In all Fairness

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Expert Perspective by Grahall’s OmniMedia Editorial Board

expert perspective telescopeAn article by David Serchuk published in Forbes on August 6, 2009 (Break out the Pitchforks!) discusses the Corporate and Financial Institution Compensation Fairness Act of 2009, also known at H.R. 3269. Serchuk says: “This bill, which just passed the House, requires that the annual shareholder meetings provide for a separate shareholder vote to approve executive compensation.”  Toward the end of the article Serchuk poses a series of questions to two folks he refers to as “industry observers”, Sacha Millstone, the vice president of the Millstone Evans Group at Raymond James (whose biography says she is an investment advisor specializing in retirement planning, estate planning, charitable giving and managing inherited wealth) and Jeff Rubin, the head of research at Birinyi Associates, a stock market research and money management firm
 
Serchuk asks Rubin and Millstone the following:
• Do you think this legislation (H.R. 3269 ) is a good idea? If so, why?
• Do you believe CEO pay should be directly overseen by shareholders? Would that do anything?
• Would limiting CEO pay hurt firms or help them? If so, why?
• Can the case be made that firms that pay their CEOs way too much under-perform, a la most Wall Street firms that ended up on death’s door before they were bailed out? (With the possible exception of Goldman?)
• Which firms are prime candidates for seeing the pay of their CEOs clipped, as you believe they are overcompensated?

We wonder why Serchuk didn’t pose these questions to compensation professionals who might be able to provide some clear perspective on this.  Rubin willingly admitted in the interview that the is “not a compensation expert.”  Millstone should have done the same, but in any event we thought you might like to know how compensation experts would answer these compensation questions so I posed them to Grahall’s compensation experts Michael Graham and Garry Rogers.

Grahall: “Do you think this legislation (H.R. 3269) is a good idea? If so, why?”

Graham: I think a better question would be to ask “Does a placebo ever cause harm?”  If our lawmakers think that allowing shareholders a non-binding “say on pay” will conquer the issue we face with executive compensation they are wrong, and ultimately it might cause more harm than good because we will not have addressed the underlying issue of why some boards do not fulfill their obligations to shareholders.  The pension funds, mutual funds and other institutional shareholders who might be able to send a message with when they vote on the executive compensation package (i.e.  “say on pay”) don’t have the time or the experience to fully understand the executive compensation programs at the companies whose shares they hold.  So what do they do?  They go to services such as ISS or Glass Lewis for advice on how to vote their shares. And these “shareholder advisory services” and their  data analysis services are clearly regressing to the mean, so that if the average number of share outstanding that are used for stock options is, say, 7%, then a company with 9% might engender a “VOTE NO” recommendation.  Is that reasonable?  Maybe, but just as likely, maybe not. “Say on pay” will not fix problems and it might cause more harm than good. 

Grahall: “Do you believe CEO pay should be directly overseen by shareholders? Would that do anything?”

Graham:  Boards are responsible for overseeing executive compensation and it is their responsibility to the shareholders to do this well.  That makes sense.  To have shareholders directly oversee CEO pay would not be effective.  Honestly, the problem does not lie between boards and their decisions about compensation.  In fact the vast majority of boards do a good job in decisions about executive compensation.  It is the classic “80/20 rule”, or perhaps in this case we would need to call it the “99/1 rule”. It is that very small percentage of “bad” boards that is causing all the uproar. And the real problem is that it is very difficult to replace these “bad boards”.  In my opinion, having CEO pay overseen by shareholders would be cutting the wrong link in this chain. (Contact Michael graham at michael.graham@grahall.com.)

Grahall:  “Would limiting CEO pay hurt firms or help them? If so, why?”

Rogers: The interesting question here is would CEO pay be limited in some companies or in all?  In the first situation, where CEO pay is capped in some, it could clearly lead to a migration of top talent to other companies.  Why would these hard working individuals take on or continue in the demanding job of CEO at a capped company when they can get more money elsewhere?  Limiting CEO pay at all companies could also lead to a talent migration of high performing individuals to different roles, but it might have other consequences as well.  Price controls like these capped pay standards might work in certain situations but artificially low prices have had a history of poor outcomes.  Perhaps you can recall 1970’s when price controls on oil caused long gas lines that led to riots when the supply slowed. Or if you are a GenX-er just think of last November when Wal-Mart artificially lowered the price of flat screen TV’s on Black Friday and in one store a security guard was trampled and killed when a mob of shoppers shattered the front door.  With examples like those there is certainly something to be said for market pricing.  Perhaps these gruesome examples aren’t perfect comparisons to capping executive pay, but when the market forces are constrained by controls, then distortions and disconnects can occur.   (Contact Garry Rogers at garry.rogers@grahall.com.)

Grahall:  Can the case be made that firms that pay their CEOs way too much under-perform, a la most Wall Street firms that ended up on death’s door before they were bailed out? (With the possible exception of Goldman?)

Rogers:  We are currently working on a research study analyzing CEO pay.  One thing that is interesting is how distorted the public’s perception might be on this subject.  Certainly a “Top 10” list of highest paid CEO’s, or any list of high paid CEOs, is headline-making news.  Our research of 1,000 companies shows median and average total compensation of $2.3 million and $4.1 million, respectively.  The use of averages and a tilt toward very large companies are just two among many ways that executive compensation research can be biased toward very high figures.  It is not surprising then that headlines and news stories report 8-figure and even 9-figure pay.  At the same time, the public needs to understand that pay at those levels is very atypical. 
Grahall: Which firms are prime candidates for seeing the pay of their CEOs clipped, as you believe they are overcompensated?

Graham: I would never presume to know the answer to that question without a thorough analysis. However, for companies where pay is predominantly skewed toward short-term incentives and founded on peer group analysis, then I would venture a guess that the pay for the CEO’s in those companies is misaligned.  Simply stated, the issue should not be “pay x$ because peers get paid y$;” rather, it should be “pay x$ because of sustainable results.”  When Boards substitute competitive analysis for performance metrics, they are more likely to overpay.

But bigger issue is one we wrote about in a recent blog “I’ll See You and I’ll Raise You”.  I believe that there will be a flurry of activity at the top of organizations as the economy moves from recession to recovery.  Top people will make a change to get a guaranteed compensation package, as opposed to staying for a performance-based package.

Grahall:  Mr. Graham, do you have a message you would like to close with?

Graham:  Yes I do, two in fact:

To Boards:  Contact us; we can help you determine if your CEO and other executives are paid appropriately. And by “appropriately” we mean not only the level of pay but also components of pay and what compelling messages those two aspects of compensation are sending to your executives.   Ultimately you must ensure that executive compensation  is structured to deliver effort that is consistent with the best interests of shareholders. 

To Shareholders:  Determining if CEO pay is appropriate or not is a difficult job, you will be better informed if you join our community and read our blogs on these subjects, sign up for the weekly digest at www.grahall.com.

Contact Grahall’s Editorial director at edie.kingston@grahall.com

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