College of Business Administrati

A survey of 760 board members by Pricewaterhouse Coopers and Corporate Board Magazine found that 67% of directors believe CEO compensation is excessive. (According to the Corporate Library, the average CEO of a Standard & Poor's 500 company received $14.8 million in total compensation last year.) The survey suggests that the new SEC executive compensation disclosure rules have not impacted executive compensation.

Paradoxically, most of the surveyed directors did not thing the CEOs of their own companies were overpaid.

U.S. Senator Carl Levin (D Mich) has begun hearings on whether to require the federal tax deduction for stock option compensation to match the expense shown on the corporate financial statements filed with the SEC and reported to the shareholders. When a company grants an employee stock options -- the option to buy a stock at a set price -- it treats the option as a business expense. When the employee exercises the options, sometimes years later, they have often increased in value, and the company may deduct that larger sum from taxable income. The difference in how stock options are treated is costing the Treasury Department billions of dollars a year, Mr. Levin said. For example, in 2004 companies claimed $43 billion more in stock option deductions than the expenses shown on their books, noted Levin, who chairs The Permanent Subcommittee on Investigations.

Stock options weren't required to be expensed at all until 2005. Stock options are the only form of compensation where tax deductions exceed what is expensed on corporate balance sheets.

During hearings by the Senate Banking Committee looking into the practices of bond-rating firms, senators accused the firms of conflicts of interest that may have contributed to the mortgage market turmoil. The favorable ratings given by the bond-rating firms (the majors are Standard & Poors, Moody's and Fitch) to real estate mortgage debt lulled many investors into a false sense of security. Among the practices questioned was that of ratings firms getting paid by bond issuers. Senator Jim Bunning (R_Ky.) likened that to a studio paying a critic to write a review of its movie. Senator Charles Schumer (D NY) suggested that the firms should instead by paid by bond investors rather than issuers.

The SEC has also been investigating whether the ratings firms have been influenced by Wall Street.

09/23/07: Coalition Fights Proposed SEC Restrictions on Shareholder Right to Nominate Directors

On July 25, 2007, the SEC put out for public comment two proposals that would open the door to a substantial weakening of shareholder rights in the proxy process and in the selection of board members. The two proposals are self-contradictory: one would bar shareholder nominations altogether; the other would allow nominations only by shareholders owning at least 5% of the company's stock for a year. Although the latter is less draconian, the 5% requirement effectively bars all but large institutional shareholders.

A total of 3,000 emails have been sent to the Securities and Exchange Commission (SEC) and the U.S. Congress in the first three weeks of operation of www.SaveShareholderRights.org, the joint Social Investment Forum (SIF)/Interfaith Center on Corporate Responsibility (ICCR) Web site launched on August 29, 2007 to oppose these controversial proposals. In addition, the SIF/ICCR Web site already has attracted nearly 200 of the 500 institutions and financial professionals it is seeking to sign a joint statement opposing the expected SEC proposals. The SEC comment period expires on October 2, 2007.

A coalition of major pension funds, state officials and environmentalists urged the SEC to require corporations to disclose the potential impact of global warming in their financial statements. Global warming-related liabilities, such as those now encumbering the insurance companies paying out for Hurricane Katrina, can have a huge affect on corporation bottom lines. The largest pension funds, such as CalPERS, are particularly vulnerable to global warming-related liabilities if they do not have this information about the companies they invest in.

Some corporations already include this information. A study by the environmental group Friends of the Earth found that the most complete disclosure came from oil and electric power industries, while auto, insurance and petrochemical companies disclosed the least information.

