Matthew Nemeth writes:
The S.E.C recently provoked a storm of controversy when it voted to amend the executive compensation reporting requirements for public companies under the Dodd Frank Act. ...
Under the proposed rule, a company would be required to report not only the amount of compensation that the Chief Executive receives, but also the median compensation that the rest of that company’s employees receive. The company is then required to report the ratio between those two figures as a measure of the gap between executive and employee compensation at that company. The 3-2 vote approving this proposed rule split down party lines, with the three Democrats voting for the rule, and the two Republicans voting against.
While this new requirement is fairly simple and seemingly straightforward on its face, many in the business community are concerned about the potential for any of these statistics to be twisted and misconstrued. The rule’s Republican opponents on the Commission suggested that “the proposal is an attempt to shame corporations into reining in executive pay by forcing companies to calculate compensation in a way that is designed to yield eye-popping results.”
I wonder, however, whether pay ratio disclosure may end up backfiring on its proponents. David Brooks observed that "When newspapers started publishing outsized CEO compensation, they expected the exposure would cause the CEOs to ask for less. It didn’t work." (I note in passing the arrogance of the mainstream media implicit in Broks' comment. Journalists really think they are engaged in social engineering.)
Instead, experience has taught that increased disclosure leads to higher levels of executive compensation. Why? First, shaming doesn't work -- or at least not very well -- in this context. Second, the more information is available about what other companies' CEOs are paid, the stronger the Lake Wobegon effect becomes. Third, if greater disclosure leads to more effective monitoring that threatens to adversely affect managers, managerial compensation will rise to compensate them for that risk.
It will be amusing if pay ratio disclosure blows up in its proponents' faces, as have prior efforts to rein in CEO pay. Will they ever learn?
Swiss voters have rejected a proposal limiting the salaries of top executives. About two-thirds of voters said no to the Young Socialists' plan. The aim was to reduce the salary gap to a 1:12 ratio – in other words to limit the salaries of top executives based on the annual minimum wage of the lowest paid employee within the same company.
The vote brings to an end to more than six months of intense campaigning by the youth wing of the centre-left Social Democrats who were backed by trade unions. ...
In the few weeks leading up to the vote, opponents - led by the business community, the government and most political parties - mounted a strong defence of the current wage system.
They warned that approval of the initiative would undermine Switzerland’s competitive edge, result in a shortfall in state revenue and impose unnecessary restrictions on relations between employers and employees in a liberal market economy.
From yesterday's WSJ:
Switzerland will vote next week on a proposal limiting executive pay to 12 times that of a company's lowest paid worker, the second time this year the country will use the ballot box in an attempt to rein in corporate compensation.
On Nov. 24, voters will be asked to approve or reject the 1:12 Initiative for Fair Pay, which organizers say would address a growing wealth gap in Switzerland. The initiative is premised on the idea that no one in a company should earn more in a month than others earn in a year.
One of the many problems with this proposal is that capping executive pay is a lousy way of dealing with income inequality, for reasons I explain in my book Corporate Governance After the Financial Crisis:
Complaints during times of economic distress about supposedly excessive executive compensation are hardly new. In the 1930s, during the Great Depression, for example, a lawsuit challenging executive bonuses as corporate waste gave rise to the aphorism “no man can be worth $1,000,000 per year.” This complaint rested, at least in part, not on a belief that executives were being paid too much relative to their company’s performance but on the belief that the amounts they were being paid were simply too high.
Similar populist themes abound in the rhetoric surrounding the crises of the last decade. A 2008 House of Representatives committee report, for example, noted that “in 1991, the average large-company CEO received approximately 140 times the pay of an average worker; in 2003, the ratio was about 500 to 1.” Delaware Vice Chancellor Leo Strine observed in a 2007 law review article that both workers and investors “feel that CEOs are selfish and taking outrageous pay at a time when other Americans are economically insecure.” William McDonough, the then-Chairman of the Public Company Accounting Oversight Board (PCAOB), complained that:
We saw … an explosion in compensation that made those superstar CEOs actually believe that they were worth more than 400 times the pay of their average workers. Twenty years before, they had been paid an average of forty times the average worker, so the multiple went from forty to 400—an increase of ten times in twenty years. That was thoroughly unjustified by all economic reasoning, and in addition, in my view, it is grotesquely immoral.
