CEOs Beware: Congress At
03.01.07, 2:40 PM ET
Since the Democrats took
control of Congress last fall, they've made executive pay a target.
Thursday, Congressman Barney Frank fired another shot.
Democrat introduced a bill to give shareholders a non-binding up-or-down
vote on a company's executive compensation program. If passed, the law won't
force corporations to redesign their pay packages just because shareholders
want them to. But it will probably have that effect anyway. It's hard to
imagine a corporation fighting a "no" vote at a time of growing
dissatisfaction with CEO paychecks.
In January, Robert
Nardelli, then chief of Home Depot (nyse:
people), left his post with a $210 million severance package. Soon
after, the Senate passed a minimum wage bill that included two provisions
increasing taxes on executive compensation. Shareholders have filed "say on
pay" proposals with more than 50 companies, from Home Depot to Apple
people ) to Pfizer (nyse:
people ), according to Institutional Shareholder Services.
Backers say Frank is
onto something. Britain has already implemented a similar plan, with
considerable success. Stephen Davis, president of Davis Global Advisors and
a fellow at the Yale School of Management, has been talking with investors
and board members in the United Kingdom about the law.
"Advisory votes are not
a panacea," says Davis, who co-wrote
The New Capitalists: How Citizen Investors Are Reshaping the Corporate
Agenda. "But virtually all parties believe this has been a
healthy addition to U.K. practice. It has not solved the pay problem, but it
has made good headway."
Indeed, many complaints
about Frank's legislation require a major stretch of the imagination. Some
critics worry that activist investors could blackmail companies, threatening
to corral shareholders into voting "no" on executive pay if the corporation
won't bend on another issue. But convincing more than 50% of stockholders to
vote against management is no easy task. For an activist investor to succeed
at such an endeavor, the pay package would have to be seriously flawed.
How Not To Tame
have reason to be concerned about any congressional foray into executive
pay. In 1992, Congress passed a law limiting the tax deductibility of an
executive's compensation to $1 million. No surprise: Many CEO salaries
immediately rose to $1 million. And since the legislation contained an
exception for performance-based pay, compensation started flowing into
restricted stock awards and options. "It didn't work well," Frank
acknowledged in an
interview with Forbes.com last week.
Taxes in the recent
Senate minimum wage bill might inspire flashbacks to 1992. Under the new
legislation, executives could delay taxes on only $1 million a year.
Currently, they can defer unlimited amounts of pay to future years,
postponing their tax bills. That means they can earn interest on pre-tax
income, a major benefit most Americans don't receive. "Your average American
worker can defer about $15,000 a year into a 401(k) plan or similar plan,"
says Carol Guthrie, a spokeswoman for the Senate Finance Committee. "This
sets a reasonable and really rather fair limit on the amount that
higher-paid workers can defer."
It may be reasonable and
fair. But will it raise $800 million over 10 years, as the Senate Finance
Committee is predicting? Some firms will cover the tax bills for their
executives--hurting shareholders, but not CEOs. Others will simply shift pay
into stock options and restricted stock--avoiding the tax and keeping pay
high, too. "They have some of the most brilliant lawyers and accounts
around," says David C. John, a senior fellow with the Heritage Foundation.
"They will find a way around it."
Frank says his bill
won't have unintended consequences, because shareholders will be voting on
total compensation, not just pieces of it, so there's no incentive for
companies to move pay around and avoid the law.
Critics say shareholders
shouldn't vote on operational issues, because they can't understand them as
deeply as the board. After all, shareholders don't vote when a company
shifts strategy, for example, or appoints a new chief financial officer.
"It's very hard for shareholders to have the same level of knowledge as the
compensation committee," says David N. Swinford, senior managing director at
compensation consulting firm Pearl Meyer. "I think it ends up becoming a
popularity contest with a very short-term focus."
is different, Frank says. The reason: Board members often have close
relationships with the executives they oversee, which can create a conflict
of interest when negotiating pay. "The CEO picked them; they picked the
CEO," Frank says. "I think it's reasonable to say that the relationship
between the board and the CEO is such a close relationship that it does
justify treating this as an exception."
It's The SEC's
Frank has one big thing
in his favor. The Securities and Exchange Commission passed new rules last
year that will force companies, starting this spring, to reveal more details
about executive pay than ever before. For years, companies have been able to
obscure certain elements of their pay packages, including pensions and
deferred compensation. The new rules will boost Frank's efforts, because he
can argue that shareholders now have a deep understanding of what they're
But with the SEC taking
a strong stance on executive pay, some critics wonder whether Congress
should join the party at all. Executives and board members love complaining
about the SEC, but they extol its virtues when congressional action is the
They have a point: The
SEC can adjust its rules more easily than Congress can change its laws. And
if Congress avoids giving shareholders a vote on pay, companies may start
adopting it voluntarily. Insurance firm Aflac (nyse:
people ) recently became the first company to give shareholders a say on
pay; with all the proxy proposals introduced on the topic this year, a few
other firms will surely follow suit.
Would it be better to
wait and see how "say on pay" works at firms that adopt it? Davis of Davis
Global Advisors says congressional action makes sense in this case. "If we
introduce this concept on a company-by-company basis, the best companies
will move to adopt it," says Davis. "The companies that really need it won't
go anywhere near it."
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