Executive Compensation Takes Center Stage

Recently, advocates of executive compensation reform efforts have been pressing ahead on three different fronts. Federal lawmakers are  considering a number of reforms, including the Corporate and Financial Institution Compensation Fairness Act of 2009 and the Shareholder Bill of Rights Act of 2009. Institutional shareholder groups continue their persistent advocacy of reasonable, appropriately structured pay-for-per-formance programs. And corporate governance watchdogs, like The Conference Board's Task Force on Executive Compensation, are busy addressing the loss of public trust in the corporate oversight of executive compensation.

Legislative Efforts
The Treasury Department's so-called "pay czar" controls compensation packages for the top 25 earners at the companies that received TARP bailout funds and have not yet repaid the government. This elite group now consists of  AIG,  Bank of America., Citigroup., General Motors, GMAC, Chrysler and Chrysler Financial.

As for corporations generally,  the Corporate and Financial Institution Compensation Fairness Act of 2009 passed the House last summer and is awaiting a vote by the Senate this fall. It requires an annual shareholder advisory vote on executive compensation and on compensation packages that include golden parachutes. It also mandates that compensation committees be comprised entirely of independent directors and that compensation consultants and other advisors satisfy separate SEC criteria for independence. The bill requires financial institutions with more than $1 billion in assets to disclose to federal regulators the structure of all incentive-based compensation. And, finally, it prohibits any incentive-based compensation that "could threaten the safety and soundness of covered financial institutions, or could have serious adverse effects on economic conditions or financial stability."

Captured by the Act are several broad principles and "best practices":  (i) that executive compensation should be closely tied to performance (e.g., by customizing incentive-based compensation to individual recipients, by increasing base salaries and decreasing bonuses, and by ensuring that a substantial proportion of incentive-based compensation is based on long-term performance); (ii) that the interests of management and shareholders should be closely aligned (e.g., by instituting significant company stock ownership and holding requirements); (iii) that unreasonable risk-taking should be disincentivized (e.g., by reducing stock option grants); and (iv) that the details of executive compensation should be made more transparent (e.g., by insisting on strict adherence to compensation disclosure rules).

 A similar but not identical bill was presented in the Senate several months ago. The Shareholder Bill of Rights Act of 2009 is an attempt to give shareholders a greater voice in the nominating and electing of directors and the compensation of executives. Like the House bill, it would give shareholders an annual "say on pay" vote on executive compensation, including any "golden parachute" provisions. It would also allow those shareholders owning at least 1% of the voting securities of a company for at least two years prior to an annual meeting to nominate their own candidates through use of the company's proxy solicitation materials.

The  bill also provides that no company could be listed on a national securities exchange if it does not require that directors must resign unless they receive at least 50% of the vote in uncontested elections; that the entire board of directors must be up for election every year; and that the chairman of the board    could not be a current or former executive of the company. 

Institutional Shareholder Activity
Particularly active in the current executive compensation reform movement is the Council of Institutional Investors. CII endorses reasonable, appropriately structured pay-for-perform- ance programs that reward executives for sustainable, superior performance over the long term. CII's position is that it is the job of a company's compensation committee to ensure that elements of compensation packages are structured to enhance the company's short- and long-term goals and to retain and motivate executives to achieve those goals.

CII's position, like the bill, demands an annual advisory vote on the compensation of senior executives. A non-binding "say on pay"vote would discourage the board's compensation committee from cavalierly handing out rewards that promote excessive risk-taking. It would also be a quick, effective way for a board to take the pulse of its shareholders with respect to the company's compensation practices.

A number of CII's additional positions are also shareholder-friendly.  It believes that executives who leave a company as a result of poor performance - whether they are terminated, resign under pressure, or the board fails to renew their contract - should not be entitled to severance payments, regarding such compensated sendoffs to be "pay for failure." Further, according to CII, companies should implement clawback provisions for recapturing unearned bonus and incentive payments to management. CII's rationale is that strong clawback policies will discourage executives from taking questionable actions that might boost share prices in the short term but that can ultimately result in disastrous financial restatements. Finally, CII believes that companies should grant stock options or other equity awards at the same time each year.  Whatever their schedule, companies should take measures not to coordinate stock grants with the release of material non-public information.

The Work of Corporate Governance Watchdogs
The Conference Board's Task Force on Executive Compensation, which was convened in March 2009, published recommendations this fall "to address the loss of public trust in the processes for oversight of executive compensation." The report published by the Task Force (which is comprised of corporate directors, shareholders, academics, and experts in compensation, governance, and law) represents the most up-to-date and politically-independent thinking on executive compensation reform.

Specifically, the Task Force highlighted the following five distinct "Guiding Principles" that every public company should adopt and follow:

• Establish a clear link between pay, strategy, and performance. Make incentive compensation a significant portion of pay, with payouts demonstrably tied to performance and paid only when performance can be reasonably assessed.
• Provide compensation that is attractive to executives, fair to shareholders and employees, affordable for the company, proportional to the executive's contribution, and clearly aligned with actual performance.
• Eliminate controversial compensation practices that conflict with the notions of fairness and pay for performance, like excessive golden parachutes, overly-generous severance arrangements, gross-ups of parachute payments or perquisites, and golden coffins - unless specific justifications exist.
• Demonstrate credible board oversight of executive compensation through the utilization of independent, experienced, and knowledgeable compensation committees.
• Foster transparency and comprehension with respect to compensation practices and appropriate dialogue between boards and shareholders.

The Task Force is encouraging public companies to act now to demonstrate their commitment to best practices in executive compensation by adopting these Guiding Principles.  We applaud the small (but growing) number of corporations that have already made this commitment:  significantly, AT&T, Cisco Systems, Hewlett-Packard, and Tyco.