Calstrs, the outfit that oversees some $111 billion of teacher pension funds in California, is now demanding that companies allow shareholders to vote on executive compensation (say-on-pay), and it has set out eight pages of guidelines seeking "more responsible executive pay policies." It is not alone.
Shareholders are becoming downright feisty
Just ask Ken Lewis. Bank of America's
Shareholders of Royal Dutch Shell
Stoking outrage against CEO compensation has been the widening gap between wages for the assembly-line worker and those in the corner office. According to The Economist, in 1980, executives were being paid on average 40 times more than an average production worker. By 1990, the ratio had doubled, and by 2003, the comparison was 400 to 1.
To a large degree, this divergence reflects the impact of a shift toward greater use of common shares and stock options to reward executives -- a practice meant to align the interests of management and investors -- and a buoyant stock market. Clearly, the market collapse last year will have shifted these trends.
Here to stay
Still, shareholder anger about former excesses, and the demand for say-on-pay, is not likely to disappear. Since May 2008, when shareholders of Aflac
Senator Charles Schumer sent a letter to colleagues on April 24 saying he would soon introduce a bill requiring that investors be allowed to vote on executive compensation and golden parachutes, and also demanding that the roles of chairman and CEO be split. There is no doubt that President Obama supports greater shareholder involvement. In 2007, he introduced a similar bill in the Senate.
Will shareholders have increasing clout in the management of publicly owned corporations? Should they? Do they care?
Maybe, maybe not
Critics of say-on-pay argue that shareholders are not in a position to judge the merits of compensation agreements, which are complicated and often misconstrued in the press. The media tends to report a single number, whereas pay often reflects awards from prior years that are finally vested or that were originally deferred.
Some managers argue that in any case, the current approach is too blunt an instrument. What does it mean if shareholders vote against a particular company's policy? That pay was too high? That perks were too generous? They don't like the golden parachute? Perhaps this is irrelevant, in that the message investors want to send is simply dissatisfaction with management. Still, as the compensation process has become more complex, the simple "up or down" vote is not seen as particularly useful.
Opposition to say-on-pay from the business community also focuses on the inability of shareholders (or their advisors) to judge the subtleties of how compensation is determined, not being privy perhaps to competitive issues or to the alternative opportunities available to individuals.
For instance, RiskMetrics, a prominent advisory firm, opposes multiyear contracts. Realistically, though, if a company wants to hire sought-after talent from across the country, you can bet he or she's going to demand more than a one-year contract. Detractors also point out that revealing increasingly detailed information about how compensation is awarded can weaken a company's competitive position. Further resistance stems from the notion that once emboldened to vote on pay, shareholders may press for influence in other realms, such as hiring policies or outsourcing. The bottom line, according to some executives, is that shareholders already have two means to express dissatisfaction: They can vote against directors, and they can sell their shares.
This Fool's view
Shareholder activism has already effectively eliminated the old "buddy boards" that were often behind excessive remuneration. It seems to me that boards today are already on notice that compensation must be based on performance.
The threat from say-on-pay is that it could (ironically) exacerbate an unhealthy focus on short-term results, a preoccupation that is already promoted by the growing marketplace power of hedge funds. Though board compensation practices will theoretically be based on multiyear trends, (and indeed the Calstrs guideline emphasizes "long-term thinking") shareholders will just as surely respond to the last year's results and vote accordingly.
Managing for short-term objectives, as we have seen with the auto companies, hurts not only companies but society at large.
It also seems to me that boards, and compensation committees, are required today to spend so much time checking boxes and seeing to the increased governance required by Sarbanes-Oxley and other measures seeking to correct past errors that they end up having little time to focus on the big picture. Maybe if AIG's board had been paying attention to the build-up in its CDS portfolio, the company would not be in today's drastic condition.
One thing is for certain. Say-on-pay is coming, and it will be a bonanza for advisory companies like RiskMetrics. Shareholders will be expected to make sense of the increasingly complicated compensation arrangements; many, no doubt, will seek help. It is not, in my view, good news when legislation fuels a boom for companies whose job it is to unravel legalese.
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