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New York Times, August 9, 2009 column


August 9, 2009

Fair Game

Imperfect Politics of Pay

THE executive compensation bill that the House passed just before the August recess was advertised as the first in a series of government safeguards to prevent risky, me-first maneuverings around executive pay in corporate America. It’s supposed to correct wrongheaded structures that generated untold millions for aggressive managers and monster losses for unwitting taxpayers.

But an examination of the bill’s fine print raises questions about whether it will, if supported by the Senate and then enacted, have the desired effect.

Recall that Washington’s past attempts to rein in executive pay have not been stellar. The Clinton-era restrictions — which removed the tax deductibility on executive salaries over $1 million — served only to fuel pay bonanzas based on stock options.

This time around, lawmakers say they want to do two things: encourage shareholder participation in how pay packages are structured and awarded at their companies and enlist regulators to reduce risky compensation incentives. The first idea is admirable; the second, not so much.

Getting shareholders more involved in compensation arrangements is surely an idea whose time has come; indeed, institutional investors report that more dialogues between companies and their owners are occurring every day.

But elements in the House bill meant to further this progress are surprisingly weak. Consider the requirement stating that some institutional investors’ votes on comprehensive pay packages — so-called say-on-pay proposals — would have to be disclosed each year.

Disclosure of how big investors vote is important, of course, given that so many small investors hand over their proxies to mutual fund companies. But why limit disclosure to say-on-pay votes?

“Shouldn’t the focus be on disclosure of actual votes on any and all compensation proposals?” asks Brian Foley, an independent compensation consultant in White Plains. That would include disclosures on how institutions voted on new or existing annual bonus plans, new stock award and long-term incentive programs, and additional share authorizations for stock plans.

For that matter, Mr. Foley wonders, why not require regular disclosures on votes related to the election of directors who serve on the company’s compensation committee?

Another missed opportunity in the House bill involves pay details in merger proxies. These documents go to shareholders when they are being asked to vote on a corporate combination. The bill would require disclosure of the aggregate amounts that management would get in a merger. But this data already appears in merger proxies.

More helpful would have been a requirement that all merger proxies provide details of cash, stock and other compensation that had been dispensed during the year the deal was announced. This data often does not show up in merger proxies because they cover only pay received by executives in the company’s previous fiscal year.

In the make-work department, the House bill also calls for a nonbinding shareholder vote on compensation to be received by executives in a merger or other change-of-control situation. If shareholders have not voted on that pay in previous say-on-pay measures, then they must be given the opportunity to do so.

While Mr. Foley concedes that this provision may highlight last-minute compensation arrangements, he questions its value, given that the vote is nonbinding and that the company is about to effectively disappear anyway because of an acquisition or other change in control.

Then there is the section in the bill on pay consultants, the folks hired by corporations to design those lush compensation packages. The House bill would require consultants to meet new criteria for “independence,” leaving the standards to be determined later by the Securities and Exchange Commission.

The bill said it would also hold “other advisers” to compensation committees to the same standard. But who exactly are those “other advisers” and what exactly will the standards be? Does the definition include legal counsel, accountants and headhunters, for example? An earlier version of the bill included legal counsel in the independence requirement. But that specificity was dropped.

Forcing a pay consultant to meet some independence criteria defined by regulators would seem to invite machinations designed to circumvent that requirement. And one person’s idea of independence may not fit another’s.

Better simply to disclose any potential conflicts to shareholders and let them decide whether they are problematic. If a consultant works for an organization that provides other services for the company, annual proxies should detail the extent of those services and the fees paid.

Perhaps the most troubling aspect of the House bill, however, is its reliance on regulators to recognize and rein in compensation practices that encourage risky actions by executives at financial services companies. Under the bill, federal regulators would write new rules to prevent “inappropriate or imprudently risky compensation practices” that could threaten the safety and soundness of major financial institutions.

It’s hard to believe that regulators are savvy enough about both pay packages and risky compensation incentives at financial companies to recognize when either or both have become dysfunctional. Remember, these are the same regulators who allowed brokerage firms to increase their leverage to wildly high levels, who helped break down investor protections put in place during the Great Depression, who let big banks balloon their balance sheets with poisonous assets and who were unable to spot the decades-long fraud of Bernie Madoff.

That’s some track record. How do you think they will do when it comes to pay? A much better fix would be to hold compensation committees and directors themselves accountable for pay policies and responsible for discouraging reckless managerial practices.

“They are focusing on the symptoms rather than on the basic issues, like the way they allowed people to go unregulated,” Mr. Foley said, referring to the House bill. “Not that there shouldn’t be a price extracted. But my concern is they are focusing on the wrong end of the mule.”

This is not surprising, of course. Regulators rarely own up to their failures. It’s far easier to lay the blame elsewhere.



A version of this article appeared in print on August 9, 2009, on page BU1 of the New York edition.



Copyright 2009 The New York Times Company




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