a Wall Street Journal interview with MIT Sloan Professor Dr. Andrew Lo:

“WSJ: What’s the most important implication of the financial crisis?

DR. LO: For CEOs and other corporate leaders, the single most important implication is about the current state of corporate governance. …

“The current crisis is a major wake-up call that we need to change corporate governance to be more risk-sensitive.”

As for AIG, Congressional pressure to tax their bonuses may have eased. Nell Minow has already asserted that punitive taxes won’t address the root of our governance crisis. She proposes a more direct “wake-up call”:

“Badly designed compensation is an indicator of poor corporate governance, and poor corporate governance is an indicator of investment risk. Instead of trying to tax the bonuses at AIG, the government and the shareholders should insist on new directors.”