Tag Archives | pay

CEO Pay in the Context of Society

An alternative approach is offered by Jay Lorsch and Rakesh Khurana in The Pay Problem, Harvard Magazine, May-June/2010, which theorizes find that the current compensation trouble stems from unexamined assumptions about the purpose of boards, executives, and the corporation.

The underlying assumption that executives would work more effectively if their monetary rewards were tied to results built on incentives for factory workers, using piece-rate schemes advocated by Frederick Taylor. But these prescriptions missed two complications when applied to senior executives:

  • often executives have little or no control over the results they rewarded for achieving; and
  • results are more often produced by a group of executives or even by an entire organization’s effort.

Turnover in chief executive suites led to a belief of a well-functioning market for senior executive but compensation in reality depends much more on negotiations than anything like a market rate. Another factor that transformed compensation was agency theory that linked top executives’ pay plans to a firm’s stock price. “Prominent business organizations switched from advocating a ‘stakeholder view’ in corporate decisionmaking to embracing the ‘shareholder’ maximization imperative.”

In 1990, for instance, the Business Roundtable, a group of CEOs of the largest U.S. companies, still emphasized in its mission statement that “the directors’ responsibility is to carefully weigh the interests of all stakeholders as part of their responsibility to the corporation or to the long-term interests of its shareholders.” By 1997, the same organization argued that “the paramount duty of management and of boards of directors is to the corporation’s stockholders; the interests of other stakeholders are relevant as a derivative of the duty to the stockholders.”

“Executive pay is rising not so much as a driver of improved performance, but as a consequence of improving performance and an accompanying rise in equity values.”

The authors want to move from the prevailing paradigm, which regards managers as needing to be bribed to perform, back to something like when managers were viewed as professionals with obligations to various “stakeholders” and to the broader society.

Re-thinking the nature of executive pay within the context of our larger economic and social system and the challenges we face may enable us to create a new model of compensation rooted in a more realistic recognition of the social context within which firms operate. It should, and can, rest on valid assumptions and fundamental values that allow us to build a more inclusive and sustainable economic future—one in which we don’t have to bribe executives to do the duties we have entrusted to them.

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Medium CEO Pay Declines

Median total annual compensation for North American CEOs declined for the second straight year, according to a preliminary CEO pay survey from The Corporate Library.

The study analyzed CEO compensation data for fiscal 2009 drawn from 823 proxy statements filed in the United States between July 1, 2009, and March 25, 2010.

The report titled The Corporate Library’s Preliminary 2010 CEO Pay Survey, is available for $45 from The Corporate Library’s online store. According to Paul Hodgson,

The decrease marks the first time since The Corporate Library began publishing its annual CEO pay survey in 2002 that the median change in compensation has declined for two consecutive years.

Median total annual compensation for all CEOs in the study declined by 2.78 percent from 2008 to 2009.

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Goodyear Vote and the Timeliness of Analysis

The Corporate Library Blog today carries a great post, Inflated CEO pay at Goodyear Tire. Good puns and even better information on CEO Robert J. Keegan’s “maximum payout for a net loss.”

Mr. Keegan received four separate stock option grants. The largest of the four market-priced grants, almost 500,000 of them, was at $4.81. Less than six months later he’d made $6.23 million worth of notional profit on that. This is just irresponsible, and it’s taking advantage of a super-low stock price to grant any stock options at all in such circumstances. It’s virtually impossible NOT to make money in such a situation.

This is Paul Hodgson writing in excellent form, including his conclusion that “it might even be time to vote against Denise Morrison, Rodney O’Neal, Craig Sullivan and Thomas Weidemeyer,” members of Goodyear’s compensation committee.

I’ve only got one complaint. The meeting is tomorrow; for many, voting has already ended. Hopefully, those who subscribe to “Board Analyst,” or other services at The Corporate Library, got this analysis earlier. However, I see, as reported by ProxyDemocracy.org, CalSTRS voted in favor of compensation committee members, so I’m left wondering if timeliness is a frequent issue during the busy proxy season.

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CEO Pay & Risk Reduction

In Reining in Excessive Risk Taking by Executives: Experimental Evidence, researchers Mathieu Lefebvre and Ferdinand Vieider find that excessive risks are likely to be reduced by aligning executives’ interests with those of shareowners. (paper available at SSRN, March 2010) Abstract follows:

Compensation of executives by means of equity has long been seen as a means to tie executives’ income to company performance, and thus as a solution to the principal-agent dilemma created by the separation of ownership and management in publicly owned companies. The overwhelming part of such equity compensation is currently provided in the form of stock-options. Recent events have however revived suspicions that the latter may induce excessive risk taking by executives. In an experiment, we find that subjects acting as executives do indeed take risks that are excessive from the perspective of shareholders if compensated through options. Comparing compensation mechanisms based on stock-options to long-term stock-ownership plans, we find that the latter significantly reduce the uptake of excessive risks by aligning the executives’ interests with those of shareholders. Introducing an institutionalized accountability mechanism consisting in the requirement for executives to justify their choices in front of a shareholder reunion also reduces excessive risk taking, and appears to be even more effective than long-term stock-ownership plans. A combination of long-term stock-ownership plans and increased accountability thus seem a promising direction for reining in excessive risk taking by executives.

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Church Investors to Vote as a Bloc in UK

PIRC Alerts reports that the UK Church Investors Group (CIG) issued a report on executive pay saying that a ratio between the pay of the top executive and that of the average pay of the lowest 10% of employees in excess of 75 times would be hard to justify. They’ve adopted a common framework.  PIRC will provide research and voting advice on group members’ holdings in the FTSE100. In practice this will mean that members participating in the initiative will be able to adopt the same voting stance, making the CIG an important new shareholder voting bloc in the UK’s capital markets.

PIRC also reports, the average vote against a remuneration report at a UK-listed company last year was 17.28%. That compares to a figure for 2008 of 3.2%. If you would like a copy of the 2010 UK Shareholder Voting Guidelines, please contact Janice Hayward on [email protected] or phone 020 7392 7894.

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Directors & Boards

The current edition features a cover article, The Great Divide: Separating the Chairman and CEO Roles. Thought leaders tackle the issues involved in splitting the two top leadership positions of the corporation. On one side of the debate: “The development is inexorable,” says Ira Millstein. “Beware the simplicity of saying two heads are better than one,” says James Robinson. Sure, the consensus of this group is that such a split should not required by law. Maybe they’re right, but the arguments in favor of splitting the roles in most cases were far more compelling than those opposed. What do you think?

New disclosure requirements are going to make many boards rethink the issue, especially when they have someone in the combined role stepping down. In another article, Henry D. Wolfe offers more timely advice in What you want in a nonexecutive chair, while Diane Lerner and Ira T. Kay offer up Revisiting the pay of the nonexecutive chair.

Several other excellent articles round out the issue, including an interview of Dennis Kozlowski by John Gillespie and David Zweig, authors of Money for Nothing. Their interview is entitled If he had it to do all over. Sure, in hindsight, Kozlowski wishes he had done some things differently; maybe he should have been a little less ambitious.

However, what is presented is mostly the self-portrait of a victim… a victim of a system well documented by Gillespie and Zweig which cedes too much authority to CEOs. If Tyco had a stronger board, he wouldn’t be working in a prison laundry. Staying out of jail, another good reason to strengthen boards by splitting board and chair positions.

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SVNACD: New Proxy Rules on Executive Compensation

Networking Before SVNACD Meeting

What are the new SEC disclosure rules for executive compensation, especially the “risk” to the corporation of their compensation plans? How are companies dealing with these new rules — what do the early returns from this proxy season indicate? Are these new SEC requirements more of an annual risk assessment of compensation than disclosure rules — is any company really going to make a disclosure that its compensation policies create a risk to the entity? Will the RMG/ISS guidelines have as much, or more, impact than the SEC rules? How will these rules relate to pay for performance? Exactly what compensation programs are “unduly risky”? What mitigation practices will companies adopt? What are the “best practices” that should be considered?

Those were some of the issues taken up by panelists bright and early at 7:30 am at a monthly meeting of the Silicon Valley chapter of the NACD:

  • Lon Allan, Chairman of the Silicon Valley chapter of the NACD.
  • Katie Martin, Senior Partner at Wilson Sonsini Goodrich & Rosati’s Palo Alto office, where she practices corporate and securities law. 
  • Tom LaWer, Senior Partner at Compensia, a management consulting firm providing executive compensation advisory services.
  • John Aguirre, Senior Partner at the law firm of Wilson Sonsini Goodrich & Rosati, specializing in executive compensation and employee benefits, including tax, ERISA and federal and state securities laws.

I’m certainly no expert in this area but I’m sure it was paradise for actual practitioners in the trenches. What follows are a few items that struck me as an interested observer. Although I know I got the order of panelists right, who said what is less certain. The links are to sites I think readers might find useful. I didn’t run them by the speakers for endorsement.

Katie Martin

Katie Martin started with some discussion on changes to required disclosures. For example, directors must disclose seats held at any time during last five years.  Legal proceedings: 10 year look back, rather than 5. Disclosure is expanded to include judicial proceedings relating to mail or wire fraud, violations of state securities, disciplinary sanctions.

