Comments of
John C. Wilcox
August 1, 2008
The
problems so clearly articulated in
Jeff Gordon’s
excellent paper can be avoided by a simple but fundamental shift in
thinking about four questions: (1) who should be accountable for
executive compensation, (2) what role should shareholders play in
designing compensation plans, (3) who should be responsible for the
quality of CD&As, and (4) what the purpose of an advisory vote should be.
In my
opinion, the answers to these four questions are as follows:
(1)
Directors should be accountable for the executive compensation strategy,
decisions and policies of their companies.
(2)
None.
(3)
Directors should be responsible for the quality of the CD&A even though it
is prepared by management to inform shareholders.
(4)
The
advisory vote should serve as a governance tool, not as a means to
micromanage compensation. It should be a referendum on how well the
directors have fulfilled their responsibilities with respect to
compensation, not a vote on specific payments or terms. The advisory vote
should address two generic questions that shareholders can fairly ask
about compensation at all companies: (a) Have the directors presented a
compensation plan that is linked to the company’s business strategy,
performance and long-term value creation? (2) Have they made a clear and
convincing case for the plan in the CD&A? If the answer to either of
these questions is No, the advisory vote provides a low-impact means for
shareholders to tell directors that more work needs to be done.
More than a year ago
TIAA-CREF published a list of 10 questions that companies should answer in
their CD&As. (See
TIAA-CREF, August 2007: "10 Questions for Evaluating CD&A's"; 1 page,
27 KB, in
PDF format.) Answering these questions is a strategic responsibility
of directors even though company executives and advisers are directly
involved in compensation planning. These 10 questions emphasize that in
addition to the accepted goals of attracting and retaining executive
talent, compensation should be customized to the specific business needs
and competitive circumstances of individual companies, should be
measurably linked to performance and should drive business strategy. If
shareholders are unconvinced that the plan has these attributes, they can
give it a failing grade and use the advisory vote to send directors and
compensation planners back to the drawing board.
I agree
with Jeff that it is unrealistic to expect shareholders to conduct
detailed evaluations of compensation schemes at each of their portfolio
companies. Even the largest institutional investors lack the expertise,
time and resources required for so many individual, customized analyses.
What shareholders can do, however, is read CD&As for the purpose of
deciding whether compensation plans answer TIAA-CREF’s 10 questions. If
the questions are not answered, and if directors have failed to explain
clearly how a plan works, how it links pay to performance, how it supports
business strategy, how it will create value for shareholders over time,
then the advisory vote is a good way for shareholders to begin a dialogue
on these questions with the company and its directors.
It
remains to be seen whether or how proxy advisory firms will customize
their compensation analyses. Regardless of what the proxy advisors do, it
is important not to lose sight of the fact that the most meaningful
information about compensation is always provided by the company itself in
the CD&A. It is wholly within the power of companies and boards to
determine if their compensation plan gets a passing grade and a favorable
vote from shareholders.
John
Wilcox
P.S.
These are my personal views and not the views of TIAA-CREF.
Forum Report
Inviting Comments on Draft of Gordon
Paper about “Say on Pay”
Jeffrey N. Gordon, Alfred W. Bressler Professor of Law at Columbia Law
School and Co-director of
Columbia’s Center for Law and Economic Studies, has invited comments
from Forum participants on his draft of a working paper that addresses the
issues being considered in our new program for
reconsidering “Say on Pay”:
►
Jeffrey N. Gordon,
Columbia Law School, July 30, 2008 draft: “‘Say on Pay’: Cautionary Notes
on the UK Experience and the Case for Muddling Through” (18 pages, 458
KB, in
PDF format)
As you’ll see, Professor Gordon provides a carefully considered review of
the evolution of corporate governance theories and practices during the
past several decades, generally and particularly in relation to executive
compensation, and then examines the potential US marketplace implications
of recent UK experience with their required shareholder advisory voting on
a “Directors Remuneration Report” (DRR) for each listed company.
Addressing the UK experience, these are some of his observations (pages
14-15):
|
The efficiency effects of the UK system are potentially a matter of
concern. …the workings of the system seem ill-suited for a dynamic
environment. For example, immediately upon adoption of the DRR
regime, the ABI and the NAPF adopted “best practices” of compensation
guidance. Because of the dominance of those two actors, whose
institution investor members own 30% of the shares of large UK public
firms, the annual shareholder vote is often a test of “comply or
explain” with those guidelines. Indeed, an alternative approach, in
which shareholders would annually evaluate firm compensation practices
in light of the firm’s performance and prospects as a whole, would be
very costly.[55]
The tendency for firms to “herd” in their compensation
practices is very strong: Follow the guidelines, stay in the middle
of the pack and avoid change from a prior year, when the firm received
a favorable vote. Yet what is the normative basis for giving
authoritative weight to the guidelines, whose conventional wisdom has
not itself been tested for performance-inducing effect?
