Oct
22
2009

With Executive Compensation Pay Cuts, What’s Next? Say on Pay

Now that the shock of Special Pay Master Kenneth Feinberg’s decision (Reuters, Oct. 22) to cut the pay of 175 executives at companies receiving the most government aid is starting to wear off, the real fun will begin. It’s looking more like Feinberg’s announcement Thursday (Treasury Secretary Timothy Geithner’s comments) is just the first salvo in a fight between shareholders and public company boards.

Actually, another salvo was just thrown by the Federal Reserve today when it issued its long awaited proposal to oversee bank incentive compensation policies. (read the press release)

And the battle cry will be, “Say on Pay!” At least that is what the researchers at The Corporate Library (TCL) and the compensation consultants over at Pearl Meyer & Partners believe. In the same week that Feinberg’s decision was leaked to the press, TCL released a “10-Point Test” for shareholders to use when they are allowed to vote on a non-binding resolution on their company’s executive compensation packages.

Say on Pay Survey

During the recently completed National Association of Corporate Directors (NACD) annual Corporate Governance Conference, Pearl Meyer released the results of an online survey (read the press release) on company preparedness for Say on Pay. The survey of 231 participants found that more than two-thirds said their company hasn’t taken any steps to prepare for such a vote and only 35 percent plan to do so in the next six months.

Just look at what they are saying over at Pearl Meyer.“Although many believe such a requirement will not take effect until the 2011 proxy season, decisions being made now regarding 2010 compensation practices could potentially be the subject of Say on Pay votes in 2011,” said Mike Enos, the company’s managing director.

A 10-Point Test

In his “10-Point Test,” Paul Hodgson, senior research associate at TCL, wrote, “More importantly, investors, straining at the leash to have a say on pay, feel that a chance for reform is within their grasp. And not just activist investors. All investment firms are likely soon to have a say on pay, whether they like it or not…”

Some might think it a bit premature to start planning for life with Say on Pay since the Corporate and Financial Institution Compensation Fairness Act of 2009, which would require an annual shareholder advisory vote on executive compensation, is not even law yet. As of Oct. 22, that bill had been approved by the U.S. House and still faces a Senate vote. But maybe the Obama Administration is starting to move into high gear on the financial regulatory reform. Case in point: Feinberg’s executive pay cut decision.

Broc Romanek’s TheCorporateCounsel.net blog has one of the best descriptions of Feinberg’s actions. Click here to read.

Principles, principles, principles

I find it interesting that while investors and some companies are gearing up for Say on Pay and the possibility that executive compensation packages will be cut, some are actually trying to get ahead of the reform wave by being proactive. Credit Suisse (Wealth Bulletin, Oct. 21) did just that on Oct. 21 when the Swiss bank adopted the G-20 compensation model that was announced back on Sept. 25. Basically, the bank will focus on higher base pay and more deferred variable compensation tied to the long-term performance of the bank. The bank has also included clawback provisions for bonuses in the new model.

With Credit Suisse’s action, I thought it was a good opportunity to write a list of top executive compensation principles. So below is a table comparing the G-20 principles to that of The Conference Board Task Force on Executive Compensation.

And right here are the principles released by the Securities Industry and Financial Markets Association (SIFMA):

  • Firms should establish compensation policies consistent with effective risk management
  • Compensation should be linked to sustainable performance
  • Risk management professionals should be appropriately independent
  • Firms should communicate their compensation practices to shareholders.

Executive Compensation Principles

G-20 Summit Financial Stability Board Principles for Sound Compensation Practices
(Released Sept. 25, 2009)

1.) Financial institutions should have an independent board remuneration (compensation) committee that oversees compensation policies.

2.) Compensation should be aligned with long-term value creation by avoiding multi-year guaranteed bonuses and requiring a significant part of variable compensation be deferred, tied to performance and subject to clawback. They should also take into account current and potential risks.

3.) Financial institutions ensure that compensation of senior executives and others who have a material impact on risk exposure align with performance and risk.

