How A Reconceived Compensation Committee Can Help Tackle Inequality

Leo E. Strine, Jr., the former Chief Justice of the Delaware Supreme Court, is the Austin Wakeman Scott Lecturer in Law and Senior Fellow at the Harvard Law School Program on Corporate Governance, as well as Of Counsel at Wachtell, Lipton, Rosen & Katz. Kirby Smith is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here) and The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).

In the three decades after World War II, workers and stockholders shared equitably in the nation’s growing wealth. But, during the last several decades, this fair gainsharing has diminished as the power of the stock market, in the form of institutional investors, has grown, and the comparative voice and leverage of workers has declined. As a result of these and other factors, a much greater share of the gains from increased corporate profitability and productivity has gone to stockholders and top management, on the one hand, and much less to employees, on the other. Contributing to this divide has been a push to tie top management pay to total stockholder return and to create incentives for management to deliver returns to stockholders, even if that requires decreasing the share that the workers primarily responsible for corporate success get. The resulting economic insecurity and inequality have caused demands for serious change in corporate governance to give greater weight to the interests of workers.

This state of affairs has led to calls to reform our corporate governance system’s power dynamic to give workers more voice. And business leaders have acknowledged that an economic system that does not work for everyone is unsustainable, most prominently through the Business Roundtable’s revised statement on corporate purpose making clear that employee well-being and fair compensation are central issues for corporate management.

In a recent Essay, we focus on one practical way for how corporate boards can make the Business Roundtable’s language a reality: by reconceiving the compensation committee. That is, a reconceived compensation committee would focus on the company’s entire workforce, not just senior management, and have the responsibility for overseeing management’s implementation of an effective system to compensate workers fairly, ensuring they receive a fair share when corporate productivity and profitability increases, and analyzing what allocation of compensation within the company’s workforce will provide the most motivation to encourage corporate success.

To accomplish this, compensation committee would be expected to understand the nation’s, the industry’s, and the company’s traditional gainsharing practices among workers, stockholders, and top management and develop and implement a corporate strategy to ensure that gainsharing is equitable. By doing so, compensation committees will also be able to more rationally set top executive compensation and establish metrics for top management compensation that isn’t solely focused on stock price. The committee should also demand more information about its workforce from management. Information such as worker pay and benefits for the top 25th percentile of workers, and every quartile thereafter, is essential. But so is information about the key employees in each business line in terms of their function, educational level and skill set, and relevance to the business line in which they are employed. All of this information should aid the committee in obtaining a complete view of how it currently compensates its workforce. Although directors should avoid getting into the nitty gritty, a solid grasp of essentials is necessary.

And the committee should not stop at pay metrics, but should explore the process by which management sets compensation for the company’s workforce. By comparing existing processes to the process the board uses to set executive compensation can aid the committee is setting appropriate pay policies across the corporation designed to properly incentivize the workforce and provide a fair distribution of corporate profits. In part, this includes understanding whether the company grants workers any leverage in bargaining and considering whether changes to the company’s existing policies should be made to treat workers more equitably and give them more voice at the bargaining table. Importantly, this also requires asking whether the company respects the right of its workers to voluntarily join a union and collectively bargain, and whether the company pays a living wage to all of its direct workers and insists that its contractors do the same.

But the committee cannot stop at issues affecting worker pay. For instance, the committee should understand whether the company is investing in the training and educating its workforce and whether it considers promoting from within or is generally focused on external candidates when promotion opportunities exist. The committee must also receive feedback on whether workers have safe working conditions, reliable and family-friendly schedules, an inclusive, discrimination and harassment-free workplace, and are treated with respect and dignity. The committee’s understanding of these issues is necessary for it to approve and oversee policies that ensure workers are treated fairly and to hold management to account for failing to do so. Embedding a focus on worker well-being in the corporation’s culture will ensure that workers aren’t just viewed as costs, but rather as partners in achieving long-term, sustainable profitability and success.

These examples are not exhaustive. Each company’s workforce is different, and boards will be required to adopt an approach that works for their organization. But by this evolutionary means that builds on the existing American corporate governance system, important strides can be taken toward making our capitalist system work better for the people most critical to its success: workers.

The complete essay is available for download here.

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