On July 31st, the U.S. House of Representatives passed bill HR 3269 that gives public company shareholders an advisory vote on executive compensation. In addition, the bill endeavors to "prevent perverse incentives in the compensation practices of financial institutions". On the surface of it, the bill appears to address the outrage of shareholders and the general public who helped bail out some of the country's largest institutions. Unfortunately, the bill has little in the way of real reform. As presently drafted, HR 3269 has three primary sections:
Section 2: Shareholder Vote on Executive Compensation
Section 3: Compensation Committee Independence
Section 4: Enhanced Compensation Structure Reporting to Reduce Perverse Incentives
While company shareholders have been demanding changes in the area of executive compensation, the HR 3269 bill, dubbed "Say on Pay" will not provide shareholders with the clout they desire. The primary reason is that the votes are non-binding as stated in Section 2. In the end, company directors will ultimately determine executive compensation structure and packages, regardless of how shareholders vote. We suspect that most investors think CEOs are already overpaid and will vote "no" regardless. It strikes us as completely reckless having novices determine executive pay. This complete lack of knowledge is the reason why independent board directors are hired in the first place. We believe that having more "Say on Directors" would be more meaningful. The real transformation should be in the way board directors are nominated and retained. We are certain that CalPERS (California Public Employees' Retirement System) would rather have a board seat than a non-binding vote on pay. A further provision in Section 2 of HR 3269 discusses shareholder approval of golden parachutes. Unfortunately, these approvals will also be non-binding.
Section 3 of HR 3269 requires that only independent board members serve on compensation committees. We wholeheartedly agree with this provision but 99% of public companies already have their compensation committees comprised of independent directors. Some experts have questioned whether the new bill would restrict CEOs in determining the pay of their direct subordinates and company-wide staff. We see nothing in the fine print that specifically states that restriction. The other provision in Section 3 addresses the compensation committee's authority to engage compensation consultants. Again, the intent is fine but existing statutes already cover this and other conflicts of interest.
Section 4 of the bill regarding perverse incentives speaks only to financial institutions of a certain size. For the moment hospitality executives don't have to worry about the government's pay czar looking over their shoulder. With that said, government regulators have done such a poor job of regulating financial institutions in the first place, what makes anyone think they will do a better job regulating executive pay?
The bill states compensation structures must adhere to sound risk management, properly account for the time horizon of risks and not have serious adverse effects on economic conditions. Sounds great but who is going to define these esoteric issues? The government, the pay czar or shareholders? The bottom-line of HR 3269 is that it might be good politics but it is a poor framework for managing pay.
19 August 2009