Letting shareholders sink one
More than 500 pages into the Dodd-Frank Wall Street Reform and Consumer Protection Act lies a nine-page section on executive compensation at public companies. It’s a small part of the new law — about 1% of the total — but it could have a big effect on how CEO pay is set and reported. Among other things, it mandates nonbinding shareholder votes on executive pay and golden parachutes, and it forces companies to compare CEO compensation with the median pay of all other employees in a single ratio. “It will make all publicly traded companies become more diligent in determining how they pay,” says Hank Federal, principal and vice president at human resources consultant Findley Davies Inc. “The overriding philosophy behind it is: Be more transparent.”
The act comes at a time when CEO pay, in North Carolina and nationwide, is trending downward but not fast enough to suit many observers. “The decrease in CEO pay has not been anywhere near commensurate with the loss of value that shareholders have experienced over the last 36 months,” says Paul Hodgson, senior research associate at The Corporate Library, a Portland, Maine-based research company specializing in corporate governance.
In North Carolina, the picture is a little more complicated. More than half of CEOs at the state’s 75 largest public companies took pay cuts in their latest fiscal year, according to data compiled for Business North Carolina by Findley Davies, with the median change being a decrease of 6.7%. Though the median one-year total shareholder return was a healthy 18.7%, that was largely because many stocks were trading abysmally low the year before. The median total return for the past three fiscal years was an 8% loss.
Cash compensation — salary and bonus — rose at more than half of the companies; earnings per share fell at about that many. At 15 companies, both happened: Cash compensation rose while EPS fell. “If EPS — basically profit — goes down, you would think that cash compensation would go down or at least there would be no increase,” Federal says.
Though most CEOs saw overall pay drop, a few received eye-popping increases. Mattress maker Sealy Corp. more than tripled the pay of Lawrence Rogers, giving him the largest percentage gain on the list, but at least the company’s performance improved in 2009 as it returned to profitability.
Tobacco maker Reynolds American Inc., on the other hand, more than doubled the pay of Susan Ivey last year — her compensation package of $16.2 million was the largest in the state — even as the company’s earnings per share fell 28%. Much of her pay came from an unusual award of stock contingent on performance; it might or might not produce any income for her. The company, in a statement, blamed the decrease in EPS partly on a big increase in pension expense and noted that its total return for the year was well above that of the S&P 500. “Reynolds American achieved solid underlying performance in 2009, despite an especially challenging economic and industry environment.”
It’s unclear whether Reynolds shareholders agree with the board’s decision to boost Ivey’s pay, because her compensation package wasn’t put to a vote. That could change with Dodd-Frank. Executive pay packages must be voted on at least every three years, starting in 2011. Every six years, publicly traded companies must ask shareholders if they want to vote on it more often.
The so-called “say on pay” provision might be the most controversial part of the law’s compensation section. Though the votes aren’t binding, they could put board compensation committees in the awkward position of having to modify pay packages that shareholders vote down or risk shareholder anger if they ignore a “no” vote. “If the company gets serious pushback or negative votes about its compensation program, it should think hard about changing its compensation practices, because these are the same people who are going to vote for directors,” says Patrick Bryant, a lawyer who handles corporate-governance and securities matters at Robinson, Bradshaw & Hinson PA in Charlotte.
For most companies, pay won’t rise to a level that would cause trouble at the ballot box, Hodgson says. But shareholders at some have shown they won’t rubber stamp pay packages: This year, three U.S. companies had them snubbed. “There are some companies out there where shareholders are bitterly angry about compensation policies, and they will voice that anger quite clearly at the next annual meeting where they have a vote.”
Shareholders also get to vote on so-called golden parachute packages relating to mergers, acquisitions or other changes in control. Most boards would rather avoid the embarrassment of having proposals voted down, so the prospect of shareholder votes on executive pay and golden parachutes could weed out the most outrageous before they go into the proxy statement, says Henry Oehmann, director of national executive compensation services for Chicago-based Grant Thornton LLP. “If you have to put it into your disclosure, in the screening process people say, ‘Are you sure we want to propose that to our shareholders?’”
Dodd-Frank also requires the U.S. Securities and Exchange Commission to come up with rules that force companies to disclose the relationship between pay and performance. Exactly what must be disclosed isn’t yet clear, but it will involve consideration of dividends and changes in stock price. “I imagine it will be somewhat open-ended, and of course companies will want to spin that stuff as favorably as they can. But it will be interesting to see what happens,” Bryant says.
Under Dodd-Frank, companies also must report the ratio of CEO pay to the median employee pay, a move some see as another tool to help shareholders figure out how to vote on pay packages and others consider an attempt to shame boards into curbing CEO pay. “It is blatantly absurd,” Federal says. “That was the Democratic House and Senate paying their dues, if you will, to the unions, because the unions publish that.” The ratios are bound to have shock value because they’re likely to be large, but comparisons across economic sectors could be difficult. Federal expects manufacturers and retailers, which often have high percentages of low-wage workers, to report higher ratios of CEO-to-median pay than, say, banks. “The number of people in the back rooms, all the IT folks, all the bond traders — there are tons of them that offset the number of tellers you may have.”
Still unclear is how much the new law, once it’s fully fleshed out by regulatory bodies, will rein in executive pay. After all, being CEO is a tough job, requiring a rare skill set, and the market for them is competitive. Directors often have to pay more than they’d like to attract or retain the right CEO. They’ll still do that, but they’ll have to do a better job of explaining why, Federal says. “In the comp committee rooms, there will be more questions asked. I think the comp consultant’s job is going to be a lot tougher. But at the end of the day, the board will get comfortable on where it wants to go and get comfortable with all the reasons why they think it’s the right way to do it, and they’ll explain that to shareholders.”
Whether or not the new law does curb abuses in CEO pay, it’s nearly certain that most employees will still have a hard time understanding why chief executives make so much money, Federal says. “We all do this: We pick up a proxy and we go directly to the compensation table, we look at the far right and we see the total number, and we go, ‘Gee whiz! I could retire on that!’ We all do that. I do that. I don’t think this is going to take away that issue. There is always some level of jealousy.””
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