…The guidelines may be “correct” in their outcome in particular
instances of compensation form, but it is hard to believe that they
will persistently produce a result similar to arms’ length bargaining,
if that is the ultimate comparator. More concerning, the
implementation of the guidelines may transmit a particular form of
compensation practice across an entire economy.
Deviations from the guidelines require, as a practical matter, a
consultation with the proxy adviser of one of the institutional
groups, either RREV or IVIS. To do otherwise may be to risk a negative
recommendation on the advisory vote. There are no studies on the
bureaucratic capabilities or expertise of either proxy advisor. The
system as a whole seems to tilt toward stasis rather than innovation
in compensation practices. Perhaps this is wise. In light of the
generally greater shareholder power in the UK, it does, however, seem
ironic that the implementation practicalities of “say on pay” may
reduce the freedom-in-fact of the shareholders’ bargaining agent.
_____________
See Kristin Gribben, U.K. Investors Warn U.S. About Say on Pay,
Agenda (Nov. 12,
2007) (citing experience of UK fund managers, who nevertheless want to
retain the advisory vote). |
After reviewing the significant differences between UK and US marketplaces,
the paper offers the following view of how legislated “Say on Pay” would
work in the US (pages 16-17):
|
Only a relative handful of the large public pension funds have
independent corporate governance expertise to guide their share
voting, and even the largest and most experienced of these, CalPERS
and TIAA-CREF, depend on guidelines that they fashion with only
limited company-specific accommodation. Most of the rest simply
delegate most of the substantive decisionmaking in the governance area
to a proxy services firm, in particular Institutional Shareholder
Services (ISS), now part of RiskMetrics.[58]
Like ABI and NAPF, ISS will establish guidelines on compensation;
indeed, such guidelines already exist. As in the UK, firms that do
not want to stir trouble will herd. Or firms with alternative ideas
will engage ISS in negotiation – but the numbers of firms and the time
for serious engagement could easily make the situation untenable. The
propensity of many U.S. institutional investors to delegate such
decisions could well give power to a handful of proxy service firms to
make substantively very important decisions with potentially
economy-wide ramifications. Indeed, the economy-wide embrace of stock
options in the 1990s resulted in part from institutional investor
pressure on firms to adopt this “best practice” way to enhance
managerial incentives.[59]
Then favored accounting treatment established “plain vanilla” options
as the “best practice” implementation. In other words, much of what we
now regret was the result of prior standardized practice that
guidelines epitomize.[60]
It is clear that legislated “say on pay” in the U.S. is
one way to catch and stop the bad-behaving outliers. But there are
costs and risks that cannot be ignored.
_____________
It
is only now, with adoption of FAS 123R, that firms may feel free to
experiment with alternative stock option forms, such as performance
triggers for grant or vesting, possibly using industry indices to
measure performance. Yet the concerns about valuation of tailored
instruments for accounting purposes may have its own uniformity
pressure. |
Finally, Professor Gordon’s conclusion, like that of many Forum
participants, is to keep an open mind about “Say on Pay” (page 18):
|
…In a 2005 article I said that the regime launched by the SEC’s CD&A
regulation deserved a five year trial before we undertook significant
change.[67]
Having looked more closely at the UK “say on pay” regime,
I am prepared to reaffirm my prior view. We need more information
about the consequences of the UK system. And we need more experience
about the possible success of present compensation-reform efforts by
shareholder activists at particular firms. If this is not a
satisfactory result from a social responsibility perspective, then the
tax code would be a better place to look than adjustment with
corporate governance.
_____________
|
Your comments on paper as well as the issues it addresses will be
appreciated. It should of course be noted that this is a draft and not a
published paper, and should be treated accordingly; anyone wanting to refer
to its statements should seek permission from its author.
GL – July 31, 2008
Gary Lutin
Lutin & Company
575 Madison Avenue, 10th Floor
New York, New York 10022
Tel: 212-605-0335
Email:
gl@shareholderforum.com
|