4.) Financial institutions disclose compensation policies and structures to guarantee transparency.

5.) Variable compensation be limited as a percentage of total net revenues when it is inconsistent with the maintenance of a sound capital base.

The Conference Board Task Force on Executive Compensation
(Released Sept. 21, 2009)

1.)  Compensation plans should establish a clear link between pay, strategy and performance.

2.)  Provide compensation that is fair, affordable and clearly aligned with actual performance.

3.)  Eliminate controversial compensation practices that conflict with the notions of fairness and pay for performance – such as excessive golden parachutes, overly generous severance arrangements, gross-ups of parachute payments or perquisites, and golden coffins – unless specific justification exists.

4.)  Demonstrate credible board oversight of executive compensation.

5.)  Foster transparency with respect to compensation practices and appropriate dialogue between boards and shareholders.

- Gary Larkin

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Sep
28
2009

Note to Directors: Risk Management Not Optional

It may have taken a financial crisis the likes of which we have not seen since the Great Depression and the election of a liberal president to get the federal government to see what corporate governance experts for years have seen. Risk really does matter.

Sure, some companies – especially those in financial services – have had a chief risk officer or the equivalent for years and COSO (Committee of Sponsoring Organizations of the Treadway Commission) issued an integrated framework for enterprise risk management back in 2004. (And those actions came after monumental accounting fraud perpetrated at Enron and WorldCom.) The difference now is that risk management is no longer an issue that just concerns CROs, CFOs and the internal audit team. It has reached the CEO’s office and the boardroom.

Aon, the Chicago-based insurance brokerage and management consultant, in its April Global Risk Management Survey found that while most organizations increased their overall risk preparedness since 2007, less than half of the respondents are tracking and managing all components of their total cost of insurable risk. And less than two-thirds of respondents had formally reviewed or have a plan in place to review three of the top 10 risks of 2009: economic slowdown (1), regulatory/legislative changes (2), and damage to reputation (6).

When the SEC and the U.S. Treasury Department (see Sept. 24 speech by Deputy Treasury Secretary Neal S. Wolin) are focusing on risk management for public companies, then you know it is no longer a secondary task, but rather a primary one for all boards and management. If auditors and audit committees felt burdened with conducting risk-based integrated audits of internal control over financial reporting, wait to see what the new administration has in store for the coming year.

For starters, the SEC under new Chairman Mary L. Schapiro has created the Division of Risk, Strategy and Financial Innovation, combining the Office of Economic Analysis, Office of Risk Assessment and other functions. It marks the first time one division, which will be headed by University of Texas School of Law Professor Henry T. C. Hu, will oversee risk and economic analysis, strategic research and financial innovation. Hu’s statement in the Sept. 16 release announcing his appointment is quite telling: “I look forward to working with the Commission and to using an interdisciplinary approach that is informed by law and modern finance and economics, as well as developments in real world products and practices on Wall Street and Main Street.”

In other words, it won’t be business as usual at the SEC as fewer political appointees and more academic and hands-on people join the regulator. It also means that all the work of organizations like COSO, the Institute of Internal Auditors (IIA), the National Association of Corporate Directors (NACD) and The Conference Board, will become more relevant. It is the research and thought leadership produced by such organizations that both regulators, lawmakers and executives will need to address current and future risk management issues.

Earlier this month, COSO issued Effective Enterprise Risk Oversight: The Role of the Board of Directors, a four-page paper that reiterates how crucial risk management is for today’s companies. “In the aftermath of the financial crisis, executives and their boards realize that ad hoc risk management is no longer tolerable and the current processes may be inadequate in today’s rapidly evolving business world,” the paper says.

The IIA has recently published 2010-2: Using the Risk Management Process in Internal Audit Planning (membership required), which is a practice advisory for internal auditors, and in May its Tone at the Top monthly e-newsletter focused on global risk. In addition, the NACD’s President and CEO Ken Daly told a KPMG Audit Committee Insights Webcast Sept. 21 that his organization is working on a Blue Ribbon Commission on Risk that is due out shortly.

