Outrage over CEO compensation is one of those predictable events, like the annual return of the swallows to San Juan Capistrano. But this year it's as if a flock of flamingos descended on the old mission, thanks to AIG. While AIG's recent antics are probably going to hold the egregiousness record for some time, there are other signs that CEO compensation is more than just a little bit broken. Highlights from governance think tank The Corporate Library's (TCL) annual CEO compensation survey include the following:
1. The compensation of 29 CEOs increased in 2008 by more than 1,000%.
2. Nearly three-quarters of CEOs had increases in base salary, and only 3% saw a decrease.1
Incredibly, in a year in which so many companies had dismal performance, only 3% of CEOs saw a decrease in pay, which is supposed to be linked to performance.
Shareholders should have the ability to approve executive compensation plans. At the moment, shareholders have little or no ability to express their opinions of executive compensation plans. A movement to encourage companies to obtain annual approval of executive compensation, or the "say on pay" movement, led by Walden Asset Management and other institutional investors, has been gathering steam for several years. There were more than 100 say-on-pay shareholder proposals filed last year,2 but according to Paul Hodgson, an expert on executive compensation at TCL, only nine companies among the 3,200 covered by TCL subjected their executive compensation plans to shareholder approval at the beginning of 2009.3
Consider that there are over 10,000 publicly traded companies in the U.S., and you'll start to understand the scope of the effort required to really solve the problem on a company-by-company basis. Of 53 proposals filed in 2007, only six received majority votes, and one other company (Aflac) adopted shareholder approval voluntarily. Say-on-pay provisions were defeated at several financial giants, including Citigroup, Morgan Stanley, and Merrill Lynch,4 whose CEO bought a $1,400 wastebasket as part of a $1.2 million redecoration project in 2008, while handing out $4 billion in bonuses.5
Reining in excessive CEO compensation will take more than a federal decree. Strengthening the voice of shareholders has to be a key part of the solution. It is well past time for a thorough, soup-to-nuts review of the SEC's policies and implementation of no-action relief, which usually centers on the "so-called" ordinary business exemption. This exemption states that companies are allowed to omit shareholder proposals on topics that deal with "ordinary business," or items that businesses normally attend to. While it is important to have some mechanism to exclude foolish or silly proposals, for many years the SEC has chosen to exclude any shareholder proposal that mentions risk, on the grounds that risk assessment is ordinary business.
Yet clearly, disclosure of the risks associated with subprime mortgages, credit default swaps and other exotic derivatives was behind the recent economic and financial meltdown, and there is nothing ordinary about it. The SEC should undertake an evaluation of the scope and performance of its no-action relief program, with input from shareholder advocates, individual investors, and institutional investors.
Another of the fundamental problems in executive compensation is the incentive structure. It should be common knowledge by now that CEO pay, at least at larger companies, is not mainly about salary, even if bonuses are included. Executive compensation has become a shell game. With more than a dozen categories of executive compensation (two of which are "salary" and "bonus"), usually the golden handshakes, golden coffins, and miscellaneous undeserved largesse goes into another obscure category that executives hope nobody will find out about, or understand.
While Americans are episodically moved to indignation and occasionally to outrage by the sheer size of executive compensation, it is equally outrageous that shareholders-which most Americans are, with the widespread use of 401(k)s-often pay for the taxes that CEOs would otherwise be forced to pay on the value of the use of the corporate jet for the CEO's family to accompany him (or occasionally her) on trips.
TCL reports that in FY 2006-7 there were 730 instances of the use of tax gross-ups among the U.S. companies it covers, with the average amount paid being over $57,000 and the maximum $5,752,050. The total tax reimbursement paid to executives (who are otherwise quite well compensated, and probably could afford to pay taxes on their own perks) was nearly $42 million.6
Inflated compensation has isolated many CEOs and senior executives in a world of privilege and unreality, that they feel entitled to enjoy life at others' expense in return for the onerous work of being one of the geniuses capable of running a corporation. It is time to put a pin in this balloon, and the best way to do it would be for Congress to make tax gross-ups illegal, unless this benefit is offered to all employees.
