The High Heel He Used to Be

by Eric Martin

In some ways, the prevailing decision-making process used to establish most executive compensation packages at large corporate entities has allowed for some of the out-of-control levels of pay that have appeared over the past couple of decades.  In most large US companies, compensation levels for executives are not set by shareholders - in fact, shareholders are shut out of the process almost entirely. 

Instead, "compensation committees" are formed to determine the appropriate levels of pay.  The problem has been that these compensation committees, which are almost always put together by the applicable board of directors, tend to include parties that receive money and other forms of compensation from the corporate entity in question, and are often selected for their "friendliness" to upper management.  Further, comp committees retain consultants that can, themselves, help a certain board member or executive shield the comp committee's activities from other board members that are supposed to be exercising oversight by creating an alternate chain of command/reporting.

The result is that there is a congenial group of parties known to each other, often with some level of conflict of interest. As a further example, some comp committee members receive financial reward (above pay for their service on the committee itself) under arrangements decided upon by the same executives for which they, in turn, are setting salaries and benefits.  Cozy, yet not conducive to independence of judgment. 

Even where there is total independence and no instance of conflicting interests, however, shareholders are still denied a say, yet these decisions often involve enormous sums of money that can affect the health and viability of the corporate entity long-term.  The Obama administration is making common sense suggestions for correcting some of these structural flaws:

The Obama administration is set to announce today two proposals that would empower shareholders and the Securities and Exchange Commission to have more oversight over executive compensation at all publicly traded firms, government sources said.

The measures would require legislation, which is expected to be sent to Capitol Hill soon, one of the sources said.

Under a so-called "say-on-pay" plan, shareholders would have a greater voice over what top earners at firms are paid.

A second proposal aims to provide company compensation committees more independence as they determine what executives should make.

Members of these committees would be banned from taking any fees from their respective firms other than what they would make for sitting on the committee. If they hire an attorney or consultant to help them in their work, the contractors could only report to the committee rather than the chief executive of a firm.

Not a magic bullet (there aren't any of those around), but a good first step.

Comments

[Brett Bellmore]

You make it sound remarkably like the process Congress designed to circumvent the 27th amendment.

[rec]

I'm worried one of these days you'll run out of Elvis Costello lines

[Brett Bellmore]

Strikes me as a tad dubious: Long term heavy drinking causes visible vascular damage, but so does diabetes, and she's a diabetic.

[Eric Martin]

"I'm worried one of these days you'll run out of Elvis Costello lines"

Lucky for me he's such a prolific bastarge

[Phil]

The other day, this "Thomas Lopez" posted in about five different threads that someone was posting racist comments under publius's handle someplace. Today, he's posted in about five different threads (see here and here, for example) this slander against Sotomayor.

What manner of trollery is this, exactly? And can it be made to stop?

[Eric Martin]

Thomas Lopez: Please refrain from serial posting on comment threads with non-sequiturs.

Such commenting behavior is troll-ish and, if continued, could result in banning. I'd rather you just participate in the conversation in a more productive way, however.

[cleek]

BJ, the word you want is "borrachita".

in America, i believe we pronounce that as "bore-RATChet-a".

[mckinneytexas]

A good step toward what? Salary caps on college basketball coaches? Movie stars? Writers? Or just corporate executives?

[mckinneytexas]

"Borrachita" means, literally, small drunk woman. I have to think if there was anything to this allegation, someone would have tumbled to it before today. Sounds like crap to me.

[Eric Martin]

"A good step toward what? Salary caps on college basketball coaches? Movie stars? Writers? Or just corporate executives?"

A good step toward bringing executive level pay into better balance with the average worker in a given corporate entity. At present, those levels are severely out of whack when compared to historic levels.

Further, those levels are out of whack with proportions seen in corporate entities in other healthy, modern industrial economies.

But above all, a good step in terms of giving shareholders a say and ensuring the independence of compensation committees.

[Hob]

What the frak? I don't know if Thomas nor BJ have ever known any heavy drinkers, but I sure have. Sotomayor looks fine. (Also, BJ, if you're going to try to insult people in Spanish, it's a good idea not to badly misspell the insult.)

[AnonymousInMA]

Eric,

Thanks for highlighting the rather egregious problems with how executive compensation is currently determined. A large pet peeve of mine is folks who argue that exorbitant executive salaries are OK because that is the value that the market has placed on successful CEOs...As you point out, there is no free labor market for corporate executives since their compensation is usually determined by their boards and compensation committees which are stacked with other CEOs.

I am cautiously optimistic that the proposed legislation might actually address these problems and bring executive compensation (and severance) packages back down into the real world...