Corporate Governance Handbook: Legal Standards and Board Practices (Third Edition)

Corporate Governance Handbook: Legal Standards and Board Practices (Third Edition)

The Conference Board Governance Center just last week released Corporate Governance Handbook: Legal Standards and Board Practices (Third Edition), which includes a separate chapter on risk oversight. “Corporate boards should give thoughtful consideration to the benefits of implementing a comprehensive risk management infrastructure and enhancing the organization’s ability to respond effectively to risk events and capture new strategic opportunities,” according to the handbook, which was authored by Matteo Tonello, associate director of corporate governance at The Conference Board. The Board is also working, in collaboration with its Directors’ Institute, on a special Risk Oversight Handbook for board members.  The new Handbook will be a compilation of emerging practices in this area, expanding on the findings of the 2006 Working Group on Risk Oversight and will be released in the summer of 2010. (See Emerging Governance Practices in Enterprise Risk Management for those Working Group findings and recommendations.) Until then, The Conference Board will release a series of short-papers on the subject, for which it will avail itself of the contribution of leading legal and financial experts.

- Gary Larkin

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Sep
22
2009

Executive Compensation on Everyone’s Mind

Whether it’s the offices of the Federal Reserve or the SEC or even at this week’s G-20 Summit in Pittsburgh, there is one issue gaining traction as companies and governments deal with the fallout from the financial crisis: executive compensation.

In the past week alone, U.S. Federal Reserve officials told several news outlets it plans to start requiring the 5,000 bank holding companies and financial institutions it regulates to submit their compensation policies for approval in order to rein in risk-taking. While the plan is still weeks away from being formally submitted to the Federal Reserve Board for its approval, the central bank’s seems determined to respond to global pressure and take action at U.S. banks.

The G-20 Summit in Pittsburgh on September 24 and 25, following up on London and Washington summits over the past year, will focus on executive compensation at banks as well. In a communiqué following the London summit in April, summit members agreed to endorse “compensation principles for significant financial institutions that ensure compensation structures are consistent with firms’ long-term goals and prudent risk-taking.”

The Conference Board Task Force on Executive Compensation

Executive Compensation Task Force Report

Executive Compensation Task Force Report

On Monday, The Conference Board released the long-awaited final report of its Task Force on Executive Compensation. The task force, which was convened in March, is a coalition of high-level business representatives and was co-chaired by Robert E. Denham, a partner at Munger, Tolles & Olson LLP Partner, and Rajiv L. Gupta, former CEO and chairman of the board of Rohm and Haas Co. The coalition issued five guiding principles it believes corporate institutions need to abide by to restore credibility and trust in pay practices.

“Real – and perceived – abuses in executive compensation have contributed to this loss of trust,” Denham and Gupta said. “And the Task Force report provides a practical set of guidelines that, if appropriately implemented, can make significant progress in restoring credibility in our corporations.” (See CNBC Sept. 21 interview here.)

The Guiding Principles recommend public companies should:

  • Establish a clear link between pay, strategy and performance;
  • Provide compensation that is fair, affordable and clearly aligned with actual performance;
  • Eliminate controversial compensation practices that conflict with the notions of fairness and pay for performance – such as excessive golden parachutes, overly generous severance arrangements, gross-ups of parachute payments or perquisites, and golden coffins – unless specific justification exists;
  • Demonstrate credible board oversight of executive compensation; and
  • Foster transparency with respect to compensation practices and appropriate dialogue between boards and shareholders.

SEC Advisory Committee

The SEC and investor groups are working to create a better relationship between shareholders and public companies regarding executive compensation.  In addition to a plethora of proposed rules regarding such areas as “say on pay,” shareholder proxy access and enhanced risk disclosure, the market regulator has created an Investor Advisory Committee (IAC) to address such issues as investor education, investor protection, shareholder voting and corporate governance.