The term "bonus" has essentially become meaningless. A bonus is supposed to be additional compensation above what is expected, and often also includes some notion of merit: a bonus is usually thought of as the reward for success. The notion of "inescapable" bonuses to employees who engineered some of the most spectacular failures ever seen on any financial landscape is ludicrous.
For years, the answer to public consternation over increasingly lavish pay packages for executives was that great performance should be lavishly rewarded. Now that performance is appalling, the logic is that we now have to pay extra to keep the people, or otherwise they'll go somewhere else-and more outrageous still, even after they already have gone somewhere else. So we pay extra for success and failure nowadays?
Many fixes are possible. My favorite: All executive compensation that is not tied to long-term goals, exceeding one year, and indexed to market movements, should be taxed as ordinary income to the recipients and not deductible from corporate taxes. This would include all compensation for all employees who receive bonuses or any form of incentive pay, perquisites, or benefits exceeding a certain threshold, such as any amount exceeding the salary.
A Call To Action For Investors And Mutual Funds
Now that we've laid out a modest to-do list for the government, here's what Pax World is doing, and some things that the average investor can do. We have already written letters to all the companies from which Pax World withheld votes for compensation committee members last year on account of what we regard as excessive executive compensation and that do not have governance structures that are conducive to fixing the problem. We will continue to do this.
While investors in Pax World should know that we will generally support shareholder proposals on say on pay, a great many mutual funds (including most of the large ones) have routinely opposed such proposals. A 2006 report from AFSCME, TCL and the Shareowner Education Group shows that of the largest 29 mainstream mutual fund companies, five always voted in favor of shareholder resolutions requesting advisory votes on pay, but ten voted for none of those proposals. The average rate of votes supporting say-on-pay resolutions among these 29 companies was less than 38%.7
Any investor can see the proxy voting guidelines of any U.S. mutual fund on each mutual fund company's Web site, as well as its proxy voting record at the SEC Web site. If you don't like the way your mutual fund company votes on executive compensation, or anything else, let them know, or find another mutual fund.
Any investor in the stock of any publicly traded company has the right to vote on the company's proxy. As an individual shareholder, you should receive a proxy each year. Daunting though they are to read, anyone deeply concerned about executive compensation should read them, and make sure that they register their wishes with their votes.
We have paid far too much for luck and charisma among the top ranks of executives for far too long. Executive compensation, and especially CEO compensation, has become more egregious and less tied to performance than ever before, and this is despite the SEC strengthening its requirements for disclosure of executive compensation at least twice in the last 15 years. Sunshine is a great disinfectant, but in this case, we also need the antibiotics of shareholder action and regulatory reform.
Julie Gorte, Ph.D, is senior vice president for sustainable investing at Pax World Management Corp. She oversees environmental, social and governance related research on prospective and current investments as well as Pax's shareholder advocacy and work on public policy advocacy.
1 Paul Hodgson and Greg Ruel, "CEO Pay 2008: The Corporate Library's CEO Pay Survey 2008," The Corporate Library, n.d.
2 Annette Nazareth, "'Say on Pay' Now A Reality for TARP Participants," Harvard Law School Corporate Governance Forum, http://blogs.law.harvard.edu/
corpgov/2009/02/27/%E2%80%9Csay-on-pay%E2%80%9D-now-a-reality-for-tarp-participants/, Feb. 27, 2009.
3 Personal Communication with Paul Hodgson, March 25, 2008.
4 Ian Katz, Investors Fail to Pass 'Say-on-Pay' Even After Subprime Losses. Bloomberg,http://www.bloomberg.com/apps/news?pid=20601103&sid=
a7SZipzVi0Mw&refer=us, April 29, 2008.
5 "Thain's Office Overhaul Said to Cost $1.2 Million," New York Times, Jan. 22, 2009.
6 Paul Hodgson, "Tax Reimbursement: The Grossest Perk, "The Corporate Library 2008 Proxy season Foresights #7, March 31, 2008.
7 The American Federation of State, County, and Municipal Employees, The Corporate Library, Failed Fiduciaries: Mutual Fund Proxy Voting on CEO Compensation, 2006.