Executive Compensation Legislation on the Move
Expanding shareholder voting rights to include corporate executive compensation has been a topic of considerable debate in Washington over the past few years, but not until the fall of 2008—when the federal government began undertaking unprecedented steps to stabilize the financial system—did “say on pay” gain real momentum. By late fall, there was strong public outcry for action as recipients of government bailout money reported high executive salaries and bonuses that appeared disconnected from their companies' financial health.
Congress took the first steps towards strengthening investor influence by imposing say on pay requirements for all Troubled Asset Relief Program (TARP) recipients in the American Recovery and Reinvestment Act, passed in February. However, in response to public uproar over American International Group’s (AIG) distribution of $165 million in corporate bonuses to their much-maligned financial products unit, the Obama Administration went one step further in early June by proposing an extension of say on pay to all publicly-traded companies.
The Treasury Department subsequently released draft legislation in mid-July that would require all public companies to hold annual, non-binding shareholder votes on executive compensation packages as well as impose stricter standards to ensure the independence of corporate compensation committees. Treasury’s say on pay proposal is modeled after a rule the United Kingdom adopted in 2002. Starting December 15, 2009, proxy materials would have to include tables summarizing the salary, bonus, stock option awards, and total compensation package for senior executives and also narrative explanations of any golden parachute and pension compensation packages. In the event of a merger or acquisition, companies would need to hold separate votes on golden parachutes and lay out simply and clearly what the departing executives would receive.
To ensure the independence of corporate compensation committee members, the legislation calls for "exacting new standards" modeled on how Sarbanes Oxley established the independence of audit committees. The provisions would require a compensation committee to be granted the funding and authority necessary to hire compensation consultants, legal counsel, and other advisers—all of whom should be independent of the company's management—to help the committee negotiate pay packages that are "in the best interests of shareholders."
Immediately following the release of the Treasury legislative draft, House Financial Services Committee Chairman Barney Frank (D-MA) issued a “discussion draft” virtually identical to the administration’s proposal, except for the addition of a section applying only to covered financial institutions that would require their regulators to evaluate and prohibit compensation practices that would:
- encourage inappropriate risks
- threaten an institution’s safety and soundness, or
- “have serious adverse effects on economic conditions or financial stability.”
The House Financial Services Committee intends to take up the say on pay measure next week. Senators Charles Schumer (D-NY) and Richard Durbin (D-IL) have both introduced say on pay legislation, but the Senate is expected to take up in the fall the version the House is likely to pass in the next few weeks.
Say on pay has bipartisan appeal in Congress, evidenced by a 2007 House vote on a Chairman Frank-sponsored bill that mirrored his current draft. Easily passing the House by a vote of 269-134— yet stalling in the Senate—Frank’s bill garnered the support of over 50 Republicans, including prominent GOP members such as Ranking Member of the Ways and Means Committee Dave Camp (MI) and Ranking Member of the Budget Committee Paul Ryan (WI). In light of this 2007 vote and current public opinion over corporate executive compensation practices, the prospects for enacting say on pay rules as part of a broader financial regulatory reform bill have significantly improved.
Arguments For and Against
Say On Pay Is Non-Binding
- While the legislation calls for non-binding say on pay, most business observers agree that corporate boards will face enormous pressure to accept the shareholder votes.
- Other countries and companies are doing it.
- Britain, Australia, Norway, Spain and France have say on pay rules similar to those currently proposed here. Roughly 25 U.S. Companies have voluntarily implemented say on pay, and the administration has pointed to AFLAC as an example of the policy’s success.
Pay Not Related to Performance
Proponents of say on pay cite research indicating that executive compensation is increasingly unrelated to company performance. Last year the Securities and Exchange Commission (SEC) revised its rules to require public companies to disclose more information about their executive compensation plans, including C-level executives and board members. However, many believe the rules did not go far enough to inform shareholders of the totality of compensation packages. The draft legislation specifically addresses conflict of interest concerns regarding CEOs negotiating their own pay arrangements during merger and acquisition negotiations.
Increases in CEO Pay Disproportionate to Worker Pay Increases
The Institute for Policy Studies and the Center for Corporate Policy determined that the CEO to worker pay gap was 42 to 1 in 1980, but by 2007, it was 411 to 1.
CEOs Caution Against Congressional Intervention
USA Today recently polled 31 large company CEOs on say on pay and 77 percent were against the government mandating the policy. The U.S. Chamber of Commerce and the Business Roundtable, an association representing large company CEOs, both assert that shareholders could demand say on pay today, without Congress passing any new laws. Business executives have raised concerns that say on pay could lead to shareholder micromanagement and government intervention and could likely drive talented executives into privately held firms. There is also the concern that large, institutional shareholders could abuse the say on pay policy to coerce management into making certain decisions that might drive up profits in the short term but would not be in the company’s best long-term interests.
