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MarketWatch, September 14, 2009 article


Special Report: Pay Dirt

The executive comp practices that almost bankrupted a nation
Many problems created the financial crisis, but none were better forecast than the outrageous compensation structure on Wall Street. In this special report, MarketWatch looks at how executive compensation and Wall Street pay got to these levels, and examines what regulators and shareholders need to do worldwide to prevent it from ever happening again.

Sept. 14, 2009, 11:55 a.m. EDT

Compensation critics get new weapons

Directors who sign off on exec pay threatened by upcoming rule changes

By Alistair Barr, MarketWatch

SAN FRANCISCO (MarketWatch) -- Compensation committee members should be worried, and that's a good thing, say investor activists who target excessive executive pay.

Upcoming corporate governance rule changes will give these activists new weapons in their battle against directors who sign off on big compensation packages. See which directors may be vulnerable.

"It's exciting and incremental at the same time," said Richard Ferlauto, director of corporate governance and pension investment for the American Federation of State, County and Municipal Employees. "If Congress and the Securities and Exchange Commission come through, shareholders will have brand new extraordinary powers to assert their views."


Serving two masters
Are CEO pay packages compromised when the same consulting firm hired by the board also provides other services to the company? The SEC wants investors to decide.

New weapons
Upcoming corporate governance rule changes will give activists new weapons in their battle against directors who OK huge compensation packages.
Legg Mason, Time Warner, XTO beware

Callaway: Grilled millionaire on the menu
Some notable European exec pay deals
10 of the most outrageous perks

Rogues Gallery of infamous CEOs
Pay deals that almost bankrupted the U.S.
Bonus backlash shocks Wall Street
Marshall Loeb: How the rich got richer
See the full special report



There's even a possibility that some compensation committee members could be voted out in coming years -- an unprecedented development that could dramatically change the way pay is set.

"Examples of compensation directors losing their seats will make other directors sit up and take notice," said Richard Clayton of CtW Investment Group, which tries to help union pension funds be more active investors. "That will make them much more averse to signing off on poor pay packages."

These new weapons could be in place before next year's proxy season in the spring. But in the world of executive pay and compensation committees, the way the new tools are used by investors will develop incrementally, Ferlauto explained.

Investors have had a non-binding vote on executive pay at U.K. companies since 2002. GlaxoSmithKline PLC's compensation was voted down in 2003 and the drugmaker replaced two members of its remuneration committee and aligned pay more closely to performance.

But nothing much else happened until this year, when investors holding more than 59% of Royal Dutch Shell shares shot down the oil giant's executive-compensation plan.

Shell is just one example of a global backlash against executive pay in the wake of the financial crisis. See Pay Dirt, a MarketWatch Special Report.

In the U.K., shareholders voted against pay packages at Royal Bank of Scotland , Bellway PLC and Provident Financial this year. A lot of investors, but not a majority, voted no on compensation at BP PLC , Xstrata PLC and Pearson too.


In the U.S., the SEC and Congress have responded to a national furor over executive pay by introducing a series of rule changes and proposals.

  • Legislation working its way through Congress would require all public companies in the U.S. to include a non-binding shareholder vote on executive compensation for any annual meeting held after Dec. 15, 2009.

  • In May, the SEC proposed a new rule that would let large shareholders nominate one or more director candidates in the proxy statements that companies prepare for annual meetings. So-called proxy access would make it much easier for investors to launch proxy battles and get directors they like on boards - a major shift in power from management to shareholders.

  • Another driver of this shift is majority voting for directors. Legislation in Congress would require every public company in the U.S. to adopt the standard. In the past, directors were elected based on a "plurality," meaning candidates needed only one shareholder vote to win. With majority voting, directors have to get at least 50% of investor votes. That makes it a lot easier for investors to oust incumbent board members if they're unhappy with pay packages approved by those directors.

  • In July, the SEC eliminated so-called discretionary voting by brokers for director elections. This type of voting usually happened when retail investors didn't tell their stock brokers how to vote for board members at annual meetings. When that happened, brokers used to vote in favor of management's slate, rather than candidates proposed by activists. With discretionary voting gone, withhold votes against directors could increase roughly 10% on average, according to corporate governance adviser RiskMetrics Group .

Yellow card, red card

Taken together, these changes and others could make directors think twice before signing off on dubious executive pay packages.

"It's a potent combination that jeopardizes the ability of compensation committees to do it the old fashioned way," said Greg Taxin of activist investment firm Spotlight Capital who used to be chief executive of corporate governance advisory firm Glass Lewis & Co.

Institutional investors may take a "yellow card, red card" approach if they disapprove of pay policies cleared by compensation committees, according to Pat McGurn, special counsel to RiskMetrics' governance services unit, referring to how soccer players are initially cautioned with a yellow card and then sent off with a red following another infraction.

If investors don't like a company's compensation plan, they may vote against it at the next annual meeting - in effect showing a yellow card. Those votes are non-binding, so companies can ignore them. But if that happens, investors may vote to oust compensation committee members the following year - the red card.

"Shareholders will not be reluctant to use the powerful new weapons at their disposal to unseat directors if they object to specific executive compensation decisions," warned Compensia Inc., a consulting firm that advises compensation committees and senior management on pay issues.

"Directors -- particularly those serving on compensation committees - should recognize that their continued service may come down to their responsiveness to shareholder attitudes and positions on executive compensation matters," the firm added in a June client alert.

Practices targeted

While some activists, like CtW, are trying to lower the overall level of executive pay, the new weapons becoming available are better suited to tying compensation more closely to long-term performance and eliminating specific practices that are frowned upon.

Giving discretionary bonuses will likely be one practice that could jeopardize compensation committee members. This happens when executive bonuses are tied to performance targets. If the goals are missed, directors sometimes give executives the bonuses anyway.

This is what got Shell into trouble. Executives were supposed to get performance-based shares only if the oil company ranked at least third among rivals based on total shareholder return. Shell came fourth, but its remuneration committee awarded the bonuses anyway.

Compensation committees may also be at risk if they let companies change performance targets in the middle of the financial year, making it easier for executives to collect bonuses.

Compensation directors may even be threatened if pay plans include lots of different performance targets, or different ways of measuring performance -- another way of making it easier for executives to collect bonuses.

The practice of granting big stock-option awards every year, even if executives already own substantial stakes in the companies they run, could also be targeted.

"Comp committees may think more before doing that," said Thomas Conaghan, a partner at law firm McDermott Will & Emery LLP.

AFSCME will be targeting so-called tax gross ups, extravagant perks, large executive pay-outs triggered by a change in control of companies, extraordinary retirement benefits for senior executives, discretionary bonuses and mid-year weakening of performance targets, Ferlauto said.

'Benevolent dictator'

Spotlight's Taxin said RiskMetrics and other corporate governance advisers like Glass Lewis (his former employer) will gain more power as institutional investors and directors look to the firms for guidance on what type of compensation is acceptable.

"Whatever RiskMetrics decides is not kosher is something that lawyers, compensation consultants and committee members will shy away from in future," he said.

That may not be a positive development because RiskMetrics sometimes can't pick up on specific reasons why companies decide to pay their executives in certain ways, Taxin added.

"In most cases the benevolent dictator will get it right and the world will be a better place, but in an important minority of cases they may get it wrong," he said. "If setting compensation were as simple as reviewing numbers and having a computer spit out results we wouldn't need compensation committees."

RiskMetrics realizes that institutional investors may rely on it more and the firm has been working more with companies to identify the nuances of compensation plans and get past the "legal boilerplate wording" that often appears in proxy statements, McGurn said.

Copyright 2009 MarketWatch, Inc.




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