Fear of falling
By Francesco Guerrera
and Joanna Chung
Published: January 5 2009 19:54 | Last updated: January 5 2009 19:54
reputations: even staunch defenders of corporate America acknowledge
that public sentiment has shifted dramatically since the onset of the
Dan Pedrotty can pinpoint the moment he first
saw middle America’s rising tide of anger against the gargantuan pay
packages of corporate executives. It was during the final few days of last
year’s presidential campaign and Mr Pedrotty, a union leader, had taken time
off from the AFL-CIO, the giant labour federation, to campaign for Barack
His job was to call white lower middle-class
voters – often called “Reagan Democrats” for their volatile political
allegiances – to persuade them to elect America’s first black president.
From the other end of the phone, as
respondents voiced their fears and anguish over their ability to cope with
the worst downturn in three-quarters of a century, one issue kept coming up
over and over again.
“Executive compensation was front and centre
for Reagan Democrats. I heard that every day,” Mr Pedrotty says. “The debate
has fundamentally changed from a shareholder issue to a taxpayers’ issue.
The level of anger and incredulousness around the country is at record
Business leaders begrudgingly agree. Even
Martin Lipton, the influential lawyer who is one of corporate America’s
staunchest defenders, acknowledged in his annual letter to boards of
directors that the attention executive pay “is receiving from activists,
regulators and the general public has reached new heights”.
Some companies have already reacted to the
country’s shifting mood. Most of the banks that went cap in hand to the
government and received billions of dollars from federal coffers have
scrapped executives’ bonuses for this year. Some, such as Morgan Stanley and
Citigroup, have even pledged to claw back part of the bonuses due to traders
and other high-flying employees if their bets turn sour.
The rest of corporate America is also heeding
the message coming from Main Street. Leading companies such as FedEx,
Motorola and Caterpillar have slashed pay and bonuses for executives. Many
others are planning to follow suit. Three out of four large US companies
have already cut, or are planning to cut, bonuses for their current year,
according to a poll by the consultancy Watson Wyatt.
But Americans are demanding more.
Three-quarters of those surveyed in a Bloomberg/Los Angeles Times poll in
early December say banks that have received government money should cancel
all bonuses to employees this year. About half of those say that all Wall
Street groups, regardless of whether they received government money, should
The backlash against outsized executive pay
is a fundamental change in America’s attitude to the way it rewards those at
the top of the corporate tree. Unlike the UK, where tabloid-fanned ire over
“fat cats” has been a recurring theme of the public debate, and the rest of
Europe, where social and political traditions have combined to keep a lid on
executive pay, the US has had few qualms in showering successful business
people with money.
For years, the prevailing wisdom was that
when it came to pay, the untrammelled interplay of free-market forces was
the best way to attract, motivate and retain top talent and sharpen
America’s competitive edge. As one corporate executive says, with more than
a hint of regret: “It was part of the American dream. If you worked hard,
anyone could become rich and enjoy it too.”
America’s belief in its meritocratic system
was reflected in the fact that the gap between the executive haves and the
rank-and-file have-nots had been rising steadily since the second world war
without really triggering widespread calls for change. By 2007 the average
chief executive made at least 275 times the pay of the average worker,
according to the Economic Policy Institute, a Washington think-tank (by
other calculations, the multiple reached at as much as 369). But few outside
the union movement and the pension funds they control had called on boards
to restrain executive pay.
The financial crisis changed all that. As
share prices plummeted, capital markets froze and the US economy tumbled
into recession, the balance of power on executive pay shifted dramatically.
“The public perception has been exasperated by the enormous losses and the
appalling stock performance of many companies,” says one Wall Street
executive. “No one complained when profits and share prices were soaring.”
WHAT BOTHERS BOARDROOMS:
‘You have an
environment where it is easy to demonise people’:
Business leaders in the US are not
going to succumb to external pressures to curb their pay without a
fight. Seen from the boardrooms and corner offices of corporate
America, the drive to restrain executive compensation looks like a
hasty overreaction to the financial crisis and economic slowdown.
“There is an angry mob out there,” says
Ted Dysart, head of the Americas board practice for Heidrick &
Struggles, a big headhunter – “and you have a receptive legislature
and an environment where it is easy to demonise people who receive
Opponents of measures such as “say on
pay” – a proposed law that would give investors a non-binding annual
vote on compensation – consider them both counterproductive and
misguided. They argue that a yearly shareholder referendum would give
activist investors and proxy services, which advise pension funds on
how to vote in annual meetings, undue influence over companies’ inner
Some corporate leaders and their
advisers suspect the current campaign against outsized executive pay
hides a power-grabbing agenda on the part of the labour movement. They
see it as no coincidence that the most fervent advocates of pay
restrictions and shareholder votes on compensation have been union
pension funds and “socially responsible” investors.
As Stephen Bainbridge, a professor at
UCLA school of law, wrote in a recent research paper, these moves are
“part of an ongoing effort by a handful of activists to shift
substantially the locus of decision-making authority” away from
executives and directors.
Even among those who play down the
notion of a leftwing conspiracy, some maintain that giving investors
more of a say on complex matters such as pay could end up harming
companies and their shareholders. The Center on Executive
Compensation, a Washington-based lobbying group, has warned that some
pension funds could be in breach of their duty to maximise the value
of their holdings were they to vote against pay packages designed to
reward executives for boosting the company’s performance.
Others warn that shareholder powers on
compensation could limit incentives. “A change in the design of the
incentives might create a system that does not reward performance and
simply cuts pay,” says James Reda, founder of James F. Reda &
Associates, a compensation consultancy.
The seemingly inevitable legislation
could have a subtler consequence for the US corporate system. Some
legal scholars regard Congress’s efforts on this issue as another step
in the creeping federalisation of corporate laws that used to be the
realm of local and state governments.
