2014-Issue 23—Faced with public outcries about excessive executive compensation during and after the 2008 recession, the U.S. Congress responded by enacting the Dodd-Frank Act in an attempt to regulate the pay of executive officers of public companies, especially the chief executive officer. For better or worse, an overall reduction in executive compensation has not been achieved, partly because of the bull market of the last three years.
The first element of Dodd-Frank to go into effect was the say-on-pay (SOP) rule, which gave shareholders a non-binding vote on their company’s executive compensation program. Effective for three years, there is little evidence that the SOP vote has accomplished anything more than a noticeable increase in the length of the compensation disclosure section of proxies and in the fees paid to advisors. In fact, shareholders have approved in excess of 90 percent of the compensation programs proposed by public companies since the legislation took effect. This is hardly the resounding disavowal that some might have anticipated or hoped for.
Evolving Executive Compensation
SOP regulations admittedly brought about changes to compensation programs, although their value is, at best, problematic. Media scrutiny and the position of the proxy advisory firms — Institutional Shareholder Services (ISS) and Glass Lewis, whose recommendations on executive compensation programs carry substantial weight with institutional shareholders — have led many public companies to eliminate or reduce golden parachute protections, withhold some long-time perquisites, and reduce the use of stock options and supplemental executive retirement plans (SERPs).
While the decision to modify these benefits is understandable in today’s difficult climate, there are sound arguments in each case as to why the affected benefit should continue to play an integral role in compensation programs. For example, experience has shown that golden parachute protections do motivate executives to work to maximize shareholder value in takeover situations. Similarly, SERPs provide executives with certainty that they will be able to cope with retirement (and motivate succession planning) for a relatively low cost.
Another change, brought about primarily by ISS, is that some companies have begun to move towards making Total Shareholder Return (TSR) (i.e., the percentage increase in share value and dividends paid during a specified period) the primary or sole means by which to measure a chief executive officer’s performance. The problem with this is that the use of TSR can result in executives being underpaid in a bear market (as stock prices fall without regard to executive performance) or overpaid in a bull market (as prices rise). It can also potentially motivate executives to attempt short-term manipulations to increase the share price in circumstances in which the price for some reason does not reflect strong executive performance and the period in which to earn the compensation is about to end. However, this can be mitigated by making the TSR relative to an appropriate peer group.
The next round of Dodd-Frank changes requires public companies to publish the ratio the CEO’s compensation bears to the compensation of the company’s median employee. The flaws inherent in this provision (cost of gathering the information; difficulty in integrating non-U.S.-based employees into the calculation; lack of adjustment for geography or sector) have been addressed by numerous commentators since it was enacted. The Securities and Exchange Commission (SEC), which was charged by Congress with circulating a rule to implement the provision, proposed one in mid-September. The SEC attempted to mitigate some of the principal criticisms, but could not, of course, address the rule itself, which, even in its present form, will require companies to devote significant time and resources to compliance.
Alvarez & Marsal Taxand Says:
The ultimate question, of course, is what’s next? If the executive compensation provisions of Dodd-Frank do not bring about the changes to executive compensation that some believe are necessary to prevent the income inequality they believe harmful to the country, will Congress be pressured to impose a hard limit on CEO compensation (either through an absolute dollar limit or a maximum ratio between CEO and average employee pay or another mechanism)? Such a limit would seem antithetical to the American dream of success. But, in the current environment, any outcome is possible when it comes to executive compensation.
One possible way to forestall any new legislation is for companies to push back harder in their proxy disclosures and public statements against any form of one-size-fits-all compensation planning such as the use of TSR as the sole compensation metric. Instead, they should argue that their own compensation committees are far more able to determine the right compensation level to motivate a particular group of executives than are proxy advisory firms whose analysis is primarily based on checklists and other superficial data.
Companies (and their boards of directors and compensation committees) clearly face increasingly complex issues in structuring executive compensation and benefit programs to minimize public discontent, while still acting to attract and retain top executive talent. Regardless of the political climate or public outcry, the best approach is to maximize the return to reward executives for actions that, in the opinion of the board or the compensation committee, are most likely to maximize share value in the long term.
Brian Cumberland, Managing Director, contributed to this article.
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