“Power corrupts, but absolute power corrupts absolutely.” This well-known quote from Lord John Acton in the late 1800’s is perhaps most often applied to dictators who managed to secure unbridled political control in their country. The corrupting influence of power, however, can also be seen in private companies. Some highly successful executives in private companies succumb to the “diva effect.” This takes place when top executives believe their lavish personal expenses and lifestyle should all be borne by the company.
We have listed below a variety of executive expenses – can you guess which one was not actually charged by a business executive? The answer follows the end of this Post after we review a number of steps than can be taken to prevent an outbreak of the diva effect.
Examples of Executive Expenses Charged to the Company
A. Multiple trips on private jets
B. Diamond engagement ring
C. Lavish hotels for honeymoon vacation
D. Private ranch purchased as company retreat
E. Circumcision of executive’s newborn son
F. Payment of private school or college tuition
G. Custom-tailored men’s suits
H. Pool deck constructed at executive’s home
I. Luxury watch worth more than $10,000
What can a business do to prevent out of control executive spending? Several things.
Company Expense Policies
The first step in preventing excessive personal executive spending is to address it in the company’s culture through discussion and adoption of specific policies. One policy example is to set expense boundaries in a per diem spending guideline for hotels and meals when employees travel out of town on business. If a company does not want executives flying to meetings in private jets or in first class seats (unless in an emergency), it needs to make this clear in written policies publicized internally. If the company believes first class travel is a perk that should be available to incentivize top executives, however, this should also be made clear.
It is not micro-managing to communicate these expectations to top management. As the company recruits and retains senior executives, its internal culture should be a critical part of the discussion with key leaders. When the company’s top executives establish the desired culture and live by it themselves, the diva effect is not likely to take root.
Development of Internal Controls
The second step in preventing excessive executive spending is to set internal controls at the company to ensure that executives are not approving their own expenses. Similarly, the executive’s business expenses should not be reviewed/approved by someone who is reporting directly to the executive and whose continued employment and compensation is determined by the executive. Instead, the executive’s business expenses need to be reviewed by someone who reports directly on this subject to the board of directors, the company’s managers or to others designated for this purpose.
The Executive Employment Agreement
The final piece to avoid the diva effect is to address these issues in the executive’s employment agreement.
- If possible, the executive should be retained as an at-will employee rather than being hired for a term of years.This at-will status permits the company to terminate the executive without cause in the future and therefore gives the company flexibility to address the executive’s employment status going forward.
- The employment agreement should specify the authorized expense level for the executive on a monthly basis, which cannot be exceeded without additional approval.This limit should be liberal enough to allow the executive to perform at a top level, but not to buy bespoke suits, fancy watches, and other luxury items without additional approval.The agreement should also state whether the executive is authorized to travel by private jet or first class.
- Finally, if the employment agreement is for a term of years, it should l include a “for cause” provision authorizing the executive to be terminated for specific reasons.Rather than setting for a boilerplate “for cause” provision, this contract term should be drafted to reflect that unauthorized expense charges are a ground for termination.
In answer to the question at the beginning of this Post, all of the listed expenses have been taken from actual court cases or legal disputes (without disclosing any individuals or companies involved) with the exception of (E), the circumcision. We have yet seen an executive who submitted circumcision expenses as a business charge for reimbursement, but when the diva effect takes hold, it may only be a matter of time.