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Forbes, March 1, 2007 article


CEOs Beware: Congress At Work
Hannah Clark, 03.01.07, 2:40 PM ET

 Barney Frank


Since the Democrats took control of Congress last fall, they've made executive pay a target. Thursday, Congressman Barney Frank fired another shot.

The Massachusetts 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: HD - news - 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 (nasdaq: AAPL - news - people ) to Pfizer (nyse: PFE - news - 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 Executive Pay

Nevertheless, investors 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 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."

Executive compensation 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 Party

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 voting on.

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 alternative.

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: AFL - news - 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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