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Using Dodd-Frank to Curb Executive Excess

Catherine Ruetschlin

Proxy season is the magical time of year when shareholders cast their votes on corporate governance. Since 2011, the ‘Say on Pay’ provision of Dodd-Frank ensured those votes would include an up-or-down non-binding voice in executive compensation packages. If that sounds toothless, well, hardly anyone is even getting gummed. According to Equilar’s say on pay tracker, most companies’ executive compensation plans passed with 90-plus percentage majorities. Consulting firm Semler Brossy reports that just 36 companies—2.1 percent of their tally—have failed their votes so far this year. 

Executive compensation reveals how a company sets priorities, judges performance, and rewards achievement. Both performance targets and the type of composition awarded (cash, equity, etc) set incentives for management – and whether those incentives provoke responsible behavior is a matter of importance well-beyond the boardroom. Plenty of historical examples demonstrate the spillover effects of corporate governance failures and the need for management oversight. But with very few exceptions, that is not happening. As a result, CEO earnings hit a record high in 2013. 

Over at Director Watch, Dean Baker offers one explanation for the largely unchecked rise in executive pay: basic cronyism. Executive compensation is set by the firm’s Board of Directors, an exclusive club made up of people with a mutual interest in keeping high-level corporate managers among the 1 percent. It is an argument echoed by shareholder advisory firm ISS last week, when they recommended that shareholders at Walmart not only use their votes tomorrow to rebuke the executive compensation package, but also to remove two of the company’s board members and appoint an independent chairman. According to the Wall Street Journal

On pay, ISS said it previously had been supportive of Walmart's pay practices, but has grown concerned with a number of moves. Specifically, it cited reductions in performance targets that don't result in a decline in pay, use of adjustments to results that have the effect of boosting executives' apparent performance, special awards with short vesting cycles, and a decision to retroactively grant more shares that boosted the possible payout under existing long-term incentive cycles already in progress. 

Such moves came "even as the company's performance continues to lag peers," ISS said. 

Unfortunately for folks with an interest in their pension funds, the Walton heirs own a controlling stake in the company which makes it impossible for other investors to follow-through on the experts’ advice. 

But despite these obstacles, the shareholder voice in corporate governance is gaining volume. In addition to Say on Pay, Dodd-Frank mandated that companies disclose more information about compensation practices across their work force. As I outlined in a recent comment to the SEC regarding the pending rule, more information about lopsided human capitol allocation will contribute to risk mitigation and make Say on Pay more effective. The presence of numerous comments from shareholders in support of the rule show that there’s an appetite for better investor oversight on issues of compensation. 

Last week, the California legislature failed to pass regulation that would create incentives for firms to reduce pay disparity by lowering the tax rate to 7 percent for companies that pay their CEO no more than 100 times the compensation of their median worker, and then taxing more unequal companies on a sliding scale. Under that regime, a company with median pay at $50,000 could offer its CEO up to $5 million and still receive the preferential tax rate. The bill, SB 1372, made it through two legislative committees and onto the Senate floor, where it received a majority of votes in favor though not enough to pass. 

Despite its eventual defeat, the attention and support for SB 1372 points to a growing understanding of stakeholders in corporate governance that include the public sector and private citizens who have been left out of the process in the past. Say on Pay pulled shareholders into a conversation that has barely begun, but the negative consequences of pay disparity for the overall economy, and the evident failure of corporate boards to provide meaningful oversight, demand a much more inclusive discussion.