Disclose experience, qualifications, attribute and skill that led to selection. Most are placing disclosures right below the biography. She discussed the new RiskMetrics Group Risk Indicators GRId (their new gov scoring system). The old CGQ scores will be frozen on March 17, 2010 and retired completely at the end of June 2010. Here’s an SEC FAQ for issuers.

My own impression, reinforced at the meeting, is that the SEC rules are largely non-prescriptive, whereas the substance of disclosures will mean more when graded by RMG. Verify the facts. Look at ways to improve. Use new D&O questionnaires, which ask directors to self-identify their particular experience, qualifications, attributes and sills.

Diversity considerations. Whether, if so, and how. The SEC rules include no mandates and the definition of diversity is being interpreted broadly.

Board leadership structure. Whether and why CEO and Chair are same or separate. If same, description of Lead Independent Director is critical. Review governance policies with respect to the role of lead independent director to consider whether further clarity is needed. Discuss and document the rationale for your current leadership structure.

Risk management oversight. Disclose the board’s responsibility for risk-management oversight. For example, is it the responsibility of entire board or is the function assigned to one or more committees for different categories of risk? This is a good opportunity to discuss these issues with the board and/or appropriate committees. Discussion will normally bring some changes and more formality. There is a trend toward having a separate risk management committee, not so much in the tech sector, but in larger firms.

With the new rules regarding 8-K requirements, we’re talking close to real-time disclosure, within 4 business days after meeting. File preliminary results, if final results not known.

Non-GAAP Financial Measures: Recent SEC Interpretations. Historically, restrictive approach by SEC to non-GAAP financial measures. Recent changes have not led to full blown non-GAAP report but anything that flushes out trends would be positive. SEC filings should be consistent with other public communications. If doing an offering, get comfort from auditors. (Revised SEC Interpretations Regarding Non-GAAP Financial Measures, Cooley Godward Kronish LLP, 2/26/10)

Focus on process aspects, risk and possible litigation. Don’t let your board get blind-sided.

John Aguirre

John Aguirre – New Compensation Disclosure Rules: Policies and Practices Relating to Risk Management — Requires narrative disclosure regarding compensation policies and practices for all employees to the extent that risks arising from such policies and practices are “reasonably likely to have a material adverse effect on the company.” Reasonably likely is the same disclosure threshold used in the Management Discussion & Analysis. Whether disclosure is required is a facts and circumstances test for each company and its compensations programs (e.g., the program features and goals). Dodd bill may require comp committee to have their own attorney. Focus on process.

Risk disclosure, grants, and consultant fee disclosure… Forward-looking statements that don’t create risk.

SEC examples of practices that may have risk requiring disclosure included business unit that:

  • carries a significant portion of company’s risk profile.
  • has compensation structured significantly different from other units within the company.
  • is significantly more profitable than other units.
  • has compensation expenses as a significant percentage of unit’s revenues or compensation that varies significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while income and risk to company from task extend over a significantly longer period of time.

If disclosure is required, the SEC noted possible areas for discussion:

  • General design philosophy and manner of implementation of compensation policies and practices for employees whose behavior is most affected by incentives created, as related to risk-taking on behalf of company.
  • Risk assessment or incentive considerations, if any, in structuring compensation policies and practices in awarding and paying compensation.
  • How compensations policies and practices relate to realization of risks resulting from employee actions in both short and long term, such as policies requiring clawbacks or imposing holding periods.
  • Policies regarding adjustments to compensation policies and practices to address changes in risk profile. Material adjustments that have been made to compensation policies and practices as a result of changes in risk profile. Extent of monitoring of compensation policies and practices.

List of SEC’s examples is not exhaustive. SEC expects principles-based approach in the disclosure, similar to CD&A requirements. Avoid generic or boilerplate discussion. SEC does not require an affirmative statement that a company’s risks arising from its compensation policies and practices are not reasonably likely to have a Material Adverse Effect. If a company does not disclose any material adverse risks, the SEC likely will, in the course of its review, issue a comment asking the company to explain the nature of the internal analysis that was conducted in making its determination that no disclosure was required.

What should you do? Update board or comp committee on new rules. Consider whether compensation policies need updated. In addition to the examples John provided, which I expect may be referenced on the SVNACD site, here are some examples from Holme Roberts & Owen LLP.

Must disclose aggregate “grant date fair value” of awards computed in accordance with FASB ASC Topic 718. Whole value of the award, even if they may never get it. This effects who is covered in your table.

Tom LaWer

Tom LaWer – The SEC has set a very high bar for disclosure. If disclosures are made, expect disclosure of past issues along with disclosure of how the issue has been fixed. The rules provide a fresh opportunity to focus in on the risk assessment of compensation policies and practices. The examination will likely influence compensation plan design… Revising compensation programs to improve design based on issues uncovered in the risk review. You might indicate, for example, that policies are reviewed annually.

No generally accepted compensation principles. Best practice guidance is sometimes conflicting. Most guidance is conventional wisdom. Standards may evolve over time based on empirical research. SEC examples tend to focus on the issues for financial companies.

Again, RMG risk guidelines might be a more important driver than the SEC.  He went over several practices that will get further scrutiny and possible mitigating factors. It is a good time to review and assess for correct goals, mix, use, and design flow. For example, did the person who was demoted still got their bonus because there was no discretion built into the compensation plan?  Are you doubling up, because long-term and annual incentive plans are based on the same metrics? Tell shareowners how your actions ensured these problems don’t arise again.

Here are some handouts from a similar panel meeting of the Twin Cities Chapter of the National Association of Stock Plan Professionals and brief overviews from O’Melveny & Myers, Grant Thornton LLP , Seyfarth Shaw LLP., Jenner & Block, Dorsey & Whitney LLP, Ulmer & Berne LLP, Thomson Reuters, and TheCorporateCounsel.net.  I hope readers find these links helpful. The panel did a great job on a rather technical topic and brought home in many examples how requirements might be addresses, especially by the predominately high tech companies of Silicon Valley. Also be sure to see SVNACD’s page with handouts and interviews, as well as a podcast from KPMG/NACD, New SEC Proxy Disclosure Rules for 2010: What Boards Are Doing to Prepare.

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ICGN Issues Global Guidelines for Setting Non-executive Director Pay

In new calls for strengthened accountability, transparency and alignment in non-executive director pay, the International Corporate Governance Network (ICGN) is specifically calling for pay to consist solely of a combination of a cash retainer and equity based remuneration. The ICGN also calls for the elimination of perquisites for non-executive directors.

Commenting on the new Guidelines the ICGN Chairman, Christianna Wood says,

As the shareholder’s representatives, non-executive directors are elected by the owners of the company and must have a strong alignment of interest with the owners in the form of meaningful equity ownership while serving on the board. Furthermore, directors have a conflict of interest in that they set their own pay and as a result need to provide the utmost transparency and clearly state the board’s philosophy behind the director remuneration programme.

These principles were crafted over the last several years in a consultation that included many of the largest global shareowners.  Ted White, Chairman of the ICGN Remuneration Committee responsible for developing the new Guidelines also commented,

These principles were hotly debated by our members from around the world.  While practices differ from country to country, continent to continent, we all agreed that this was an important policy and that the principles of accountability, transparency and alignment of interest were agreed upon principles that should exist in the setting of all non-executive director remuneration programmes.

The ICGN acknowledges that remuneration practices differ around the world.  Carl Rosen, ICGN Executive Director added:

Among the agreed upon themes are that non-executive director equity remuneration should be immediately vested and not performance-based.  The ICGN believes that directors should have solely cash retainer and equity ownership remuneration, with a preference against the use of options.

The Guidelines aim to help communicate investors’ perspectives on this critical issue and are primarily addressed to companies and their non-executive board members.  Since remuneration policies are set by the board, it is important that they be transparent, address shareholder expectations, and those setting them be held accountable. Accordingly, three principles underpin these guidelines: transparency, so investors can clearly understand the program and see total remuneration for non-executive directors; accountability, to ensure that boards maintain the proper alignment of interests in representing owners; and alignment of interest between non-executive directors and shareowners.  The cornerstone of non-executive director remuneration programs should be alignment of interest through the attainment of significant equity holdings in the company meaningful to each individual director.  Key aspects of the Guidelines are as follows:

  • Places an emphasis on non-executive director alignment of interest with long-term owners.
  • Draws a distinction to differences to executive remuneration, particularly related to performance-based remuneration.
  • Opposes the use of performance-based remuneration for non-executive directors.
  • Examines the tools of remuneration, and favors solely cash retainer and equity, with a preference against the use of options.
  • Provides flexibility for companies to implement the principles in ways consistent with their unique circumstances.
  • Calls for clear disclosure including the philosophy of the non-executive director programme.
  • Calls for equity to be vested immediately but subject to holding periods.
  • Suggests companies establish ownership guidelines for non-executive directors.
  • States non-executive directors should not be eligible for retirement benefits.

The Guidelines are intended to be of general application around the world, irrespective of legislative background or listing rules. As global guidelines, they need to be read with an understanding that local rules and structures may lead to different approaches to these concepts. The ICGN will also seek change to legislation, regulation or guidance in particular markets where we believe that this will be helpful to generating corporate governance improvements and particularly where such change will facilitate dialogue and accountability.