Stephen Davis, executive director of the Millstein Center for Corporate Governance at Yale, is the chair of the Investor as Shareholder Subcommittee of the new IAC. He believes executive compensation is a “central pillar of corporate governance because it is very often the case that investors get what they pay for.” Before heading out to a conference in Mexico City Monday, Davis told me investors have a better chance of gaining value on their shares if executive pay is aligned with real long-term performance.

“On the other hand, if a board steers investor capital toward pay for failure, or excessive risk taking, then shareowners are at risk of losing — and, by the way, so are stakeholders such as employees and communities, and sometimes the nation as a whole, as we’ve seen in the financial crisis,” he said. As for the subcommittee’s progress, Davis hopes to better define the agenda at an Oct. 5 meeting. He expects executive compensation to be a big part of the subcommittee’s focus.

KPMG ACI Webcast

The topic du jour continued to be executive compensation as KPMG’s Audit Committee Institute and the National Association of Corporate Directors held its Quarterly Audit Committee Webcast Monday morning. When discussing governance reform proposals, Ann Yerger, executive director of the Council of Institutional Investors, and Ken Daly, NACD president and CEO, chimed in on the need for some executive pay reform.

“Regulatory reform alone isn’t sufficient,” Yerger told the Webcast audience of 2,300. “Many corporate governance failures contributed to the [financial crisis] results we saw. … The U.S, has fallen short when it comes to corporate governance issues.” The CII believes there are four actions that should be taken: establish majority voting for directors; create true shareholder proxy access; institute executive pay reforms, including independent compensation consultants; and mandate independent board chairs.

Of the seven pieces of legislation being considered by Congress, Daly expects the so-called Sen. Charles Schumer “Shareholder Bill of Rights” and Rep. Barney Frank’s “Compensation Fairness Act” will get the most traction. He expects Frank’s bill, which was approved by the House in late July, to be acted on in the Senate by the end of next month or November. He thinks the Schumer bill will see some action in the first or second quarter of 2010.

Worth Reading …

Here are some recent articles on the subject of executive compensation:

HBS Working Knowledge Excessive Executive Pay: What’s the Solution?

Audit Committee Compensation and the Demand for Monitoring of the Financial Reporting Process, (Paper by Ellen Engel, University of Chicago Booth School of Business; Rachel M. Hayes, University of Utah – David Eccles School of Business; Xue Wang, Emory University – Goizueta Business School).

- Gary Larkin

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Sep
18
2009

A New Voice in Corporate Governance

With this post, The Conference Board Governance Center is launching the Governance Center Blog, which will provide real-time analysis of breaking topical corporate governance issues and links to the most influential resources in the corporate governance space. The blog’s main purpose is to provide directors, the C-level suite, general counsel and corporate secretaries with the latest information on such issues as executive compensation, separation of chair and CEO, shareholder proxy access, and financial reform, to name just a few.

Depending on the news cycle, the blog will be updated at least three times a week, by Corporate Governance Editor Gary Larkin, who joins The Conference Board after four years as managing editor of KPMG’s Audit Committee Insights. In addition to posts from Mr. Larkin, the Governance Center will invite key corporate governance experts to be guest contributors.

In addition to the posts, the blog will have links to well-known corporate governance blogs, such as the Harvard Law School Corporate Governance Forum, Corporate Governance Network blog, The Corporate Library Blog and Compliance Week blogs. There will also be links to such resources as KPMG’s Audit Committee Institute, PWC’s U.S. Corporate Governance Web site, the SEC and various corporate governance publications.

We would like to welcome you to become a subscriber to the Governance Center Blog, a free service of The Conference Board Governance Center. All you have to do is click on the subscribe button on the right sidebar.

We look forward to being your No. 1 source for corporate governance news. If you have any questions, are interested in being a guest contributor or have a news tip, contact Gary Larkin at 212-339-0320, gary.larkin@conference-board.org

- Gary Larkin

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