Just as Sarbanes-Oxley, the law passed
in 2002 after the Enron and WorldCom scandals, introduced US-wide
standards of corporate governance and accounting practices, so
“say-on-pay” laws could take a big area of responsibility away from
state legislators. Regulatory competition between states has been
called the “genius of American corporate law”. Any such move would
only deepen the corporate world’s opposition to investors’ and
politicians’ attempts to challenge their right to pay executives as
much as they see fit.
The public outrage
is almost certain to lead to an outcome that would have been unthinkable for
executives before the crisis: new legislation to curb companies’ ability to
award princely compensation to their leaders. Barney Frank, the influential
Democratic congressman who chairs the House of Representatives financial
services committee, says Congress will move quickly on a “say-on-pay” law
that will give shareholders a non-binding vote on executive compensation.
Opponents of the
legislation argue that even though, in theory, boards could disregard
shareholders’ opinions, a high percentage of No votes would put pressure on
directors to change their compensation system in a way that could be
detrimental to the company’s long-term fortunes. In addition, enshrining in
law the principle that shareholders can have a say on executive pay would
undermine boards’ traditional primacy on the issue.
When it was first
proposed two years ago, the measure, which mirrors provisions already in
existence in the UK, Australia, Sweden and the Netherlands, failed to
attract enough support to become law. It was approved by the House of
Representatives but it was never ratified by the Senate despite the strong
support of Mr Obama, its main proponent in the upper chamber.
Emboldened by his
presidential election triumph and a clear majority in both houses of
Congress, Democrats are confident of getting “say on pay” on to the statutes
this time around. In fact, some of their leaders, such as Mr Frank, are
already thinking of more sweeping measures to curb the risky activities that
pushed Wall Street to the brink of extinction and the US economy into a deep
“One thing we could
clearly do is ‘say on pay’,” he says. “But the tougher question is dealing
with perverse incentives. If you take a risk and it pays off, you get a
bonus. If you take a risk and lose the company money, you break even – that
is a bad incentive.
“I don’t care about
bonuses going forward as long as we deal with deductions going backward, we
have to find some way to make that a law,” adds Mr Frank, suggesting
clawback provisions could be enshrined in legislation. “They can have any
bonus as long as it’s a two-way street.”
pension funds are backing that drive and are to propose shareholder
resolutions at more than 50 companies this year demanding clawback
provisions on bonuses. Supporters of greater restrictions on executive pay
argue that financial turmoil has demonstrated the failure of many boards and
their advisers to link compensation to performance.
enable us to discuss what is wrong with a pay model that focuses on
recruitment and retention rather than the value added by the CEO,” says
Richard Ferlauto, director of pension and benefit policy at American
Federation of State, County and Municipal Employees, a big union. “Not only
have these compensation schemes not been performance-based but they have
been designed in a way that wasted shareholder value.”
Frank and most of his colleagues do not appear inclined to back a draconian
measure that most corporate executives had begun to fear in the current
climate: government-mandated limits on compensation. “I don’t think Congress
will have an interest on wage controls for corporate executives,” says
Christopher Cox, chairman of the Securities and Exchange Commission who
previously served as a congressman for 17 years.
Yet in at least one
respect, corporate governance experts say, legislators have in effect
created new ceilings on pay by attaching strings to the funds doled out by
the Troubled Asset Relief Programme (Tarp), the $700bn government rescue
plan for the financial industry. Tarp has rules barring companies from
giving “golden parachute” exit payments to certain executives and
restricting compensation above $500,000 from being tax-deductible.
To many corporate governance experts,
these restraints are long overdue. But the fact that it took a crisis of
historic proportions – and aggressive government intervention – to usher in
these changes highlights the long-standing failures of boards to set
appropriate standards for executive pay.
Harvey Pitt, the
former SEC chairman who now runs Kalorama Partners, a consulting firm, says:
“It is decidedly un-American to pay people when they don’t perform and don’t
do the job they were hired to do. It’s a huge issue that boards have not
really addressed in the way they should be addressing it.”
To some observers,
boards and executives should have seen this coming even before compensation
became a lightning rod for the average American. When Mr Cox launched a
review of compensation disclosure rules after he became SEC chairman, his
agency received 30,000 comment letters from investors and other interested
parties, until then the most ever on a single issue. When the rules came
into effect in 2006, they significantly expanded the information companies
were required to make about what, how and why they reward their highest-paid
Yet companies still
fall short of explaining fully how they evaluate an executive’s
compensation. “The fact of the matter is that corporate America has never
understood what is required to justify the high levels of compensation paid
to senior executives,” says Mr Pitt. “Companies have not really invested the
time and energy to focus on what it is they want their senior executives to
do and how to measure whether they’ve achieved it.”
He adds: “If the
business community is not going to do this, then somebody else will.
Congress is understandably upset and is taking matters into its own hands.”
Additional reporting by Greg Farrell
DC DECISIONMAKERS: HILL TO CLIMB
Barney Frank (right), who became chairman of
the House of Representatives financial services committee after the
Democrats took control of Congress in 2006, has long had executive
compensation high on his priority list. The Massachusetts congressman plans
to hold hearings on pay and will be among the figures to shape debate and
any forthcoming legislation.
First elected in
1980, Mr Frank has been called both a political theorist and a pit bull. He
wants to explore ways to constrain incentives for executives to take on
In the Senate,
Christopher Dodd, the banking committee’s
Democratic chairman, will play a big role. He is concerned that companies
receiving assistance through the government’s financial rescue plan – which
placed limits on pay – are not doing enough.
As incoming Treasury
secretary, Tim Geithner could also shape
policy given his discretion to set terms under the bail-out programme.
Financial Times Limited 2009