The ICGN Non-executive Director Remuneration Guidelines has been developed by the ICGN Remuneration Committee in consultation with ICGN members. A consultation paper on the subject was sent to ICGN members for comment and a wide range of responses were received and contributed toward the final draft. The Guidelines will be launched at the ICGN Conference, being held on the 24 – 25 March at London’s Guildhall, entitled ‘Will shareholders rise to the ownership challenge?’ The event is hosted by the City of London and supported by the Department for Business, Innovation and Skills, among other partners.

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Fix the Boards – Fix the System

Money for Nothing: How the Failure of Corporate Boards Is Ruining American Business and Costing Us Trillions by John Gillespie and David Zweig begins with a story familiar to just about everyone on the globe — corporate and economic collapse brought on by greedy CEOs. The authors look behind the headlines to reveal and document the systematic failure of corporate boards who are supposed to look out for shareowner interests but are still too often picked by the very ones they are supposed to advise and monitor… the CEOs.

They discuss how companies spend enormous sums of shareholder money to fight off reforms, either directly or through organizations like the US Chamber of Commerce or the Business Roundtable. According to the authors, “corporate boards remain the weakest link in our free enterprise system.”

A brief overview is provided on how we got here and what it means for shareowners and society. Much of the book is given over to example after example of conflicts of interest, overlapping boards, and a world driven by the greed and status needs of CEOs. Studies have shown that 80% of acquisitions fail to deliver and many fail outright. Too often they are driven by incentives that reward empire building over the generation of profits.

Jennifer Lerner, the only psychologist on the faculty of Harvard’s Kennedy School of Government, finds that “Americans tend to exhibit anger more readily than those in many other cultures, and the effects of being in power closely resemble those of being angry.” CEOs and other executives, it turns out, have substantially larger appetites for risk and are more optimistic about outcomes. Changing the context can improve outcomes, especially where the environment demands “predecisional accountability to an audience with unknown views.” In the case of corporations, that would be a diverse independent board, not predictable lapdogs of management.

Later chapters review “The Myth of Shareholders’ Rights” and other issues, including proxy mechanics that allow moving shares to be voted multiple times based on the “day of record,” when large blocks of stocks may be most likely to have several different owners. They document that not only do shareowners have little power, the gatekeepers and guardians paid to protect shareowner interests are almost always conflicted, leading to de facto control by management. At the same time, laws like the “business judgment rule” make it nearly impossible to hold fiduciaries accountable. Pension assets that are turned over to plan managers who provide kickbacks back to corporations earned 29% lower returns, according to a cited 2009 GAO report. The failures documented by Gillespie and Zweig cost investors and the public trillions, bringing the world economy to its knees.

It is time boards stopped being the CEOs friend and instead took on the role of the CEO’s boss. After a thorough examination of the issues, documented with an abundance of real-life examples, Gillespie and Zweig close with a list of recommendations that could go far in changing the culture of the boardroom, strengthening accountability, reducing conflicts of interest, and getting shareowners involved. In a very abbreviated form:

  • Create a new class of public directors and a training consortium
  • Insist of gender, ethnic, and perceptual diversity
  • Limit directors to three or fewer boards and require substantial “skin in the game”
  • Initiate more communication between directors and shareowners
  • Split chair/CEO roles & learn lessons from nonprofits
  • Allow 10% of shareowners to call an extraordinary general meeting
  • Add clout to say-on-pay, reform executive compensation, and shareholder approval of golden parachutes
  • Ban staggered boards and require majority votes elections
  • Proxy access for shareowners, daylight nominating & election processes, & require real board evaluations
  • Require board risk committees & empower boards to gather independent information
  • End conflict of interest in mutual fund voting by allowing third party voters per Investor Suffrage Movement
  • Reform voting mechanics to end manipulation by management
  • Reform auditor business model & Fix “up the ladder” provision of SOX
  • Reform rating agency model, fully disclose lobbyist expenses, provide real funding for SEC enforcement
  • Federalize corporate law
  • Better coverage of governance issues by the financial media
  • Better financial education, including how corporate governance works

Gillespie and Zweig hit all the bases for a solid home run. They tell us how the game is fixed and how the rules can be changed to play fair. After all, shareowners own the “ball” and all the other equipment. Will we listen? Even more importantly, will we act?

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CEO Greed Doesn't Work for Shareowners

“Firms that pay their CEOs in the top ten percent of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results are consistent with high-pay induced CEO overconfidence and investor overreaction towards firms with high paid CEOs.” That was the conclusion of Performance for pay? The relationship between CEO incentive compensation and future stock price performance by Cooper, Gulen, and Rau… one of two studies highlighted in Does Golden Pay for the CEOs Sink Stocks? (Jason Zweig, WSJ, 12/26/09).

According to Rau, CEOs in his study averaged $23 million—but leave their shareholders poorer (relative to other companies in the same industry) by an average of $2.4 billion per year. Each dollar that goes into the CEO’s pocket appears to take $100 out of shareholders’ pockets. If that is true, there is obviously something very very wrong with the typical incentive structure.

The CEO Pay Slice by Bebchuk, Cremers, and Peyer investigated the fraction of the aggregate compensation of the top-five executive team captured by the CEO – and the value, performance, and behavior of public firms. They found “CPS is negatively associated with firm value as measured by industry- adjusted Tobin’s Q.” CPS is found to be correlated with

  1. lower (industry-adjusted) accounting profitability,
  2. lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements,
  3. higher odds of the CEO’s receiving a “lucky” option grant at the lowest price of the month,
  4. greater tendency to reward the CEO for luck due to positive industry-wide shocks,
  5. lower performance sensitivity of CEO turnover,
  6. lower firm-specific variability of stock returns over time, and
  7. lower stock market returns accompanying the filing of proxy statements for periods where CPS increases.

Zweig’s article goes on to cite Benjamin Graham’s 1951 recommendation that directors “must have an arm’s-length relationship with management; they also should combine “good character and general business ability” with “substantial stock ownership.” (They should have purchased most of their shares outright rather than getting them through option grants.)” He also notes that Graham called to independent directors to publish a separate annual report analyzing whether the business is “showing the results for the outside stockholder which could be expected of it under proper management.”

Each month I take readers on a time trip in CorpGov.net’s “WayBack Machine,” to see what we were discussing 5 and 10 years ago. It is interesting to see how often we are grappling with the same issues. If we had only listened to Graham 58 years ago, how different would corporate governance be today? While we can’t change the past, we can at least work to ensure CEO pay is better aligned long-term shareowner value in the future.

Service Employees International Union (SEIU) Master Trust launched a campaign recently, mostly aimed at banks, proposing the following reforms:

  • Requiring that at least 80 percent of an executive’s annual compensation be subject to multi-year vesting and/or holding periods;
  • Requiring executives and directors to hold a significant equity stake in the company and basing that stake on the value of the executive’s annual compensation package;
  • Making the timing of the equity awards predictable so shareowners know by the annual meeting date the total compensation level awarded to the executive team in the previous year;
  • Enacting effective clawback provisions that call for the automatic return of any bonus or incentive compensation awarded on the basis of financial results that subsequently required restatement;
  • Requiring a substantial portion of annual cash and/or equity bonuses to be held until performance criteria are achieved;
  • Making retention grants conditional upon executives remaining with the company;
  • Prohibiting executives and directors from engaging in any hedging, derivative or other transactions with respect to equity-based awards granted as incentive compensation;
  • Placing restrictions on severance payments, death/disability payments, compensation related to changes in control and perquisites;
  • Forming a shareowner advisory committee to advise the board and the compensation committee on executive and director compensation;
  • Allowing shareowners to cast an annual advisory vote on executive compensation;
  • Including in proxy statements information about the steps being taken to align compensation with long- term incentives, to avoid incentives that promote undue risk taking and to prevent windfalls where there is no long-term shareowner gain;
  • Requiring that at least three independent directors serve on the compensation committee;
  • Prohibiting compensation committee directors from serving on the audit committee; and
  • Adopting bylaws that allow shareowners to place director candidates on corporate ballots subject to certain conditions.

These seem like a good start. However, the devil is in the details. For example, requiring 80% of an exec’s annual compensation be subject to multi-year vesting and/or holding periods… getting 80% two years later meets that vague definition but certainly doesn’t meet criteria that would dissuade CEOs from gaming the system. Certainly, much more needs to be done in this area. RiskMetrics made an important change to their policy for 2010 by assessing the alignment of CEO’s total direct compensation and total shareholder return over a period of at least five years.

More discussion at How to Tie Equity Pay to Long-Term Performance, HBR, 6/24/09; Executive Compensation, Ethicsworld.org; Are senior executives worth what they are paid? Steven N. Kaplan vs Nell Minow, The Economist, 10/28/09.

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Yale Governance Forum June 2009: Restoring Trust

Rising StarsPrior to the Forum, I attended a reception honoring the Rising Stars of Corporate Governance for 2009. Those included in the photo are (left to right, top to bottom):

  • Evelynne Change, Coordinator for Corporate Governance, African Peer Review Mechanism (APRM) Secretariat, New Partnership for Africa’s Development (NEPAD)
  • George Anderson, Partner, Tapestry Networks
  • Elizabeth Ising, Associate Attorney, Gibson, Dunn & Crutcher LLP
  • Stephen Brown, Director & Associate General Counsel, Corporate Governance, TIAA-CREF
  • Deborah Gilshan, Corporate Governance Counsel, Railpen Investments (a subsidiary of rpmi)
  • Rachel Lee, Senior Corporate Counsel, EMC Corporation
  • Nada Abusamra, Attorney at Law, Partner, Raphaël & Associés Law Firm
  • Julieta Rodríguez Molina, Associate Attorney, Galindo, Arias & López

David Hess, Assistant Professor of Business Law & Business Ethics, Stephen M. Ross School of Business, University of Michigan and Alexis B. Krajeski, Associate Director, Governance and Sustainable Investment, F&C Investment were also named rising stars but were unable to attend the reception.