United for a Fair Economy and the Institute for Policy Studies has come out with their 2007 version of their annual Executive Excess report on executive compensation. Some of the key data are:

In response, the report offers the following proposals for legislative change, mostly to the tax code:

8/20/07. SOME BRITISH COMPANIES BEGIN PUTTING "CARBON LABELS" ON THEIR GOODS

In what could be a precursor to a more environmentally-conscious business community, a handful of British companies have begun putting "carbon labels" on their products, according to a story in today's Los Angeles Times. This information discloses the amount of carbon dioxide expelled into the atmosphere during the production of the specific food item labeled; it does not reference anything actually in the product. The information allows consumers to see how their decisions impact the environment in quantitative terms. Such measured impact of carbon dioxide is also known as a "carbon footprint." The label idea was given a boost when the CEO of Tesco, a supermarket chain in 12 countries, pledged to put the labels on all of the 70,000 products on its shelves.

According to the LA TIMES, the former CEO of Brocade Communications Inc., Gregory Reyes, was convicted of securities fraud and making false statements in the backdating of stock options compensation he received from the company. This case is significant as a possible forerunner of similar prosecutions against many other Silicon Valley companies--and their CEOs--that had engaged in the same unlawful practice in compensating their upper managements. Options backdating was a popular means of recruiting and retaining key management during the dot-com boom.

Backdating the exercise price of a stock option is not illegal per se. But failing to report the backdate in the corporation's financial statements is the crime of which Reyes was convicted. Moreover, the backdating typically understates corporate expenses, thereby overstating corporate profit and misleading investors. That is why the widespread use of backdated options has caused over 100 corporations to restate their earnings.

The House and Senate have each introduced bills that would dramatically change the income tax treatment of "carried interest" profits earned by fund managers in their capacity as general partners of investment partnerships. For decades, the individuals who ran private equity, venture and hedge funds convinced Congress that the 20 percent carried-interest profit share they took on deals wasn't ordinary income (taxed at up to 35 percent) but a capital gain (taxed at 15 percent), even though they typically were risking almost none of their own capital. Hedge fund managers, private equity fund managers, and real estate operators are the targets for legislation that would eliminate the perceived benefits derived from doing business through partnerships. [A measure of just how rich these managers are is a list compiled annually by Alpha magazine of the top 25 hedge fund managers. Average earnings for these financial titans last year were $570 million, an increase of 57 percent from 2005.]

The House bill, H.R. 2834, introduced on June 22, 2007, changes the income taxation of the carried interest by re-characterizing each of the items of partnership income and deductions as ordinary income or ordinary loss. As a consequence of the re-characterization, the benefits of the reduced tax rate on qualified dividends and long-term capital are eliminated.

The Senate bill, S. 1624, would eliminate the exception for passive-type income for publicly-traded partnerships that provide investment advisory and management services. These partnerships would be taxed as corporations, and distributions to partners would be taxed as dividends. In effect, the partners would be subject to a double tax on distributed profits. The partners would also lose the more beneficial 15% tax rate on long-term capital gains.

7/16/07. House And Senate Committees Introduce Bills Increasing Taxation Of Fund Managers

7/12/07. HEDGE FUNDS FACE POTENTIAL REGULATION

In light of the recent spate of sharp downturns in the sub-prime mortgage-based securities held by many hedge funds, the SEC and Congress moved closer to measures that would constrain the heretofore unregulated hedge fund industry by requiring greater transparency and susceptibility to fraud suits. The primary concern are the pension assets that are increasingly invested in such funds. Recently, for example, the San Diego County Employee Retirement Association had invested $175 million in the Amaranth Advisors fund that later collapsed. Both the SEC reg and the proposed legislation would facilitate suit against fraud committed by the funds.

Many feel that far too many of the sub-prime mortgages held by the hedge funds were irresponsibly and unethically extended to borrowers with little possibility of making the payments. By some estimates, hedge funds are now worth $2 trillion. If they continue to slide due to sub-prime mortgage foreclosures, that could spread instability throughout the financial markets.

