Announce that empirical legal scholarship is the dumbest idea in the legal academy in the last 20 years. And that most law & PhD. folks are only in law for the law school paychecks. As I just did. Yikes.
Update: For a more serious and slightly more measured version of my take on the issue of ELS, see this 2011 post.
I'm giving a talk at the National Business Law Scholars Conference today, The CEO Pay “Problem”: It’s All Marjorie Margolies’ Fault, which reviews Michael Dorff's new book on executive compensation.
Here's the text:
The CEO Pay “Problem”: It’s All Marjorie Margolies’ Fault
It is rare that an issue as complex as executive compensation can be traced to a specific decision by a single person at a precise moment in time, but I nevertheless want to offer up a candidate.
The date was May 27, 1993. The place was the floor of the House of Representatives in Washington D.C. The person was Marjorie Margolies.
Newly elected President Bill Clinton’s first budget was in deep trouble. Every Republican in the House had voted against it, as had a number of Blue Dog Democrats (remember them?).
Congresswoman Margolies had opposed the bill, but changed her mind at the last minute after extended personal lobbying by President Clinton himself.
As Margolies walked down the aisle of the House to cast what became the deciding vote on the 1993 budget, numerous Republican Congressmen jeered "Goodbye Marjorie!,” waving handkerchiefs as though saying farewell to a ship sailing out to sea.
It is a moment that does not appear in Michael Dorff’s estimable new book Indispensable and Other Myths (2014), but probably should have.
Marc starts off by telling us what he really thinks about proxy advisory firm ISS:
On Monday, Staples, Inc will try to win its “Say-on-Pay” vote with ISS recommending against approval the executive compensation plan. ISS made its recommendation based on its usual arbitrary, micro-managing concerns which are not the subject of this post.
He goes on, however, to explain what's wrong with "at risk" pay schemes:
Among public companies, having 80% to 90% of target total executive pay derived from “at-risk” compensation, i.e., variable pay such as bonuses, has become the norm. Thus, even if the bonus plan is perfectly designed to pay for performance, or, I should say, especially if it is so designed, a company is guaranteed to eventually encounter management retention problems. After a couple years of poor performance–which can happen despite good management–key employees will be getting only a fraction of what they can earn elsewhere, and will get restless. In fact, the only way to avoid retention problems with such a skewed compensation structure is to fudge on “performance-based” awards when things are bad. That is what got Staples (and many other companies) into trouble.
It's an excellent analysis.
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.