I also caught this quick shot of several members of the Millstein Center for Corporate Governance and Performance staff who were involved in making the Forum a huge success. Included here from left to rightMillstein Center staff are:

Note regarding the limitations of this report: Often at the Forum several sessions met concurrently; I could only be in one place at once. Additionally, in order to encourage the free exchange of information and opinion, I agreed, generally, not to report for attribution. Therefore, the following notes provide only a brief sketch of what I focused on and how my limited observation mixed with my own opinions. Of course, sessions were designed to elicit debate among experts with often well known conflicting opinions, so consensus was relatively rare but insights were not. I’ve provided some links that may give readers a better understanding of the positions of individual participants.

Plenary 1: What is the proper balance between regulation and private sector initiatives to restore trust in the market system?

Moderator: Ira Millstein, Senior Associate Dean for Corporate Governance, Yale SOM; Senior Partner, Weil, plenary1Gotshal & Manges LLP. Discussants: William Donaldson, Chairman, Donaldson Enterprises; Fmr. Chairman, SEC; Founding Dean, Yale SOM; William Goetzmann, Edwin J. Beinecke Professor of Finance and Management Studies and Director, International Center for Finance, Yale SOM; Mats Isaksson, Head, Corporate Affairs Division, Organisation for Economic Co-Operation and Development (photo: right to left)

I think there was general recognition by panelists that we have been through a recent period of very little regulation, when far too many ignored risk. There was frustration that mutual funds and other intermediaries frequently don’t acknowledge or behave as if they work for us. Instead, too many are more concerned with lining their own pockets.

Reference was made to the glorious revolution of 1688. I’m not sure I got the context but I imagine it was a call for shareowner democracy, in much the same way as the Bill of Rights in 1689 ended absolute dominance by the king. While we seem to be near ushering in an era of democratic rights for shareowners, there were also concerns with the likelihood of over regulation, especially enactment of regulations that aren’t enforced, either because of practicalities, lack of will, or follow through.

One danger of over regulation is that it often leads to an assumption that someone is taking care of “it.” Regulations work best when they empower markets and those dependent on the regulated to make the markets work or to enforce the rules.

The focus on “say on pay” for CEOs is overblown, according to at least one panelist. There’s very little evidence that it will bring down pay. In fact, the movement risks taking attention away from the real problem of incentive structures for dealers and traders who were walking away with huge bonuses for short-term deals. Hedge fund and private equity groups were seen as possible problems. Yet one panelist cited an OECD Steering Group conclusion that “activist” hedge funds and private equity firms could help strengthen corporate governance practices by increasing the number of investors that have the incentive to make active and informed use of their shareholder rights.

Regulators frequently respond like generals that just lost a war. They plan how to win the last war, not the next. We need to understand tomorrow’s markets, yet we are the product of our experience. Throwing out Glass Steagall created something of a free for all, although there doesn’t appear to be much political will for turning back.

It all starts with the education. Principles start at home but have been diminished in our educational system, especially in business programs. We lost our bearing with the appointment of SEC commissioners who didn’t believe in rules or regulations.

We need regulations, like we need traffic lights. Too few have asked what makes for a great company. Get at key factors like employee morale and quality, not just making money. Others argued the DNA of selfishness brought us prosperity. Don’t blame everything on markets and don’t expect everything from them. The market won’t fix things that must be fixed by politics, like the disparity of wealth.

Students come into university with a competitive history of community service. Yet, once here, most spend their summers working for hedge funds or commercial banks. Their next level of winning is a salary beyond imagination. We need to change educational structures to broaden the entrepreneurial to include giving back to society.

A fundamental question involves our approach. Do we try to solve with our problems with prescriptive regulations or by empowering shareowner engagement? Clearly, most believe the later. Owners need structures to support their ability to hold management accountable. Proxy access, say on pay (primarily as a vehicle for communication), supercharging dialogue with boards…. those are the directions.

What about rights that follow a share of stock? Should you be rewarded for holding for the longer term? It gets complicated. Most seemed to recognize the importance of large activist shareowners. Some felt that since pension funds feed the private equity funds, they need to take a larger part in keeping these funds in line and their costs down. Others focused on conflicts of interests among intermediaries, such as credit rating agencies that are paid by issuers and given monopoly status by the government. One answer might be rating the raters, either by SEC or others. A member of the audience from Egan Jones pointed to his firm as not being paid by the entities being rated, so there is a clear alignment of interest between investors and the firm.

There were lots of good ideas but little unanimity on solutions. Like mutual funds that make more money by starting more funds than by earning money for their clients, intermediaries seem likely to continue to lead most investors astray. AndrewMetrick

Plenary 2: Has the public corporation model been under challenge from the current crisis? Are there lessons from private equity?

Moderator: Andrew Metrick (left), Theodore Nierenberg Professor of CorpRichFerlautoorate Governance, Yale School of Management.

Discussants: Rich Ferlauto (right), Director, Corporate Governance aSuzanne Hopgoodnd Pension Investment,
AFSCME;

Suzanne Hopgood (left), Director, Board Advisory Services, NACD; Ronald W. Masulis

Ronald W. Masulis (right), Frank K. Houston Professor of Finance, Owen Graduate School of Management, Vanderbilt University; Thomas Werlen

Thomas Werlen (left), Group General Counsel, Novartis International AG

Andrew Metrick started the group off with a reference to Michael Jensen’s Eclipse of the Public
Corporation
. Jensen thought the public model was broken.
The KKRs of the world were going to take over, loading corporations up with debt. They would take a direct role in corporate governance. Private equity does seem to be taking a larger role. The public model is costly, based on information intermediaries analyzing markets. Private equity structures better align investor

interests, at least those of the managing partners, with those of the company but investors are not getting a lot of detail with that model either. So, we have two different models to solve asymmetric information issues. Two competing models. Have public markets failed?

Panelists also raised other issues. Are they engaged with beneficial owners and other stakeholders? Do they demonstrate independence of thought or are they trapped in group think? We want diverse directors who are reflective and engaged in self evaluation. Do shareowners have the resources to intervene? They have a collective voice problem, often a lack of expertise but have a fiduciary responsibilities to beneficial owners. What we’ve experienced is regulatory arbitrage, a race to the bottom, seeking the weakest regulator.

At least one panelist felt strongly suspect of the private equity model. Within the top quartile, these funds that can take advantage of cheap money. It wasn’t the model that worked but circumstances. In fact, they were over leveraged, depending on loopholes in tax system. Often they skimmed low hanging fruit and took short-term exit strategies.

Other approaches might include investor representation on boards where, through collective action, they can effectively engage on behalf of beneficial owners. Stakeholder engagement councils could be convened as method of risk management. Certainly, we need more in the way of director disclosure and evaluation concerning their expertise and philosophy. The current information disclosures for director nominees is nearly worthless. Use of new technologies can help get us over collective action problems. Regarding risk management, we need to move to independent chairs but also need inside directors on risk committees with deep knowledge of companies. In a theme often repeated, investment companies must resolve conflicts between their fiduciary obligation to the company and their duty to investors. Resolution must find solely in the interest of investors.

Board composition is critical. Transparency in public companies instills discipline, even if you must issue a statement that investors can no longer rely on financial statements. Turnaround boards must be focused and committed. They should develop their strategic plan, determine skill sets needed, match those with the skill sets of board and ask what value each director brings to board. Disclose it in proxy. Shareholders will love it.

Public corporations in the US are generally characterized by strong management and atomistic shareholders. We suffer from information asymmetry to the degree that it is almost impossible for shareowners to monitor. Unfortunately, independent board members also lack knowledge of the business and management. Frequently, they don’t devote as much time to job as they should. Private corporations generally have fewer board members, more diversity, hands on involvement, and are incentivized to spend more time and effort. Public companies should take a lesson from such private boards. Strengthening boards is more important than shareowner involvement, since most shareowners will never have access to needed information or enough incentive to monitor.

Academic research shows that improving corporate governance is a primary driver of wealth creation. Concentrated ownership gives major owners control. Expertise, financial incentives, guarding against empire building, more efficient reporting systems, high leveraging, managers with invested liquid assets, bonuses in stock rather than cash… Why don’t public boards model such characteristics?

Financial reporting doesn’t track risk taking activity. Quarterly reports lag on risk. Our current system rewards high risk taking for short-term earnings. Inside directors have been dismissed but they are critical with regard to knowing what questions to ask (even better if they are also serve on more than one board).