The rhetoric of class warfare makes a poor foundation for economic policy. As a justification for regulating executive compensation, however, it is particularly inapt. First, why single out public corporation executives? Many occupations today carry even larger rewards. The highest paid investment banker on Wall Street in 2006 was Lloyd Blankfein of Goldman Sachs, for example, who “earned $54.3 million in salary, cash, restricted stock and stock options,” or about 4 times the median CEO salary from the year before. The pay of some private hedge fund managers dwarfed even that sum. Hedge fund manager James Simons earned $1.7 billion in 2006, for example, and two other hedge fund managers also cracked the billion-dollar level that year. Not to mention, of course, the considerable sums earned by top athletes and entertainers.
Second, regulating executive compensation may scratch the public’s populist itch, but it does little to address inequalities of income and wealth. To be sure, as Brett McDonnell observes, fat cat “CEOs have become poster boys for” the dramatic increase in “inequality in income and wealth in this country.” Even if one assumes that redressing such inequalities is appropriate social policy, however, capping or cutting CEO pay is not an effective means of doing so.
Steven Kaplan and Joshua Rauh determined that executives of nonfinancial corporations comprise just over 5 percent of the individuals in the top 0.01 percent of adjust gross income. Hedge fund managers, investment bankers, lawyers, executives of privately-held companies, highly paid doctors, independently wealthy individuals, and celebrities make up the bulk of the income bracket. They further found that the representation of corporate executives in the top bracket has remained constant over time and that realized CEO pay is highly correlated to stock performance. Accordingly, they conclude that “poor corporate governance or managerial power over shareholders cannot be more than a small part of the picture of increasing income inequality, even at the very upper end of the distribution.”
McDonnell is critical of the Rauh and Kaplan paper on several grounds, but even he concedes that “it does seem quite plausible that investment bankers, the managers of hedge funds and private equity funds, and corporate lawyers are at least as large a part of the problem of rising inequality as are the top officers of public corporations.” If so, regulation that singles out public company executives is unfairly under-inclusive. Such regulation, moreover, will have important distortive effects. If public corporation CEO salaries lag relative to those paid in other fields, the best and brightest will shift career tracks to the higher-paying jobs.
In sum, we need not decide here whether wealth and income inequality in society deserves legislative attention. In either case, regulating executive compensation is an inapt and unfair approach to that broader social issue. The disparities between CEO and worker pay packets thus cannot justify what Sarbanes-Oxley and Dodd-Frank did to executive compensation.
Granted the SEC has to adopt a rule implementing the asinine requirement in Dodd-Frank Section 953(b) re disclosure of the ratio of CEO pay to that of a company's average workers, but I still want to praise Commissioner Gallagher for telling it like it is (do we still say that?):
Today, the Commission will vote on proposed rules to implement yet another Dodd-Frank mandate having nothing to do with the SEC’s mission and everything to do with the politics of not letting a serious crisis go to waste.
The pay ratio computation that the proposed rules would require is sure to cost a lot and teach very little. Its only conceivable purpose is to name and, presumably in the view of its proponents, shame U.S. issuers and their executives. This political wish-list mandate represents another page of the Dodd-Frank playbook for special interest groups who seem intent on turning the notion of materiality-based disclosure on its head.
There are no – count them, zero – benefits that our staff have been able to discern. As the proposal explains, “[T]he lack of a specific market failure identified as motivating the enactment of this provision poses significant challenges in quantifying potential economic benefits, if any, from the pay ratio disclosure[.]”
Amen. Damn straight. And so on. Go read the whole thing, which includes an argument that while the SEC had to act it did not have to act now, which I found wholly persuasive.
The only thing missing from his excellent analysis was a citation to the fact that I discuss this asinine provision in the chapter on executive compensation in:
Is it fair that CEOs make 700 times what the average worker makes, even if the chief executive is doing a terrible job and thousands of workers are laid off?