6/18/07. YAHOO CEO STEPS DOWN AMID COMPLAINTS OF COMPENSATION PAID DURING DECLINE

Yahoo's chief executive Terry S. Semel resigned yesterday as part of a management shuffle designed to reverse flagging fortunes as the company continues to lose ground to rival Google. At an annual shareholders' meeting last week, some investors complained the company's top executives were overpaid and called for executive pay to be tied more closely to performance, although that proposal failed to gain a majority. During his tenure, Semel was richly rewarded. He has realized gains around $451 million from stock options and other pay, according to a report by the executive compensation firm Equilar, making him one of the highest paid executives in the nation.

6/17/07. SHAREHOLDER FORUM SEEKS TO STUDY RELATIONSHIP BETWEEN EXECUTIVE COMPENSATION AND CORPORATE PERFORMANCE

A “Forum” program is being initiated for shareholders of Verizon Communications Inc. (NYSE:VZ) to examine the relationship of executive compensation incentives to the company’s achievement of long term enterprise objectives, as a foundation for considering investor decisions about both capital commitment and voting. By looking at Verizon's business strategies, the Forum will examine the relationship of compensation to the achievement of key business objectives as a means of finding out where managers are placing their own bets. Information about the forum is available at http://www.shareeholderforum.com/vz.

The frequent lack of relationship between executive compensation and corporate performance was effectively examined and critiqued in the book, Pay without Performance: The Unfulfilled Promise of Executive Compensation, by Lucian Bebchuk and Jesse Fried.

6/13/07. PUBLIC DISSATISFIED WITH CORPORATE LEADERS

According to a Los Angeles Times\Bloomberg national poll released today, corporate chiefs are viewed with suspicion: 81% of respondents said the CEOs are overpaid, but only 33% said they were ethical.

6/10/07. REPORT FINDS EXECUTIVE PAY CAN TAKE BIG SLICE OUT OF CORPORATE PROFITS

The LA TIMES released its annual report on CEO pay at the state's 100 largest public companies. Among them, averaged 2% of net income, theoretically reducing the price of the stock by that much. This data is now required to be reported per new SEC disclosure rules. The TIMES states this has aroused the ire of investors. A companion article suggests tactics that investors can employ to express their disapproval and staunch the growth of CEO pay. These tactics include:

Withhold votes from directors who serve on board compensation committees that set CEO pay.
Offer proposals to give shareholders an advisory "say on pay," vote on CEO compensation, including supplemental retirement benefits
Require that CEO pay be linked to company performance
Submit proposals restricting the use of "poison pill" defenses making takeover attempts prohibitively expensive.

4/20/07. HOUSE PASSES EXECUTIVE COMPENSATION BILL

The House passed the bill 269-134, sending it to the Senate. (Also today, Sen Barack Obama, D-Ill., introduced a similar bill in the Senate.) The bill, H.R. 1257, the Shareholder Vote on Executive Compensation Act, was opposed by the White House and most Republicans. They argued that the Securities and Exchange Commission has recently taken steps to make corporate pay packages more transparent and that Congress should stay out of corporate affairs. President Bush earlier this year questioned the extravagant pay of some company managers and directors, but said it was not a matter for government involvement. "There is no justification for many of these pay packages," said Rep. Spencer Bachus, R-Ala., top Republican on the House Financial Services Committee. But "this is Congress beginning to intrude on corporations."

But Democratic backers of this provision said that investors need a say when companies losing money or laying off workers are paying executives eight- and nine-figure salaries and retirement packages.Frank noted that the SEC had recently required corporations to include a chart of compensation for top officials but had said it did not have the power to compel a vote on executive pay. He said the bill requires corporations "simply to add to that a box that says 'I approve/I disapprove.'" As with the new SEC disclosure rules, the bill only applies to the compensation of the five top executives.

Democrats, while stressing that the bill makes no judgment on what is excessive pay, cited studies that the average CEO of a Standard and Poor's 500 company receives $14.78 million in compensation. Rep. Brad Miller, D-N.C., said that 15 years ago the average CEO made 140 times what a worker at his company earned but that now the difference is 500 times. He said the aggregate compensation of the top five executives is now 10.3 percent of the corporate profits of public corporations.