Leveraged buyouts more frequently have the financial incentives, diversity, and critical skills. Regarding directors in general, foreign directors in the US are not helpful, since they tend to miss meetings. The recent IRRC report, What Is the Impact of Private Equity Buyout Fund Ownership on IPO Companies’ Corporate Governance?, was raised. “Whatever benefits there may be to the private equity model, they seem to disappear once a private equity backed company goes public. The findings are contrary to conventional wisdom and significant for investors,” said Jon Lukomnik, program director of the IRRC Institute. When they go public, such firms were more likely than others to have classified boards, poison pills, and restrictions on director removal by shareholders. Additionally, the report indicates that lucrative consulting agreements for former executives, generous employment agreements, and special bonuses are significantly more common at private equity buyout backed companies. Finally, the analysis indicates that once taken public, executive compensation at private equity backed companies tended to be higher, less performance-related, and less at-risk than at comparable companies that did not have private equity sponsorship.

One panelist asserted the value of discipline around directors with audit experience. Companies perform better with outside discipline and an organized agenda. Outside directors are key. Committee chairs must bring the discipline. Another said good governance isn’t just a matter of process. The key is balancing strategic vision and monitoring functions. Constructive challenge comes most frequently from the chair or lead director. Executive session useful in getting “snits” managed. It forces and focuses discussion. Telephone meetings are useful specific issue. CEOs who speak last will ensure generation of genuine discussion. Private companies are better for rapid change, while public companies are better for high growth mode/cycle. Public companies generally have a lower cost of capital, whereas private companies are easier to restructure. Both have their place.

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panel 2

Focus Panel 2 (photo right): What effect did the financial crisis have on this year’s proxy season, if any? What is the long-term impact of the crisis on shareholder governance responsibilities?

Moderator: Meredith Miller, Assistant Treasurer for Policy, State of CT.

Discussants: Kenneth Bertsch (right), Executive Director, Corporate Governance, Morgan Stanley Invest. KennethBertsch

Abe Friedman (left), Managing Director, Global Head of Corporate Governance & Proxy Voting, Barclays

Abe FriedmanMark Preisinger (Note product placement. That got a laugh.), Director of Corporate Governance, Coca-Cola CompanyPreisingerYerger and Ann Yerger, Executive Director, Council of Institutional Investors.

Miller led off with general statements about the proxy season. There was an increase in no action requests but a reduction in the number granted. There also appears to be an increase in withholds, more requests to split the chair/CEO, more contests. Demands for bonus pools and majority vote were also being pressed.

Other panelists noted the level of engagement is going up. Funds are more frequently being contacted by CEOs CFOs, general counsel, and even board members. Abe Friedman described how he must prioritize, screen and log calls. With the largest fund, I can imagine that gets tough during proxy season. He and others said they pay attention to these calls and often learned something, especially if there is a proxy contest or vote no campaign.

One panelist pointed out there are many issues on the table that still haven’t been resolved. It is time to get serious about majority voting, which may be a done deal at many of the largest companies but has still not been adopted by most small companies. Declassifying boards, poison pills (voting on it), and proxy access… If there ever was a time to focus on the few important things, now is the time.

Again, there was dispute among some panelists and participants on the say on pay issue. All agree that pay is really important because of how it incentivizes. But some think say on pay is not the right answer. It can even be harmful. Say on pay is seen by them as the executive’s safety net. We’re not going to know all the details related to pay, since disclosing strategy would harm competitiveness. And, of course, the execution of strategy should be a prime component in pay for performance. When shareowners vote overwhelmingly for pay that is structured badly, this simply provides legitimacy for poor practices. Say on pay will prove to be a shield, not a sword. Investors should focus on voting out those who approve unjustified pay. Focus on majority vote, so that directors who are not doing their job can be voted out. The ultimate say on pay is voting out directors.

Others who were initially skeptical have come around because the pay issue is the single most significant marker with the public. The cost of poorly structured pay is significant. Owners are already voting on bonuses, stock options. It provides another “pulse check.” Capability needs to be developed. It is an evolutionary process.

Another panelist was pushing hard for 10% thresholds to call a special meeting. This is something Bob Monks also emphasized when I spoke to him about the next point of shareowner leverage. Most shareowners seem to be willing to withdraw resolutions if companies make substantial movement towards a lower threshold. That makes me think shareowners may be settling for 25%, which will be harder to lower in the future. Compromise may not be such a good thing if it draws a line that is more difficult to move in the future.

At least one panelist and several in the audience seemed to be pushing for advance disclosure of proxy votes. Anne Sheehan spoke up from the audience about their experience at CalSTRS of announcing their votes through platforms at Broadridge and ProxyDemocracy. She was glad they started at end of season because it gives them some time to “test drive” the sysLaura Berrytem before going through a full proxy season. Yes, it has been something of an adjustment to plan a little further in advance. Several discussed possible downsides, primarily logistics, increased contact from benefical owners, and being afraid of announcing a vote and then and having to change. I know that ProxyDemocracy is out beating the bushes. I’d love to see more involvement and disclosure by international and mutual funds, as well as endowments and other mission-based funds.

Laura Berry (left), of the Interfaith Center on Corporate Responsibility, spoke from the audience, noting ICCR’s many years of attempting to raise issues regarding subprime loans and asked if panelists would be looking at social proposals more seriously because of their ability to predict problems. Yes. Everyone seems in agreement on that AnneSimpsonone. As a side note, IRRC celebrates its 40th anniversary through a year-long series of monthly audio podcasts entitled The Arc of Change. You can join ICCR’s Facebook group to keep up on their activities.

Focus Panel 5: The role of institutional investors in restoring trust

PeterButlerModerator: Anne Simpson (right), Senior Portfolio Manager for Corporate Governance, CalPERS

Discussants: Peter Butler (left), CEO, Governance for Owners LLP

Anne SheehanCatherine JacksonCatherine Jackson (right), Manager, Corporate Governance & Proxy Voting
Ontario Teacher’s Pension Plan Kieth Johnson

Keith Johnson (left), Head of Institutional Investor Legal Services, Reinhart Boerner Van Deuren

Anne Sheehan (far right), Director of Corporate Governance, California State Teachers’ Retirement System (CalSTRS)

There was discussion about the need to be as transparent as we are asking our companies to be. We need to be working closely with regulatory agewncies and to be prepared for changes. Otherwise, we are going to be like the dog that chased the car and caught it. We need to be active participants in the market, engaging with the SEC and Congress and speaking with one voice.

Keith Johnson said the UK’s University Superannuation Scheme developed a questionnaire for candidates and nominating committees. It asks candidates about their skills, how they relate to those of the board and its needs, as well as why they they will make effective directors. The Canadian Institute of Corporate Directors has posted a list of Key Competencies for Director Effectiveness that ties in well with board evaluations.

Cathrine Jackson said OTPP has been disclosing proxy votes in advance on their website in advance for years. In her opinion, too many funds outsource voting and engagement. Transparency and accountability; OTPP seems to be leading the pack.

One panelist said shareowners need to combine forces. Over diversification has become a problem. We need to “think globally and act locally.” (As an aside, the original phrase “Think Global, Act Local” first appeared in the book Cities in Evolution (1915) by town planner and social activist Patrick Geddes.)

Questions were raised about the skill set fund managers have, how we solve the free-rider issue, who should pay for necessary research, who should actually engage with companies. If companies paid, every shareowner would pay for research. It was suggested that half the money required come from companies, the other half from a levy on every investment scheme that gets tax relief. The issue of shareowner representatives for corporate nomination committees was also raised. Apparently, this is something like the approach used in some Scandinavian countries. (see Swedish director-election rules could cross Atlantic, MarketWatch.com, 4/17/09)

Another issue raised was stock lending with warnings that some have sold their franchise. Most appeared in agreement that funds should always recall their stock for voting. The difficulty arises primarily when special meetings are called. OTPP doesn’t lend their stock anymore. One suggested that long-term shareowners should be given loyalty payments. (Sleight Corporation (link to PowerPoint) in France considered paying extra dividend payments after two years but, as I recall, they rejected the idea.)

What would get shareowners to act responsibly? Suffering huge losses should be motivation enough. Ideas were thrown out such as asking DOL to establish by regulation that pensions must be engaged, enforcing current rules, sharing resources between funds, pooling resources. OTPP is opening up to accept other funds from other entities. California funds have made some attempt to share resources. Engagement must be based on bottom line results. It was a good dialogue with many creative ideas.Jonathan Koppell

Plenary 3: Government as shareholder of or lender to public corporations: What is the government’s role?

Moderator: Jonathan Koppell (right), Faculty Director, Millstein Center for Corporate Steve OdlandGovernance and Performance, Yale SOM

Discussant: Steve Odland (left), Chairman & CEO Office Depot (As far as I know, Odland was the only CEO to attend or at least to present at the Forum. That’s certainly to his credit but where were the others? More are needed at forums like this to ensure adequate dialogue.)

There was an interesting discussion here by Odland who recounted his experience with investors and a proxy contest. There were multiple shareholders with different timeframes and strategies. The gist of it was that investors aren’t of one voice and even if they are, the voice can change dramatically and sometimes is not accompanied by memory. Whatever strategy management uses, some shareowners aren’t going to like it. He had many good points. Not every activist is a good activist. Odland would like long-term interests to be aligned. Three years seems like forever to many hedge funds and other shareowners. We’ve got to find common ground.