Don't you just love it when billionaires (Icahn is worth over $20 billion!) get all populist on you? Personally, I find political punditry by populist plutocrats preposterous.
Prominent LA attorney and UCLAW alum Jim Barrall has a great op-ed today in the WSJ's CFO Journal, in which he argues that:
Companies, investors and their advisers are waiting anxiously by their computers to see how the SEC deals with the enormous challenge of drafting rules under probably the most poorly conceived and drafted statute in the history of U.S. executive compensation.
The SEC will hold an open meeting Wednesday to consider whether to propose the long-awaited “CEO pay ratio” rules required by the Dodd-Frank Act, enacted in July 2010. The expectation is that the rules will in fact be proposed and will be published for public comment.
As most know, the law requires the SEC to adopt rules requiring that public companies disclose the ratio of the total compensation of their median compensated employees and the total compensation of their CEOs. The statute was inserted into the Dodd-Frank Act in a last minute markup in the Senate Banking Committee, with no debate and apparently without much thought or care. ...
The law not only has put the SEC in a difficult position and will impose new burdens and costs on public companies, sadly, it will not produce information which will be meaningful to investors in comparing CEO pay ratios among companies, because companies and their employment and compensation arrangements are all so different in many ways.
Go read the whole thing.
BTW, I discuss this provision in the chapter on executive compensation in:
Section 953(b) of the Dodd-Frank Act required the SEC to develop disclosure rules requiring issuers to disclose the ratio of the “median” total annual income for “all employees” to the annual income of the CEO. BNA is reporting that new SEC Division of Corporation Finance director Keith Higgins has stated that the “real challenge” of writing the mandated rule is developing a methodology for calculating the “median” annual total pay of the issuer's workers. Higgins also reportedly predicted that calculating employee pay will involve some statistical sampling.
I observed in Corporate Governance after the Financial Crisis:
This requirement is going to be hugely burdensome:
[It] means that for every employee, the company would have to calculate his or her salary, bonus, stock awards, option awards, nonequity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings, and all other compensation (e.g., perquisites). This information would undoubtedly be extremely time-consuming to collect and analyze, making it virtually impossible for a company with thousands of employees to comply with this section of the Act.
Statistical sampling likely would somewhat reduce that burden, but will raise new questions, such as: Did Dodd Frank authorize sampling? The statutory language is the median of all employees, which may require a rule that counts everybody (recall the Supreme Court cases about the census using sampling?).
Will the SEC finally do a sufficiently robust economic analysis of the costs and benefits to avoid adding to the string of rules that have been struck down?
Will there be safe harbors for firms that use the mandated statistical sampling but still end up with incorrect disclosures?
Appropriately for Shark Week, Keith Paul Bishop spanks one of my least favorite groups of "people":
In enacting the Dodd-Frank Act, Congress made it clear to everyone, other than the plaintiffs’ bar, that say-on-pay votes were advisory only, did not create or imply any change in fiduciary duties of directors, or create or imply any additional fiduciary duties of directors.
One of the big problems with the whole idea of pay for performance is how you measure both pay and performance. Because executives receive many different forms of compensation, much of it deferred in various ways and some of it in kind (e.g., various perks), there are serious problems with figuring out exactly how much they are being paid. Conversely, because there are many ways of measuring performance, there are at least as many problems at that end.
In light of the rising influence of proxy advisory services, such as ISS, which purport to use pay for performance metrics in making various voting recommendations, the question of whether outfits like ISS are getting it right has become quite important. A recent paper by Stephen O'Byrne offers some very pertinent criticisms and suggestions in that regard:
Institutional Shareholder Services (ISS) announced a new approach to evaluating pay for performance in late 2011. This paper explains the new approach, highlights four significant weaknesses of the new approach and explains how ISS could substantially improve its Pay for Performance Model, now and in the future. Without making any change in the data it collects, ISS could improve its assessment of pay for performance by: (1) adopting more meaningful measures of the three basic dimensions of pay for performance – pay leverage, pay alignment and pay premium at industry average performance, (2) defining reasonable trade-offs between leverage, alignment and cost, (3) changing its peer group selection methodology so it’s selecting labor market peers, not companies that fall in the same sector but don’t compete for the same talent, and (4) giving examples of simple compensation programs that provide perfect pay for performance. In the future, ISS could provide more value to investors by using "mark to market" pay to calculate better measures of pay leverage and alignment and by using stock ownership and mark to market pay to calculate a more comprehensive measure of the CEO’s shareholder value incentive ("wealth leverage").