Investor advocates, union pension funds and shareholder groups have supported the legislation: e.g., in March, 2007, the Council of Institutional Investors urged companies to adopt such advisory shareholder votes. Such measures have been raised at several corporate meetings this year, and 36 more are pending, according to Institutional Shareholder Services. Of the influence of institutional investors, one Republican representative stated, "It greatly worries me that this bill could set a precedent of giving activist institutional investors, who may have their own political and social agendas unrelated to the financial wealth of the companies, more influence," said Rep. Mike Castle, R-Del.

In 1990, the ratio of average pay for CEOs/average worker earnings was 107, per United for a Fair Economy. As of 2005, that ratio was 411 (down from 511 in 2000, reflecting the then-booming value of stock options). At least one public opinion poll reflects widespread cynicism about how corporations distribute their wealth. According to a survey by Lake Research Partners, almost 7 in 10 agreed with the statement: "When corporations are profitable, the benefits are not shared with workers but go only to the top."

The push for this legislation has been impelled by recent reports of huge CEO compensation plans at Home Depot, Exxon, and Occidental Petroleum.

Republicans unsuccessfully offered amendments requiring pension funds and other shareholder groups to reveal their spending or their votes on compensation issues. Also defeated was a proposal by Rep. Scott Garrett, R-N.J., that would have eliminated the shareholder vote when compensation packages do not exceed averages at comparable companies by more than 10 percent.

Democrats, while stressing that the bill makes no judgment on what is excessive pay, cited studies that the average CEO of a Standard and Poor's 500 company receives $14.78 million in compensation.

Rep. Brad Miller, D-N.C., said that 15 years ago the average CEO made 140 times what a worker at his company earned but that now the difference is 500 times. He said the aggregate compensation of the top five executives is now 10.3 percent of the corporate profits of public corporations.

3/25/07. "cLAWBACKS" CLAW FORWARD

According to a report in the 3/25/07 NY Times, the use of "clawback" provisions in corporate executive pay packages--the return of compensation paid when the executive has been involved in financial misconduct--are becoming more prevalent at major corporations. An executive compensation research firm found that they are showing up in more proxy filings this year. Among the 50 of the largest 100 largest companies in the United States that have filed their proxies for 2007, 44 percent had clawback provisions. They are becoming broader as well, extending to the recovery of gains from stock options that may have been exercised while dubious practices were taking place. Kraft’s provision, for example, is very broad. Under its terms, recovery of compensation after a financial restatement at the company can require the partial or full repayment of a bonus, of gains on exercised stock options, or of the sale of vested shares. The company can also cancel the executive’s restricted stock grants and stock options.

Some of these disclosures are a result of the Securities and Exchange Commission’s new executive compensation disclosure rules. The new policies to recoup pay also augment the provisions under the Sarbanes-Oxley law. The new rules go further by extending the policies to include option gains. They also send an important message because they apply to compensation already granted. The biggest risk is that the stock price spiked up and the executive exercised and sold the stock.

3/24/07. cORPORATIONS DEFY SEC "PLAIN eNGLISH" RULE RE EXEC PAY

SEC Chair Chris Cox complained that corporate proxies filed under the new transparency rules have not met the requirement of "plain English disclosure" re executive compensation. That requirement epitomizes the overarching objective of the new reporting rules. In addition to threatening sanctions for future transgressions, Cox announced the forthcoming use of software that would facilitate inter-company analysis and comparison of executive pay data. Users will be able to graphically compare executive pay data for companies they select.

3/15/07. Hewlett-Packard shareholders vote against board candidate nomination, Vote for Linking Executive Pay with performance and For Requiring shareholder Approval of "Poison Pills"

Hewlett-Packard Co announced that its shareholders had voted against the proposal to allow large shareholders to nominate their own candidates for the board of directors.