They talked about who is the best owner across boundaries. Is government similar to other investors? How do you deal with generic issues of self-dealing with the government as owner, since the sovereign is both above the law and the regulator. Power corrupts and absolute power corrupts absolutely. Put the finest most capable people on boards to exercise their best independent judgment. CEOs would love to have large shareholders long-term. There was discussion of how to avoid unintended consequences and some commitments from people in the audience to try to work and find common ground with the Business Roundtable.

Plenary 4: Will the crisis help or hinder the integration of the global financial markets?Jeff Sonnenfeld

Moderator: Jeff Sonnenfeld, Lester Crown Professor in the Practice of Management & Senior Associate Dean, Executive Programs, Yale SOM (right)

Discussants: (left to right) Leonardo Peklar, Chairman, Socius Consulting, Inc.; Marcos Pinto, Commissioner, Securities and Exchange Commission of
Brazil; John Sullivan, Executive Director, Center for International Private
Enterprise (CIPE) James Shinn, Lecturer, Princeton University.

Leonardo PeklarMarcos PintoJohn SullivanJames Shinn

Sonnenfeld showed a Saturday Night Live parody of the stress tests. I hadn’t seen it… funny.

The main basis for optimism appears to be the hope that institutional investor will pay a premium for good corporate governance and that corporations will lobby governments to get standards raised. However, there were assertions that there may actually be a slight negative correlation between price and the quality of corporate governance by most indicators. Additionally, there is little evidence of corporations lobbying to improve governance. Witness continued opposition to proxy access from the US Chamber of Commerce and the Business Roundtable.

Don’t give up though. There is a strong correlation between the amount of money managed by pension funds and the quality of governance, especially when they have the political support of the citizens. (Hmm… what about when defined benefit plans are under all out attack?)

Brazil’s Novo Mercado, with its higher governance standards, seems to be working in a “race to the top.” However, apparently a similar attempt in Romania didn’t.

Brazil has had rebirth. Stocks have appreciated 40% since the beginning of year. Flows are positive since January, with about 37% coming from outside Brazil. Most derivatives are also regulated and there is disclosure of related third-party transactions.

In most markets, shareowners have been trading liquidity for control. The financial crisis revealed severe shortcomings in corporate governance. When most needed, standards often failed to provide the checks and balances that companies need in order to cultivate sound business practices. The OECD’s Corporate Governance Lessons from the Financial Crisis provides an overview of these shortcomings and resulting challenges.

There were discussions around block holding, both by families and governments, and how the role of director differs in a country like China where they may represent both shareowners and the government. The wisdom of Millstein’s advice to the OECD was acknowledged to be outcome oriented. How we get there may differ.

Comments from others:

On Thursday, Ira Millstein announced that leaders from the Millstein Center had joined three former SEC Commissioners, a former World Bank President and a former US Treasury Deputy Secretary in calling for enactment of long-championed financial market accountability and transparency reforms that include access to the proxy, say on pay, independent board chairs and creation of a permanent commission to develop and oversee updating of a US code of corporate best practice principles. That was a bold, but important, step for an academic center. To me, it demonstrated why the Forum consistently attracts so many insightful corporate governance leaders from around the globe. – Keith L. Johnson, Chair, Reinhart Institutional Investor Services

More photos from the Forum:

Andrew Shapirogroup 1Meredith Millergroup2>Mary Ellen Andersen
Ira MillsteinStephen Davis

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Mutual Fund Voting

Rank Fund Family Score
1 (tie) Templeton 7
1 (tie) Oppenheimer 7
3 (tie) T. Rowe Price 7.67
3 (tie) AIM 7.67
5 (tie) Schwab 8
5 (tie) JP Morgan 8
7 Janus 9
8 American Century 10.67
9 Legg Mason 11
10 Federated 11.33
11 Franklin 11.67
12 Morgan Stanley 13
13 Van Kampen 13.33
14 (tie) TIAA-CREF 13.67
14 (tie) BlackRock 13.67
16 (tie) Putnam 15
16 (tie) Scudder 15
16 (tie) American Funds 15
19 Vanguard 15.33
20 (tie) Fidelity 16
20 (tie) Lord Abbett 16
22 Columbia 17.33
23 Ameriprise 18.33
24 Barclays 20
25 MFS 21.67
26 AllianceBernstein 23.33

FT says mutual funds are expected to spend more time evaluating proposals, especially compensation-related resolutions. (Pay proposals to dominate proxy season, 4/5/09) They also note that “mutual funds have contributed to corporate America’s excessive pay by voting in favour of companies’ compensation plans, research by corporate governance experts will reveal on Monday. (Mutual fund votes helped to boost pay, 4/5/09) Better to start giving a damn in 2009 than never.

The Corporate Library, Shareowners Education Network and AFSCME analyzed 2008 votes in Compensation Accomplices: Mutual Funds and the Overpaid American CEO and found “AllianceBernstein, Barclays Global Investors, Ameriprise and Bank of America’s Columbia Management were the most consistent backers of management proposals to increase executive pay.” In 2008, the 26 mutual fund groups studied voted in favor of management compensation proposals 84%, 82% in 2007 and 76% of the time in 2006. “T Rowe Price, Templeton (part of Franklin Resources) and Charles Schwab were at the top of the rankings of those voting to constrain pay, the study found.”See table to right.

My analysis: It looks like funds got a little bit of fiduciary responsibility religion when the SEC required mutual funds to start disclosing their votes in 2004 but grew complacent… probably since few people use voting behavior as a factor when considering where to invest. Now, since almost all funds are losing a ton of money for their customers, they are probably worried blame may spread to them… as it should. Voting rights are assets and must be treated as such. Always voting with management and simply saying that is “in the best interests of its shareholders” won’t cut it anymore.

What should an investor do? The report came out with four recommendations (my additions):

  1. Mutual fund families that have been consistently
    categorized as “Pay Enablers” should revise their
    proxy voting policies to ensure that they promote
    responsible compensation programs that encourage
    the creation of long-term shareholder values and do
    not promote excessive risk-taking. (Contact funds in your portfolio and let them know of your concerns.)
  2. Mutual fund companies should have a uniform
    mechanism in their corporate governance and proxy
    voting policies for establishing and communicating
    their view of pay to boards, especially compensation. (If you can’t identify this in your funds policy, contact them and ask them what it is.)
  3. Retail investors in mutual funds, whom the
    Shareowner Education Network calls “citizen
    investors,” have a responsibility to critically evaluate
    how their mutual funds vote on pay issues and hold
    those funds accountable for votes that enable pay
    abuses. (Of course, you’ll want to view performance as well. However, if they are relatively the same and your “enabler” funds refuses to budge, dump them.)
  4. The Securities and Exchange Commission (SEC)
    should require funds to distribute a Plain English report
    on proxy voting to their investors and should revise
    and improve the N-PX data disclosure. (The SEC should also urge funds to announce their votes in advance of annual meetings. If votes are an asset and they put a lot of effort into voting, shouldn’t they want retail shareowners to copy their voting behavior?)

Another good source of information (although the funds reviewed are limited) is ProxyDemocracy.org. Here’s their highest rated ten funds on executive compensation issues and their activism scores.

  1. Green Century Equity Fund 79.7
  2. AFSCME Employees Pension Plan 74.0
  3. Florida SBA 70.8
  4. Sentinel Sustainable Core Opportunities Fund (formerly Citizens Core Growth) 65.5
  5. Trillium Asset Management 61.4
  6. Domini Social Equity Fund 60.6
  7. CBIS 56.4
  8. Calvert Social Index Fund 51.4
  9. Calvert Social Investment Fund 48.6
  10. Parnassus Fund 48.5

The ten least activist funds and their scores are as follows:

  1. Dodge & Cox Stock Fund 0.0
  2. Dodge & Cox Balanced Fund 0.0
  3. Barclays Global Investors S&P 500 4.6
  4. AllianceBernstein Large Cap Growth Fund 5.3
  5. AllianceBernstein Value Fund 5.5
  6. Vanguard Wellington 7.6
  7. Vanguard Windsor II 8.2
  8. Growth Fund of America 9.4
  9. Northern Institutional Balanced Fund 9.4
  10. Northern Institutional Mid Cap Growth Fund 9.5

Look up yours here. ProxyDemocracy also rates funds for their activism on corporate director elections, corporate governance and corporate impact (social and environmental issues). Other more comprehensive analysis can be found at Fund Votes and The Corporate Library. In a related article, Amgen’s proxy directed shareholders to a 10-question online survey written by pension-fund manager TIAA-CREF to help it evaluate pay plans of companies in which it invests. (Companies Seek Shareholder Input on Pay Practices, WSJ, 4/6/09) And, of course, there’s plenty of blame to go around. (Executives Took, but the Directors Gave and Who Moved My Bonus? Executive Pay Makes a U-Turn, NYTimes, 4/4/09)

Two good observations from Dave Lynn: “The study does note a contrary trend that I think everyone has probably noticed in the past couple of years – mutual funds seem to be increasingly willing to withhold support or vote against directors serving on compensation committees of companies where pay practices are perceived as subpar. One limiting aspect of the study is that the data only goes through June 2008, so the full impact of the recent “torches and pitchforks” attitude toward compensation is not fully reflected.” (The SEC’s Corporate Governance Agenda Comes into Focus, TheCorporateCounsel.net Blog, 4/7/09)

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February 2009 Special News Supplement: Corporate Governance Roundup 2009

Yippee-i-o-ki-ay! From the conference flyer, I half expected Will Pryor, Director of the IAFF Local 10Ehnes14 and conference “go-to” guy, to show up in chaps, especially with his e-mail encouraging attendees to dress casually. Well, maybe next year. Suits and jackets prevailed in the fashion arena but there was little in the way of pretense as funds from all over California and beyond shared mostly proxy strategies. The conference was also well attended by consultants, service providers and investment advisors. Jack Ehnes (right) was the emcee and set the tone for moderators by keeping everyone on track and additing insights, without dominating the conversation.