CITE: The ISS Pay for Performance Model (May 24, 2012). Available at SSRN: http://ssrn.com/abstract=2289360
One of the problems with shareholder activism is that it can be heard to tell what the activist's motives are. This is especially true for highly politicized investors like union or state and local government funds, which may well camoflauge politically motivated conduct by claiming they're concerned with good corporate governance. A case in point, from the WSJ:
An influential union investment group is opposing the re-election of McKesson Corp.'s MCK +0.30% chairman and two other directors, citing what the group said was excessive chief-executive pay, the company's failure to heed a shareholder advisory vote calling for splitting the chairman and chief executive roles and other governance issues. ...
In a letter to McKesson shareholders expected to be sent Monday, CtW Investment Group urged a vote against the re-election of John H. Hammergren, who serves as McKesson's chairman and CEO, and of directors Alton F. Irby III and Jane E. Shaw, who respectively head the board's compensation and governance committees. ...
CtW, an arm of the labor federation Change to Win, advises union pension funds that collectively have more than $250 billion in assets. ...
In its letter, CtW opposed the re-election of Mr. Irby, the longtime chairman of McKesson's compensation committee, over what it claimed was "one of the most exorbitant CEO pay practices in the S&P 500." It cited research from Equilar Inc., a pay consultant, that Mr. Hammergren's three-year "realizable pay" was four times the median among his peers, and mentioned the CEO's "unmatched" $159 million pension benefit.
But here's what CtW left out of their letter, as reported by The Economist:
Hammergren’s ... pay is not outrageous, at least by the generous standards of corporate remuneration. His pension, for example, has been accumulated over 14 years, which puts it in line with those given to bosses of other big companies (who often serve shorter terms). Its sharp rise in value in 2013 was largely due to changes in the interest-rate assumptions made by actuaries.
When Mr Hammergren took over in April 2001, McKesson’s share price was $27; now it is $115—a rise of about 325% in a period in which the S&P 500 index rose by just 40%. His combined rewards over the period represent about 3% of the $19 billion increase in the company’s stockmarket value. For many people, no amount of outperformance can justify such extravagant compensation. Hard-nosed investors may see it as a reasonable deal—and will be wishing that other handsomely paid bosses delivered such healthy returns.
When you look at Hammergren's pay relative to McKesson's performance, it becomes clear that this is not a case of what Bebchuk and Fried call Pay without Performance. And, if you believe Bebchuk and Fried, all institutional investor activists want is Pay with Performance. At least as far as CtW is concerned, however, the McKesson case shows that that's not what these highly politicized funds want. No. They want to wage class warfare.
Whatever happened to the much heralded "say on pay" movement?
So far this year, shareholders in 2,173 public companies have cast their proxy ballots on executive pay—and overwhelmingly signaled their overwhelming approval. Ninety-seven percent of U.S. companies received shareholder votes affirming their executive pay packages,according to Equilar. Only 57 companies saw shareholders reject the executive pay proposals. Seventy-two percent of the companies got more than 90 percent approval from shareholders. ...
From its very beginning, the "say on pay" movement was an attempt to reduce executive pay. Instead, since becoming a requirement for all public companies in 2011, "say on pay" has led to the routine endorsement of C-suite compensation. In fact, it may even be encouraging rising pay for top executives who can now point to direct shareholder approval of their pay packages....
"The 'say on pay' experiment is a bust," writes Jesse Eisinger of Pro Publica.
So what went wrong?
Perhaps shareholders just never shared the conviction of self-styled shareholder advocates that executives were overpaid. As UCLA law professor Stephen Bainbridge has pointed out, over the long term CEO pay growth has largely been matched or exceeded by gains by shareholders. Shareholders might just be convinced that things are working just fine.
He goes on to assess other possibilities, as well. Go read the whole thing.