RESTRAINING EXECUTIVE EXCESS: SUGGESTED POLICIES
Improved Disclosure: On January 17, 2006, SEC commissioners voted unanimously to overhaul the way companies report CEO pay. The SEC proposal -- which is expected to come into effect in 2007 -- has broad support among investors and the business community. To learn more about the SEC proposal, WATCH this C-SPAN program with Nell Minow, director of The Corporate Library.
Experts on CEO pay, including Harvard Law Prof. Lucien Bebchuk, say that while the SEC's proposal may lead to increased transparency and a decline in "stealth compensation" (such as signing bonuses, "death retention bonuses" and options "reloads"), it will not necessarily diminish the disparities between the top and bottom of any companies.
For years, experts have pointed out that CEO pay raises at many companies have had little relationship to actual performance. It's one thing for Exxon Mobil to pay Lee Raymond an enormous pay/retirement package (consumers may be getting riled up about gas gouging, but with the company reporting record profits, the company's shareholders have few complaints). But it's quite a different story at companies like Pfizer, which has paid CEO and chair Hank McKinell $65 million since he took the top job at the company (as well as a promised $83 million pension), even though the company's stock has lost 46 percent of its market value since he took the reins.
Put CEO Pay Up for a Vote. Shareholders should be allowed to vote on executive compensation packages. The SEC has long held that shareholders have broad purview over matters of executive compensation and could mandate that shareholders directly approve corporate pay practices. At a minimum, shareholders should be granted increased participation in the board nomination process, a proposal that remains under consideration at the SEC.
As the WSJ reported on April 10, 2006 (Joanna L. Ossinger, "When it comes to CEO pay, why are the British so different?"), British companies have been required since 2002 to put executive-compensation practices up for an annual shareholder vote. As we suggest in a letter to the NYTimes (4/17/06), this may be one reason British corporations are more restrained (the WSJ report suggests it is one reason British CEOs typically receive about half the total compensation of their American counterparts). While the UK policy is non-binding, the only time a report was voted down, the company (Smithkline Beecham) chose to renegotiate a new contract with the CEO.
Rep. Barney Frank (D-Mass.) introduced HR 4291 , "The Protection Against Executive Compensation Abuse Act," which would require shareholder approval of executive pay plans, in effect forcing full disclosure.
The SEC should either allow proxy votes on CEO pay, or make it a listing requirement of the major exchanges as part of its proposal to require increased disclosure of executive compensation, as investor groups have suggested. (To see all of the comments on the SEC's proposed rule on executive compensation, go here).
Cap CEO pay through a maximum wage. This can be done by eliminating tax deductions for executive compensation above a certain amount -- e.g. above 25 times that of the lowest-paid employee, a standard originally proposed by management guru Peter Drucker. Rep. Martin Sabo (D-Minn.) has included this proposed standard in "The Income Equity Act of 2003," which would eliminate all tax deductions for compensation above 25 times that received by the lowest paid worker in the corporation. For more information see Rep. Sabo's web page.
Limit CEO pay during bailouts and bankruptcies. A related proposal was inserted into Section 331 of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 — the bill pushed through Congress by credit card companies. The otherwise wretched piece of legislation explicitly limits executive pay for the first time ever in federal law to a fixed multiple of the pay that goes to average workers. Under the new provision, no company that enters into bankruptcy can award its executives any “retention” bonus or severance pay over ten times the average bonus or severance payment given to regular employees in the previous year.
These kinds of bonuses have been granted too many times. Delphi, the giant auto parts manufacturer that announced in 2005 that it would file for bankruptcy, is asking the bankruptcy court to okay $37.5 million in stock options and actual shares of stock, plus millions more in cash bonuses, for five of the company's top executives. The company filed for bankruptcy right before the new law went into effect. Nevertheless, the law establishes a pay equity principle — the notion that rewards at the top ought to be linked to rewards at the bottom — that could pave the way for broader executive pay limits in the future.
The Fairness and Accountability in Reorganizations Act of 2006, introduced as S. 2556 by Senator Bayh (D-IN) and H.R. 5113 by Rep. Conyers (D-MI) is intended to "ensure that workers are treated more fairly during [bankruptcy] reorganizations by limiting executive compensation deals and requiring corporations to provide a more accurate picture of their holdings before attempting to modify collective bargaining agreements or promised health benefits."
In 2002, the federal judge overseeing WorldCom's attempt to emerge from bankruptcy (after executives committed the largest accounting fraud in history) appointed former SEC chief Richard Breeden to recommend reforms to fix the company as part of the restructuring process. Breeden's report made a number of recommendations, including a new pay structure for both top executives and the board of directors. As a result, MCI (the company's new name) has set a lid on "total compensation from all sources" for the company's CEO of "not more than $15 million" a year.
Cap severance payments to executives at companies that are still under investigation for financial fraud. The Supreme Court ruled (10/11/05) in a case involving two former Gemstar-TV Guide International, Inc. executives that the SEC could freeze their severance payments. The SEC has reportedly accused the two former executives of inflating Gemstar’s revenue by at least $223 million.
Cap CEO pay for companies receiving government contracts or other assistance. Commercial airlines were granted $5 billion in compensation and $10 billion in credit for losses resulting from the 9/11 terrorist attacks. The Air Transportation and System Stabilization Act prohibited federal bailout money for companies whose officers or employees received a total compensation (including salary, bonuses, stock awards and other benefits) that exceeded $300,000 in calendar year 2000 (except for employees whose compensation was determined through a collective bargaining agreement entered into before 9/11/01.
According to OMB, the maximum "benchmark" compensation allowable under government contracts during FY 2003 is $403,273. (See Section 808 of Public Law 105-85. This standard applies to both defense and civilian procurement agencies.) The benchmark is "the median amount of the compensation provided for all senior executives of all benchmark corporations for the most recent year for which data is available." See CFR Vol. 68, No. 85 pp. 23501 -23501. here, continuing here .
Expense options. It's widely recognized that an explosion in the use of stock options as a form of executive compensation was a key factor in creating an incentive to cook the books, a development that led to many forms of corporate fraud and abuse. Corporations are currently entitled to a tax deduction when stock options are exercised, while loopholes in accounting rules allow corporations to avoid counting them in financial statements when they are issued, creating misleading financial reports. Over 350 corporations -- including 104 members of the S&P 500, representing 38% of the index based on market capitalization, have pledged to voluntarily expense their options. FASB has indicated it will issue new rules on the issue, while certain members of Congress oppose expensing options. For more information see the Citizen Works page on expensing options, AAO Blog, .