Session One

The fist panel was composed of Bill McGrew of CalPERS, Ann Sheehan of CalSTRS (left), and John Wilson of TIAA-CREF, ASheehanmoderated by Ralph Whitworth of Relational Investors. I was a little surprised to learn that TIAA-CREF, with more than twice the assets of CalPERS, has about half as many staff working on corporate governance issues. (6 vs 11) Maybe the bigger you are, the less you need to spend to influence outcomes. Each discussed their fund’s proxy policies and initiatives. Since I live near Sacramento and am more familiar with CalPERS and CalSTRS, I paid more attention to Wilson discussing TIAA-CREF’s collaborative approach.

They don’t look at themselves as “activists” but as moderates, engaging in private dialogue, using a non-prescriptive approach but having influence behind the scenes. With holdings in about 7,000 companies, they view themselves as universal owners and all that entails, focusing more on driving changes in the market vs at individual companies. Their efforts can largely be broken into three areas: proxy voting, corporate engagement, and thought leadership. Wilson made one of the stronger arguments at the conference that divestment simply allows companies to profit from genocide in Sudan, for example, by selling shares to investors who don’t care. TIAA-CREF emphasizes reputational risk to companies in situations where they aren’t open to other arguments. (Although in the case of the Sudan, it is now mostly Asian companies that continue operating there.)

All three giant funds emphasized their relationship with CII, ICGN, global reporting initiative and other national and international organizations. All are concerned with executive pay and agreed the problem is more the rationale of the pay package, not so much the size. Pay needs to be structured in a way that it can’t be gamed. It should encourage sustainable development of the company. All support proxy access, as did just about everyone at the event.

Session Two

This was a short session with two panelists: Ann Yeger of CII (below, right) and Allen MacDougal of PIRC, HKimmoderated by Hank Kim of NCPERS (left). Is your public pension fund under attack? See Lies, Lies and More Attacks on Pension Plans, as well as other publications from NCPERS.

Yerger discussed CII’s efforts and involvement in economic reforms. For example, the Investors’ Working Group (IWG), led by William Donaldson, and Arthur Levitt Jr., both former SEC chairs. The non-partisan panel of experts is co-sponsored by CII and
the CFA Institute Centre for Financial Market Integrity. An initial report and
recommendations are expected by late spring. In April, CII expects to release a white paper commissioned by their credit rating
agencies subcommittee. I liked this phrase from a handout: “The ability to attract capital and investors, not just listings, is what makes markets competitive… investor interests should always come first.” Top concerns for CII were identified as:Yerger

  • majority voting for directors
  • proxy access
  • broker voting eliminated
  • independent board chairs
  • independent compensation consultants
  • say on pay
  • clawback provisions for unearned bonuses
  • no pay for failure – termination for poor performance

MacDougal (below left), from PIRC went on to discuss “a way out of the crisis.” He brought up the need for asset managers to be subordinate to fund trustees and the need for trustees to get involved in market reform. He also mentioned the United Kingdom Shareholders Association (known as “UKSA”), formed in 1992 to support and to represent the views of private (ie. non institutional) shareholders. UKSA provides investment education and conveys the views of investors to the boards of British companies, to the MacDougallGovernment, to the Stock Exchange, to the media and to other bodies. Wouldn’t it be grand to have something like this in the US?

He also brought up an organization that arose to help get qualified independent directors on boards. ProNed was established in 1981 by the Bank of England, following a series of banking crises in the 1970s. Yes, somewhat similar to what we now face in 2009. With proxy access likely to be granted soon, it would be great to see a clearinghouse like this in the US. Shareowner groups seem much more likely to take action if they can easily coalesce around director candidates already vetted by shareowners. There’s a ProNed in Australia. I’m not sure how involved shareowners are in it, or even how involved they were in the original.

A few of MacDougal’s other ideas involved independence of compensation and audit consultants, collective funding by investors of the effects of incentives on behavior (with regards pay), employee representatives on boards would provide another avenue of oversight (as in European countries), additional investor representation is needed in government commissions and regulatory bodies, and he favors mandatory voting disclosure for all fund managers. “We need to be radical AND practical,” he said. I say, we need to get more speakers, like MacDougal, from outside the US with a fresh perspective. I’m glad he made the long trip for the event.

Session Three

Ralph Whitworth, of Relational Investors, Denis Johnson, of Shamrock Capital, Scott Zdrazil of Amalgamated Bank and Mike Ibarra of Landon Butler presented their investment opportunities, proxy strategies and practices. Dan Pedrotty of the AFL-CIO moderated. Relational Investors and Shamrock take stakes in just a few companies. Relational focuses on:

  • business strategy (long-term value, mitigating risk),
  • capital allocation to maximize return,
  • capital structure (optimal use of debt/equity),
  • governance (transparent, responsive, accountable),
  • board composition (diverse, independent, engaged),
  • compensation (LT alignment, reinforce strategy and risk mgt.),
  • communication (timely, accurate, consistent, realistic)

During thDenis Johnsone Q&A, Whitworth said he doesn’t favor more rights for long-term investors. I haven’t heard anyone from these types of funds who does. I suppose when a fund makes a commitment of time and effort, they want to be heard right away, not ignored for the first few years.

Shamrock’s strategy was similar, although Johnson (left) placed more emphasis on removing anti-takeover provisions and providing shareowners the ability to call a special meeting. Shareowners need to accept more responsibility for removing ineffective directors. Withhold votes should have been greater in the past. Shamrock will help ensure such votes will be higher in the future. Proxy voting policies should place a greater emphasis on poor relative stock performance, he says.

Scott Zdrazil, of Amalgamated Bank, emphasized their resolutions for 2009. They’ve been using resolutions to try to “move the market” since 1992. This year they have over thirty. Zdrazil highlighted the following:

  • majority vote standard for director elections
  • annual election of all directors
  • separation of CEO and chair
  • oversight and disclosure of political contributions
  • curtailing “golden coffins”
  • clawbacks for unearned compensation
  • say on pay
  • double trigger change in control provisions – to kick in, must be change of control and termination of CEO
  • ban gross-up – let CEOs pay their own taxes
  • golden parachutes
  • healthcare reforms – adopt universal principles for national healthcare reform
  • adopt ILO labor standards

Mike Ibarra, of Landon Butler, emphasized the history of their Multi-Employer Property Trust (MEPT) funded mostly by building trade unions and pensions. He described their Responsible Property Investing as comprehensive in terms of environmental, social and governance, to preserve and enhance economic returns. The MEPT claims to have created 52 million jobs through 2006 and has played a key role in revitalization and historic preservation. They’re beating the comparable indexes, so you can do well by doing good.

Session Four

After a nice lunch, we heard from the AFL-CIO, CTW/SEIU, AFSCME and LIUNA, moderated by Carolyn Widener, of CalSTRS. Dan Pedrotty, of the AFL-CIO said they will shortly issue a rating for registered investment advisors, discussed the need to reregulate capital markets, focus more on risk management, and push for greater disclosure. He then talked about some of their new proposals:

  • golden coffins
  • hold past retirement – retain 75% of comp shares until two years after termination
  • healthcare initiative – universal, continuous, affordable, high quality

Rich Clayton then discussed the focus of Change to Win and SEIU. The focus was broader than most, with initial emphasis on the Investor and Employee Free Choice Act, which is critical to ensuring that higher productivity leads to improved paychecks. He had plenty of graphs to demonstrate our new gilded age and how the increasing disparity on income and benefits has helped fuel our problems and the financial crisis. The proportion of workers wanting to join a union has risen substantially during the last 10 years but intimidation has kept them from doing so. Clayton also touched on the 2009 resolutions being introduced by SEIU’s Capital Stewardship Program. These include:

  • say on pay
  • climate risk and greenhouse emission targets
  • labor standards / ILO compliance
  • regulatory reforms
    • proxy access
    • say on pay, and other exec compensation reforms
    • ending broker votes
    • ESG disclosure and clarification of fiduciary standards
    • reinvigorating long-term ownership discussions

Scott Adams described AFSCME’s top three governance priorities as say on pay, proxy access and vote no or withhold campaigns on directors. They will continue pushing majority vote requirements, board declassification, anti-gross ups, and in attempting provisions to recover solicitation expenses. New initiatives this year are requirements to hold equity shares for several years in escrow and to delete golden coffins. They are also working on reforms to reconstruct bond rating agencies.

