Say on Pay as an Opportunity for Understanding

One of the most contentious current issues in employee benefits revolves around “excessive” executive compensation. Wall Street bonuses in the millions for executives whose companies are flagging have been making the front page for years. Given the current economy and the high rate of unemployed and underemployed Americans, I’m not surprised to see a bit of the populist spirit burn as many perceive that the rich are getting richer through extravagant executive compensation plans. In this edition, we’ll take a look at what seems so unfair about executive compensation and what opportunities “Say on Pay” legislation presents for bridging gaps between shareholders, boards of directors, and executives.

Luckily for the populists, cracking down on executive pay is one of the few issues that garners bipartisan support in Congress, who passed say on pay legislation under the Dodd-Frank Act § 951 in 2010. “Say on pay” quite literally means providing shareholders a say on their executives’ pay. Shareholders now vote annually on an executive compensation plan, either approving or disapproving of the plan. Though the vote is non-binding in America, approval is highly sought by boards of directors and executive compensation committees.

Say on pay has been almost as controversial as the issue it was enacted to regulate. Since the vote is non-binding, companies whose plans fail to win shareholder approval may execute their compensation plans regardless. Some worry about the influence of proxy advisory firms, who took an active role in the process. Others note that despite numerous recommendations by such firms against approving executive compensation plans, shareholders overwhelmingly supported most plans last year. Ignoring the voice of shareholders, as well, may expose companies to derivative suits, which have sprung up across the country since last year with limited success. Finally, no company wants to be next on the front page for its excessive and unfair executive compensation practices, verified by shareholder outcry.

Far more daunting a prospect is binding, or mandatory, say on pay. Binding votes require that if a corporation’s executive compensation plan is rejected, it must come up with a new plan, which must be approved before it can be implemented. The United Kingdom may soon enact just such a provision if it follows the recent proclamation of David Cameron, who has vowed to hit back at big executive bonuses in light of failing businesses. If binding say on pay gathers steam, in the UK or the US, executive compensation committees will take on greater prominence and stress, as both executives and shareholders must be pleased by their decisions.

At the heart of this debate, I am left with one core question: what about executive compensation seems to create such anger and drive populist sentiments? The answer is more than simply vastly increasing executive compensation. Apple’s new CEO, Tim Cook, has been making news recently for his astounding restricted stock award worth around $375 million, but the tone of the reports is more akin to amazement than judgment. Should Apple’s stock turn south under his leadership, however, it wouldn’t be surprising to see a proportional shift in the tone of reports on Mr. Cook’s earnings, as well. A successful company paying its executives well, while perhaps interesting, is not exciting. An underperforming company paying its executives well is more than exciting; for many, it’s infuriating. Thus, we see that the answer is excessive compensation paid by companies with performance issues. The situation simply seems unfair.

But how unfair are these executive arrangements? Objectively, one might expect an unfair plan to pay its executives too much, or more than they are worth. An executive’s worth, one may argue, is measured by the services that executive provides. The value of these services are doubtless different when considered prospectively and retrospectively. If a company does well, then in retrospect, the executive may feel he or she is due more for having assisted the company reach great growth. If a company does poorly, then in retrospect, shareholders and even the public at large will likely feel that the executive was overpaid for his or her work. The problem with this approach, of course, is that compensation committees must create these plans prospectively, with limited protections against future poor performance. They are being judged on stricter standards than they can maintain, and whenever that happens, one should not be surprised when the results are negative. In reality, the circumstances faced by the compensation committee seem more unfair than their decisions.

Unfortunately, the problem of “excessive” executive compensation will likely continue, as some businesses will always seem to have overpaid their employees retrospectively. The best remedy a compensation committee can conjure is to prospectively and proactively communicate its compensation policies with its shareholders. In that sense, say on pay is actually a great medium for such communication, as it presents (and somewhat demands) an opportunity to help shareholders understand why certain decisions were made at certain times. Though explanations will never quite remove the sting of a lower share price, it will help shareholders, boards of directors, and even executives function with greater understanding of the perspectives of one another, which in itself is a laudable achievement.

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One comment on “Say on Pay as an Opportunity for Understanding

  1. nelsonhunt says:

    Great article. I’m learning executive comp from you, Prof. Renfro. Glad to have to writing with us!

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