The Palo Alto-based company said that more than 50% of the shareholders voted against the proposal, which required a two-thirds majority to be passed, at the annual shareholder meeting in Santa Clara, California on Wednesday. The proposal would have allowed investors with at least 3% of the company’s shares for at least two consecutive years to nominate as many as two candidates to the board. The proposal was introduced by the American Federation of Stat the, County and Municipal Employee (AFSCME) Pension Plan and was also sponsored by the New York State Common Retirement Fund, the Connecticut Retirement Plans and Trust Funds and the North Carolina Equity Investment Fund Pooled Trust. Hewlett-Packard had urged shareholders to reject the proposal, saying measures could lead to the appointment of "special interest" directors and to "divisive and expensive proxy contests."

Shareholders passed two resolutions, however, at the annual meeting, which narrowed the management’s options. One resolution, called the shareholders’ rights plans, prevents Hewlett-Packard’s management from taking "poison pill" measures without shareholders’ approval. The other resolution was regarding executive pay being more closely linked to performance.

3/9/07. Lawmakers debate "SAY ON PAY" bill on executive pay

After a House hearing, Rep. Barney Frank (D-Mass.), chairman of the Financial Services Committee, said his panel would vote this month on a bill that would require all companies to allow shareholders to vote annually on pay deals approved by directors, as well as on "golden parachutes" for departing executives when a company faces a possible takeover. Such "Say on Pay" shareholders proposals are advisory only, but have been both popular and effective in Britain.

Insurer AFLAC Inc. (AFL.N: Quote, Profile , Research) in February voluntarily became the first major U.S. company to adopt "say on pay." Shareholder resolutions calling for advisory votes on pay have failed at four recent annual shareholder meetings, although gaining substantial support.

On Tuesday one failed at Citigroup (C.N: Quote, Profile , Research), with 43 percent of the vote. Coca-Cola Co. (KO.N: Quote, Profile , Research) investors defeated on Wednesday a "say on pay" measure that won 30 percent of voting shares. Morgan Stanley (MS.N: Quote, Profile , Research) and Bank of New York Co. Inc. (BK.N: Quote, Profile , Research) investors recently rejected "say on pay" proposals.

Shareholder votes on pay have been adopted in Britain, Australia and Sweden, and advocates say that, while pay packages are rarely rejected, the votes help to keep executive compensation in check.

1/31/07. PRESIDENT BUSH CALLS FOR TYING EXECUTIVE COMPENSATION TO PERFORMANCE

In his State of the Union address, President Bush took aim at lavish salaries and bonuses for corporate executives, standing on Wall Street to issue a sharp warning for corporate boards to “step up to their responsibilities” and tie compensation packages to performance. My commentary follows.

President Bush's call is an apt sentiment. But his injunction, however laudable, is ultimately unachievable without a fundamental restructuring of the board-CEO relationship—key aspects of which are rife with conflicts of interest. The President’s call correctly presumes that the board of directors is the primary gatekeeper in the corporate governance scheme. Yet to properly execute this role, the board must be truly independent of management. The problem is that what regulatory law calls an “independent” director is a term of art and not a reality.

Affecting CEO pay reform means first appreciating this: underlying the board-CEO relationship is a corrupting dynamic that is both incubator and impetus for excessive CEO compensation. In theory, board members have a fiduciary responsibility to the shareholders who elected them. That model is in tension with various salient influences that instead make directors beholden to CEOs. Consider:

The desire to be reelected to the board. Directors must garner management’s nomination to its slate of directors on the shareholder proxy statement.
Director pay. The CEO can indirectly but effectively impact director pay, especially where the CEO and the Chair of the board are the same person.
Lucrative external business. Even so-called independent directors may have discrete business relations with the corporation (e.g., consulting) whose continuation depends upon the CEO’s support. Under the New York Stock Exchange rules, for example, directors may receive up to $100,000 annually of such additional compensation and still be considered independent. Similarly, a director remains independent even if he is an officer of another business that in the last three years received the greater of anything less than $1 million or 2% of its gross revenue from the corporation.
Interlocking Directorships. To illustrate this arrangement, assume Smith, a director of Corporation A, is CEO of Corporation B, on whose board sits Jones, the CEO of Corporation A. Even if Jones is not on B’s compensation committee, Smith’s compensation at Corporation B can be directly affected by Jones in his capacity as a director. CEO pay is usually larger in the many companies with interlocking directors, a practice that may be implicated in other financial mischief: according to a recent study, interlocking boards played a significant role in the spread of options backdating, the mounting scandal currently roiling the corporate world. It is small wonder that Justice Louis Brandeis observed, “The practice of interlocking directorships is the root of many evils.”
Non-economic reasons. Notwithstanding all of the above, a director’s most prominent inhibition to real arm’s-length bargaining over CEO compensation may be non-economic. Most directors desire to avoid conflict with the leader of the corporation (particularly where the CEO is also Chair of the board). Loyalty and cooperation tend to be rewarded. These circumstances further impair the desired independence of board members from the CEO whose compensation they must approve.

Corrective prescriptions abound. They include new tax disincentives, shareholder approval of CEO pay (“say on pay”) and rethinking the use of compensation consultants. None of these nostrums address the root cause of the problem. Institutional reform of the board does. As management guru Peter Drucker wrote: “Whenever an institution malfunctions as consistently as boards of directors have in nearly every major fiasco … it is futile to blame men. It is the institution that malfunctions.”

More direct and effective ways to approach the goal of director independence are possible, including:

Separate the roles of CEO and Chair of the board. Nothing confounds a gatekeeper group’s mission more than when the chief gatekeeper is also the most potent threat to crash the gate.
Eradicate potential conflicts of interest. Ban service on multiple corporate boards; eliminate all external financial relations with the corporation.
Impose term limits on directors. That would often sever future financial ties to the corporation of the kind described and, presumably, free directors to make executive compensation decisions that are in the interests of the shareholders. Which, after all, is what they are supposed to do.

11/27/06. EXECUTIVE COMPENSATION REFORM PROPOSED

“As Profits Surge, Workers Still Wait.” According to a story in the Los Angeles Times, corporate earnings keep rising at double-digit pace while workers are lucky to get even low-single-digit wage increases. Moreover, worker pay increases are declining. In the third quarter of 2005, S & P earnings rose 11.5%, the 14^th straight quarter of double-digit growth. In contrast, worker salaries rose only 2.2% for that period, down from 2.6% from the same quarter last year. Adding healthcare and other benefits, worker salaries were up 3% in the past 12 months, compared with 3.7% in the previous 12 month period.

On Nov. 10, 2005, Congressman Barney Frank (D-Mass.) introduced the Protection Against Executive Compensation Abuse Act. See details below from the Council of Institutional Investors' Statement:

Executive compensation is an extremely important issue for the Council of Institutional Investors, an association of more than 130 public, corporate and union pension funds with more than $3 trillion in investments . Pay decisions are one of the most direct ways for shareowners to assess the performance of the board. To properly perform this assessment, shareowners must have comprehensive, accurate and clear information detailing long- and short-term compensation to executives. The provisions in the Protection Against Executive Compensation Abuse Act bill that call for full disclosure of information about all compensation paid to executives and the performance measures tied to compensation would assist shareowners in this effort.

The bill also dovetails with the Securities and Exchange Commission's current efforts to improve and update executive compensation disclosure rules... The bill's provisions requiring shareowner approval of certain types of compensation and disgorgement of ill-gotten bonuses. The Protection Against Executive Compensation Abuse Act would require companies to seek shareowner approval of a comprehensive "executive compensation plan" that would include details about management's pay and the performance measures tied to that pay. The legislation also would require companies to include in their "executive compensation plan" their policies on disgorgement of ill-gotten or improperly awarded bonuses.

According to the AFL-CIO: In 1980, the average CEO earned about 42 times the pay of the average worker; now, that ratio is 431/1--more than 10 times higher.