Geithner: 'Say on Pay,' No Caps
White House proposals on executive compensation include support for
shareholder control and compensation committee independence
By Phil Mintz
The White House proposal for overhauling executive-pay practices, announced on June 10, was as notable for
what the Administration isn't advocating as for what it is.
Treasury Secretary Timothy Geithner said the Administration would support
legislation known as say
on pay, which would give shareholders a nonbinding vote on executive pay
packages. Geithner also threw his support behind separate legislation aimed at
making compensation committees more independent from management. It was the
first time the Administration has said openly it would support so-called "say on
pay" legislation, though it has earlier signaled its interest in seeing it
passed. But Geithner added that the Administration won't mandate compensation
limits.
"We are not capping pay," Geithner said after a meeting with Securities &
Exchange Commission Chairwoman Mary Schapiro, Federal Reserve Governor Dan
Tarullo, and top compensation experts. "We are not setting forth precise
prescriptions for how companies should set compensation, which can often be
counterproductive. Instead, we will continue to work to develop standards that
reward innovation and prudent risk-taking, without creating misaligned
incentives."
The combined moves sent a sigh of relief across the corporate sector, where
many had feared the Administration was planning more stringent controls on
compensation. "What they have proposed is fairly modest; we were expecting
something much more heavy-handed," says Michael S. Melbinger, the head of the
executive compensation practice at Winston & Strawn in Chicago. "They're
basically ideas that have been kicking around awhile; they're not that far from
what already constitutes best practices."
Shareholder Interests
In his remarks,
Geithner said the Administration is putting its support behind pending
say-on-pay legislation, which would give the SEC the ability to mandate
nonbinding shareholder votes on executive compensation packages. The rules would
apply to all public companies, according to a fact sheet distributed by the
Treasury Dept.
"Say on pay—which has already become the norm for several of our major
trading partners, and which President Obama supported while in the Senate—would
encourage boards to ensure that compensation packages are closely aligned with
the interest of shareholders," Geithner said.
The Administration had been widely expected to push for an expanded say on
pay measure for months. Obama is a co-sponsor of the say on pay bill now before
the Senate, and he frequently cited the need for it on the campaign trail. And
when the White House announced its initial pay restrictions on the financial
sector in February, it had already made say on pay the de facto standard for the
ailing financial services firms that had turned to Uncle Sam for help. The only
way any of the firms which had been bailed out by the Treasury's Troubled Asset
Relief Program (TARP) could get around the stiff pay limits imposed by the Obama
Administration and Congress was by submitting their compensation plans to a
shareholder vote. "There is no one in the country who didn't expect this to be
the law of the land by year's end," says Melbinger.
Still, the President's overt backing will likely speed things up. "There's
already a broad consensus on Capitol Hill behind say on pay; this virtually
guarantees swift passage," says Patrick McGurn, special counsel to proxy advisor
ISS Governance Services. While he had expected a bill to move by late in the
year, McGurn now thinks it could be signed into law before the August recess.
That means say on pay could be in effect by the time 2010 proxy season rolls
around next spring.
What impact might that have? Governance activists say it won't bring pay
levels down instantly—indeed, it may not bring them down at all. But over time,
it should help make boards more responsive to shareholder concerns, which could
lead to pay packages in which pay is more closely tied to company performance.
That's what's happened in the UK since say on pay was adopted. "Boards are
embarrassed to be told by the shareholders they are supposed to be serving that
the package they've agreed to isn't adequate," says Jesse M. Fried, a law
professor at the University of California at Berkeley and co-author of Pay
Without Performance: The Unfulfilled Promise of Executive Compensation. "The
vote may be non-binding, but the prospect of having pay arrangements voted down
will cause boards to consult with large institutional investors before the
finalizing a deal." He also argues that the adoption of say on pay in the UK has
opened the door to more communication between boards and shareholders in
general, leading to improved corporate governance overall.
In addition, Geithner said the Administration will introduce legislation that
would give the SEC power to make sure that corporate compensation committees
adhere to independence standards "similar to those in place for audit committees
as part of the Sarbanes-Oxley Act."
The committees would also have more direct authority over independent
compensation consultants and outside counsel. The rules would apply to all
companies listed on national securities exchanges, according to Gene Sperling, a
top Geithner aide. Treasury's goal: "To ensure that compensation committees are
not just independent in name, but in fact," Sperling said in a media conference
call, adding that it was critical for compensation committees to have "the rules
and the tools they need to be independent."
Governance experts say those changes will help, but mostly on the margin.
"There's definitely a need for tightening of standards, but it's not a glaring
problem," says McGurn. On their own, the improved board standards would not
likely bring much of a change if say on pay were somehow to stall in Congress.
"Unless the balance of power is shifted between shareholders and the board, we
won't see any lasting impact on pay practices," warns Fried. "You might see some
minor improvements for a while, but when the heat dies down, boards would
eventually lapse back into bad habits."
Fully Understanding Pay Packages
While backing away from some of the more stringent controls on pay that some
in Congress and elsewhere have advocated, pay experts say the Administration's
proposed changes may be more likely to have an effect. Efforts to impose strict
controls on pay in the past have been largely ineffective and often led to
unintended consequences, argues James F. Reda, head of independent pay
consultant James F. Reda & Associates. "You can't legislate this kind of
thing; it just creates more work for clever lawyers," he says. Instead, he
argues, the only effective way to bring pay under control is to do what the
Administration appears to be doing: "You've got to make the compensation
committee as independent as possible," says Reda. "And make sure there is
disclosure; you've got to make sure the compensation committee truly
understands" what a contract entails. That may sound obvious, but until the SEC
imposed heightened pay disclosure requirements in 2005, many directors didn't
understand how the various elements of a CEO's pay package added up—one reason
why they were as surprised as shareholders when departing CEOs often left with
stunningly high packages.
Meanwhile, the Administration is preparing to announce pay practices for top
executives at financial firms that received money from the $700 billion Troubled
Asset Relief Program. A provision of the $787 billion stimulus package passed
earlier this year put limits on the pay and bonuses of the 20 top-earning
executives at companies receiving federal bailout money.
Mintz is news
editor for BusinessWeek.com in New York. With reporting by Jane
Sasseen