Christine Hurt ticks off the executive compensation provisions of the Dodd-Frank bill, having observed that:
In every Congressional session in recent memory, legislation has been proposed to somehow curb executive compensation. Two narratives are commonly used: (1) executives should not receive pay without performance and (2) the difference between employee compensation and executive compensation should not be as large as it is. Both of these arguments are hard to counter. It's hard to argue that anyone should be paid more than they deserve, and falling back on traditional concepts of enforcing arms-length bargains just isn't that catchy. And who wants to argue for income disparity? That doesn't win you a lot of friends, either. However, most of these proposals just languished until the 2008 Financial Crisis, when bill writers dusted off old executive compensation legislation and inserted the words "systematic risk" a few times. Now we have a third narrative: incentive-based compensation created a system that rewarded excessive risk-taking. This isn't just bad for the individual companies, so we can't just leave it to them to rework their bonus structures. This type of excessive risk-taking is bad for the system, so we must regulate it.
Lisa Fairfax comments on the proxy access provision of Dodd-Frank that:
... there is considerable debate about the relevance of proxy access to the financial crisis and recovery effort. One the one hand, as the Wall Street Journal notes, some advocates of proxy access place "blame for much of the recent financial crisis on a lax culture inside corporate boards," and presumably believe that proxy access can counteract that culture. On the other hand, opponents, like the head of the Business Roundtable, insist that provisions like the proxy access rule are "totally unrelated" to the financial crisis. Even those who may acknowledge some connection between the financial crisis and issues of board accountability sought to be addressed by proxy access, nevertheless contend that the web of issues that triggered the financial crisis are far too complex to be resolved by a proxy access rule.
All of which prompts Usha Rodrigues to pose a question:
I've been focusing on the corporate governance provisions in the bill, and have enjoyed both Christine and Lisa's posts. Christine seems to think of the executive compensation reform as much ado about nothing, a politically cheap and easy way to claim "reform," and I'm inclined to agree. What interests me is how the main regulatory tools here involve giving more information, votes, or proxy access to shareholders as a way to discipline managers. I remember when the story was that the financial crisis was caused by managers acting to enrich shareholders at the expense of the larger economy. So how does empowering shareholders help with that?
FWIW, here's my take: The basic problem that lies at the bottom of the financial crisis of 2008 was pressure on management to maximize short-term shareholder returns.As such, the logic of empowering shareholders is flawed.
Consider, for example, the problem of executive compensation. As was the case with all US corporations, banks and other financial institutions shifted in the 1990s to a much greater reliance on equity-based "pay for performance" compensation schemes. The logic of such schemes is that they align manager and shareholder interests. Managers tend to be risk averse. Executive pay that aligns them with shareholder interests thus is inherently designed to get managers to be more willing to take risk.
Shareholder activists long have complained that these schemes provide pay without performance. This was one of the corporate governance flaws Dodd-Frank was intended to address. It does so in several ways, most notably say on pay.
The trouble, of course, is that shareholders and society do not have the same goals when it comes to executive pay. Society wants managers to be more risk averse. Shareholders want them to be less risk averse. If say on pay works, it will encourage greater alignment of manager and shareholder interests. Say on pay therefore should encourage managers to be more risk preferring.
We know that equity-based executive compensation resulted in higher risk taking by banks before the crisis. Ditto re other measures of shareholder empowerment.
As Christopher Bruner aptly observes, "the shareholder-empowerment position appears self-contradictory, essentially amounting to the claim that we must give shareholders more power because managers left to the themselves have excessively focused on the shareholders’ interests." Bruner at 13.
It's noteworthy that the UK went through basically the same sort of financial crisis as the US and at about the same time and for roughly the same reasons. Bruner at 8. This is significant because UK shareholders have much greater participation rights than US shareholders. If empowered shareholders couldn't prevent a financial crisis in the UK, why was empowering shareholders an appropriate response to the financial crisis in the US?
Indeed, "features such as independent board chairs and “say on pay” votes have been available to U.K. shareholders for years, yet evidently did little to prevent the crisis or mitigate its effects on the U.K. financial system." Bruner at 25.
Even if bank and financial institution governance were flawed in ways that shareholder empowerment plausibly might address, that would not explain the form Dodd-Frank took. It regulates corporate governance of all public corporations, whether they are in the financial industry or not.