Richard Metcalf then described LIUNA’s program. They seem to make more of an effort than most (TIAA-CREF in this bunch excepted) to engage companies before filing. They are using a questionnaire to determine if companies have done adequate succession planning. Turnover of CEOs has increased and there is a growing trend of looking to the outside (presumably for a savior). We’ve seen high exposure misfires, such as at Home Depot. They’re also disturbed by conflicts of interest among executive compensation consultants. LIUNA is seeking annual performance reviews by the board, development of criteria for internal candidates, planning three years in advance and annual disclosures on succession planning. He also described efforts to limit the SEC’s “ordinary business” exclusion, which has been used to exclude proposals like those submitted by LIUNA in 2006 seeking evaluation of risk at mortgage lending by home builders. Others thrown out sought to draw attention to credit rating conflicts, succession planning and evaluation of risk. He quoted former SEC Chairman Harvey Pitt, “It is impossible for the SEC to determine what the ordinary business of a corporation really is.”

Session Five

The final session saw brief presentations from Glass Lewis, Corpgov.net, ICCR, and the RiskMetrics Group. Bob McCormick of Glass Lewis led off with a comprehensive presentation that touched on the credit crisis, executive compensation, majority vote for directors, say on pay, M&A, contests, the new administration, initiatives from 2008 and those we will see in 2009. The loss of broker votes, combined with majority requirements, will make a difference in director elections. In his handout, McCormick discusses the Waxman Report on Conflicts of Interest Among Compensation Consultants, which found that almost half of the S&P 500 got executive pay advice from conflicted consultants. Another issue he raised that has been too little discussed is redomestications to lower corporate tax rates. Apparently, several are or were looking to Switzerland. For 2009, he discussed many of the same proposals already mentioned above and the likelihood of SEC and Congressional support for proxy access, eliminating broker votes, say on pay, compensation consultant conflicts, etc.

You can pull up a four-up pdf of my presentation, IncreaseVotingClout4 at and a copy of my very brief paper at corpgov.net/news/2009/GRU.doc. My hope is to generate additional interest and involvement in Proxy Democracy and the Investor Suffrage Movement. If you get inspired or have questions, please contact me. At Proxy Democracy we are primarily seeking funds willing to post their votes in advance of annual meetings; including the reason(s) for votes would be even better. ProxyDemocracy will soon beta test the ability of retail shareowners to vote directly through the site based on information posted there, including votes by trusted funds. At the Investor Suffrage Movement we are developing a network of people willing to present shareowner proposals locally, saving proponents, such as public pension funds, substantial expenses for time and travel. We are also helping shareowners write proposals, defend them against no action requests and, as mentioned, present them at annual meetings.

Laura Berry (left) then gave an impassioned presentation on the Interfaith Center on Corporate ResponsibilityLaura Berry. “Inspired by Faith. Committed to Action.” ICCR represents about 300 faith-based institutional investors with over $100 billion in invested capital. She emphasized how their prophetic voice has anticipated emerging areas of corporate responsibility. Over many years prior to the recent market collapse, they introduced 120 resolutions on subprime lending and securitization. Resolutions allow them to begin a conversation and to educate. This year, they filed 292 resolutions but engaged in 350 dialogues. They introduced some on governance issues, such as executive pay, but many more on social issues, such as: adopt human rights policy, reduce emissions, recycle, health care reform. They are making good use of data developed by Trucost to determine which companies to target on climate risk indicators. One example of their successes is that WalMart is now boycotting Uzbekistan cotton over its use of force child labor during harvest. I have bulletins from ICCR going back a dozen years and, of course, they’ve been around since the early 1970s.

The finCBowieal presentation of the day was from Carol Bowie (right) of the RiskMetrics Group. She described their elaborate process to develop policies and requested feedback on information posted on their Policy Gateway, a really great resource. She also highlighted some of the key policy updates for 2009. I’ve got resolutions in at companies to reincorporate to North Dakota because of their shareowner friendly policies, and was a bit disappointed that RMG is taking a case-by-case approach on such resolutions… better than opposing them all. RMG has come out with a strong bias in favor of pay resolutions calling on executives to hold until retirement and “bonus banking,” holding for years. It appears they are taking a much harder look at executive pay, with revised performance tests. Say on pay factors include:

  • alignment of incentive plan metrics with business goals (something which few CD&As address)
  • peer group benchmarking process
  • performance trend vs. pay trends
  • internal pay disparity
  • balance of fixed vs. performance-based pay
  • poor pay practices
  • information/rationales in CD&A regarding pay determination
  • board’s responsiveness to investor input

See also Hot Proxy Season Topics for 2009 and Explorations in Executive Compensation.

All in all, it was a great conference, close to the airport (less hassle), low key and very informative. Sorry for all the clipped head shots. Next year I’ll bring a camera. I went to a similar conference about 15 years ago in Oakland and there were only about twenty people attending, as I recall. This time there were about 150. Next year, I’m sure attendance will be in the hundreds. Three cheers to the Los Angeles Pension Trustees Network for sponsoring the event.

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The False Promise of Pay for Performance

The False Promise of Pay for PerformanceMany, including this reviewer, called Bebchuk and Fried’s Pay without Performance: The Unfulfilled Promise of Executive Compensation the best corporate governance book of 2004. James McConvill’s The False Promise of Pay for Performance: Embracing a Postive Model of the Company Executive, largely a critique of Pay Without Performance, deserves similar attention.

Bebchuk and Fried clearly demonstrated that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors. Their recommendations on improving executive compensation are aimed at eliminating or reducing some of the most egregious problems and are written to shareholders, since such reforms are not likely to be raised by “independent” directors, as independence is currently defined. One of their major points is that board members should not only be independent of CEOs, they should also be dependent on shareholders. Continue Reading →

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Best Book of 2004

Pay Without Performance

Pay Without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors.

After thoughtful analysis, they find “systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives.” The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and “perverse incentives” for managers to “misreport results, suppress bad news, and choose projects and strategies that are less transparent.”

Their recommendations on improving executive compensation are clearly aimed at eliminating or reducing some of the most egregious of the practices of those they document. Interestingly, the recommendations are written to shareholders, apparently because there is little likelihood such reforms will be raised by even “independent” directors without further corporate governance reforms. A few examples are as follows:

  • To reduce windfalls in equity-based plans, shareholder should encourage that at least some of the gains in stock price due to general market or industry movements be filtered out. “At a minimum, option exercise prices should be adjusted so that managers are rewarded for stock price gains only to the extent that they exceed those gains (if any) enjoyed by the most poorly performing firms.”
  • Executives should be prohibited from hedging or derivative transactions to reduce their exposure to fluctuations in the company’s stock and should be required to disclose proposed sale of shares in advance to reduce perverse incentives to benefit from short-term gains that don’t reflect long-term prospects.
  • Do not provide large payments to executives who depart because of poor performance.
  • The compensation table should include and should place a dollar value on all forms of “stealth” compensation, such as pensions, deferred compensation, postretirement perks and consulting requirements.
  • Allow shareholders to propose and vote on binding rules for executive compensation arrangements.

Although many directors now own shares, their related financial incentives are still too weak to induce them to take on the unpleasant task of firmly negotiating with their CEOs. Recent reforms requiring a majority of independent directors, and their exclusive use on compensation and nominating committees, may be beneficial but “cannot be relied on” to produce the kind of arm’s length relationship between directors and executives needed. CEOs retain influence over director compensation and rewards, as well as social and psychological rewards. “The key to reelection is remaining on the company’s slate.” Remaining on good terms with the CEO and their director allies continues to be the best strategy for renominatation.

Executive compensation “requires case-specific knowledge and thus is best designed by informed decision makers.” They conclude, “While we should lessen directors’ dependence on executives, we should also seek to increase directors’ dependence on shareholders.” After discussing the now failed “open access” SEC proposal to grant shareholders the right to place a token number of candidates on the ballot after specified “triggering events,” the authors propose the following significant corporate governance reforms:

  • Access to the ballot should be granted to any group of shareholders that satisfies certain ownership thresholds. Their example is 5%, held for at least a year.
  • Such slates should be able to replace all or most incumbent directors in any given year.
  • Companies should be required to distribute the proxy statements of shareholder nominated candidates and should be required to reimburse reasonable costs if they garner “sufficient support.”
  • Legal reforms should require or encourage firms to have all directors stand for election together.
  • Shareholders should be given the power to initiate and approved proposals to reincorporate and/or adopt charter amendments.

In their conclusion, the authors recognize the “political obstacles to the necessary legal reforms are substantial” and that “corporate management has long been a powerful interest group.” The demand for reforms must be greater than management’s power to block them. “This can happen only if investors and policy makers recognize the substantial costs that current arrangement impose.” Pay without Performance will certainly contribute to such recognition. It should be required reading for every fund fiduciary, SEC board and staff, as well as all members of Congress. Shareholders should read while sitting down.

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Pay Without Performance

PayWithoutPerformancePay without Performance: The Unfulfilled Promise of Executive Compensation was the best book published in 2004 in the field of corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of corporate governance, executive pay, and clearly demonstrate that many features of executive pay are better explained as a result of shear managerial power, rather than arm’s-length bargaining by boards of directors. After thoughtful analysis, they find “systematic use of compensation practices that obscure the amount and performance insensitivity of pay, and the showering of gratuitous benefits on departing executives.” The cost of current corporate governance systems is weak incentives to reduce managerial slack or increase shareholder value and “perverse incentives” for managers to “misreport results, suppress bad news, and choose projects and strategies that are less transparent.” Continue Reading →

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