Executive Compensation—It Just Won’t Go Away

Over the last several years executive compensation has been an issue that has received a lot of attention from Wall Street, union pension funds, activists, and others. The Dodd-Frank Say-on-Pay mandate was put in place and early on there was surprising push back from shareholders. There were results that have been tracked about the impact of Say-on-Pay and the support from shareholders over several years that are as follows:

Based on the recent Towers Watson Research of approximately 13,050, roughly 3,000 companies show their positive results on Say-on-Pay in 2013 are up to 90% from 89% in 2012. The percentage of those companies receiving negative ISS board recommendations drop from 13 to 11 percent.

It is clear that company disclosures are better focused on explaining executive compensation generally. This is a result of a conclusion reached by Ning Chiu of Davis Polk, LLP. Companies are also more sensitive about those issues that will raise questions and possibly trigger negative proxy advisory firm recommendations. Clearly, the large companies are responding to shareholder Say-on-Pay concerns and are being advised by their outside counsels on the proper manner of preparing detailed compensation disclosure in their proxy statements. Further, we believe that many of these companies are reaching out to their large institutional investors and having a dialogue with them concerning compensation, getting feedback, and responding appropriately—so progress has been made.

The issue will raise its ugly head again as the SEC and its sixty-day waiting period is completed and the fight over whether or not these regulations concerning disparity between the CEO and the median salary of its employees should be disclosed. Time will tell.

It is clear that boards have become more sensitive to the issue. They are working hard to tie their executive compensation programs to specific targets of performance which is refreshing and clearly should significantly help improve the performance of the company. However, there are still companies that continue to pay outrageous (as defined by some people) sums of money to CEO’s and others in their company. One could question an annual compensation package for a CEO that is roughly 100 million dollars. How do you justify this? Isn’t there that old fashion dictum that you get a job and are given an appropriate salary to carry out your responsibilities? Why do you have to be incentivized to do a good job? Shouldn’t that be part of your make-up? Clearly, this area of executive compensation has gotten out of hand and has been a ratcheting up of salaries. If one takes a look across the board, salaries have gone up dramatically compared to the median rank and file employee. As we take a look at electric utilities that are regulated by state commissions and the salaries that are being paid, If you look at those salaries today versus what was being paid 5-7 years ago, how did we get to these numbers? What has changed in terms of the responsibility of the job? We say, not much. How do you justify these significant increases?

Now there is a move afoot by the Securities and Exchange Commission that regulations will be put in place which will evaluate the disparity or difference from the median employee salary and that of the CEO and what the ratio is. In some European countries, this is already taking place. If this does go into effect in the United States, it is going to provide, in some cases, shocking disparity—whether justified or not—and will provide even more reason for union pension funds, state pension funds, or city pension funds to become more aggressive in their negotiations with companies that they have invested in. This will eventually align them with activists and some institutional investors.

The question is—what to do about it? It appears as if these regulations will move forward and companies need to start preparing themselves for the fallout that may occur. It may be that this becomes a tempest in the teapot and it runs its course over a period of time. On a case by case basis companies can justify the differences, but there will be some organizations that, quite frankly, will be embarrassed by the result. So, will executive compensation as a major issue go away? We do not think so. It is out there like a festering boil. Even though responsible managements have taken steps to ensure the shareholders are protected by putting in prudent compensation plans that are tied to specific performance, there are others that continue to ignore this. They are the ones that create the problems for the majority. We will just have to wait and see.

Postscript

Stock ownership should be the incentive to drive long-term performance. The stock ownership plans should be prepared in a manner which forces long-term results to benefit the holders of the stock and maybe the stock does not vest until a certain period has passed—perhaps five years—and certain performance results over that five year period have been achieved. This would certainly tie the executives of the company directly to the shareholders who have invested and believe in them.