[Madrocketscientist]

I hope this goes through because I know I'd certainly like to have more of a say in how the executives at companies I hold stock in are paid.

[bilejones]

There is another, more subtle conflict. Members of these boards (and especially compensation committees) are almost certain to be senior executives within the same industry. By setting the compensation of a CEO they are helping to set the compensation levels of the industry and thus, indirectly, their own.

[chmood]

But will you still love a man out of time?

[mckinneytexas]

Perhaps I should have asked, once you get finished capping executive pay, where do you go from there? College basketball coaches?

The market does set executive compensation. Analysts monitor who is running which company and factor that in to their assessments. If people don't like a particular company's executive compensation program, they don't have to buy the stock.

With respect, I think this concern over shareholders' rights is a veil for the Progressive instinct to equalize pay, control the market and plan centrally at every opportunity.

[Phil]

If people don't like a particular company's executive compensation program, they don't have to buy the stock.

Similarly, the shareholders -- the people who actually own the company -- should be the ones who decide how much the execs get paid, and if candidates don't like it, they can look for a better deal.

[Tony P.]

mckinneytexas, I am a progressive, liberal, leftie -- pick your favorite term. I am not especially in favor of capping executive pay.

I would, however, add several more tax brackets at the top end. If a company wants to pay its CEO $100 million a year, that's cool. If the CEO turns down the job because his second $50 million will be taxed at 90%, that's fine too.

Note that this does not distort the market for CEOs. All potential CEOs would face the same tax rate; all companies would be competing for CEOs with pre-tax dollars.

--TP

[Bernard Yomtov]

Similarly, the shareholders -- the people who actually own the company -- should be the ones who decide how much the execs get paid, and if candidates don't like it, they can look for a better deal.

Exactly. The shareholders are the owners. They should get to set the pay levels. Pretty simple, really.

If people don't like a particular company's executive compensation program, they don't have to buy the stock.

Why should they have to sell their stock? Suppose I own shares in a lucrative business, but the CEO is vastly overpaid because of the mechanisms Eric describes. Why should I have to surrender the fruits of my astute investment because of that?

BTW, a further issue that ought to be addressed is the role of investment companies - mutual fund operators - in this game. These companies often hold huge blocks of a company's shares in their funds, at the same time they are trying to get other business form the company. This might be managing pension funds, for example.

There is aclear conflict of interest here, since the funds have every incentive to support management, rather than represent the interests of their shareholders, in these sorts of matters.

[Gary Farber]

"With respect, I think this concern over shareholders' rights is a veil for the Progressive instinct to equalize pay, control the market and plan centrally at every opportunity."

With respect, I'm sure you're wrong, since just about no one is proposing any such thing for any other category of employment, and since there's a specific manner of abuse at issue here.

[Shane]

I agree with mckinneytexas that movie stars and ball players are paid way too much and rates ought to be brought down. But since their pay is not set by their peers, I don't see the comparison.

Seriously, I can't see why CEOs sitting on CEO committees setting pay for CEOs doesn't offend people as rank unionism.

[efgoldman]

Tonight in the ABC story on the administration proposal, someone said:

In recent months, the financial industry has voiced its displeasure with pay curbs imposed by the government, arguing that these restrictions limit their ability to attract and retain top talent in a competitive environment. (emphasis mine)

Really, Gracie? And where else are these MBA Masters of the Universe going to take these talents? To WalMart as greeters and cashiers? This is, of course, the same "top talent" that drove some of the leading financial and industrial companies in history STRAIGHT INTO THE CRA*PPER and took the rest of the economy with it.

Talk about arrogance that knows no bounds!

[russell]

"Sounds like crap to me."

That Thomas Lopez' comments bear the hallmarks of a long-term, heavy drinker.

"The market does set executive compensation. Analysts monitor who is running which company and factor that in to their assessments. If people don't like a particular company's executive compensation program, they don't have to buy the stock."

Yes, that's realistic.

"With respect, I think this concern over shareholders' rights is a veil for the Progressive instinct to equalize pay, control the market and plan centrally at every opportunity."

Yes, certainly the history of the American left over the last 50 years is a record of their unrelenting quest to level income levels and control every aspect of the American economy.

"What American left is that?" I hear you ask.

Good question.

Seriously -- giving shareholders greater say on executive compensation is, somehow, a bad thing?

Who the hell do you think owns the company?

Executive compensation comes right out of shareholders' pockets. If there is anyone in the world who should have a strong voice in setting compensation levels, it's shareholders.

And no, "If you don't like it you can sell the stock" doesn't really cut it.

Why should executives have to answer to shareholders? Because it's their freaking money. That's why.

Thanks -

[[NOT]efgoldman]

Krugman explains my point better than I in this interview. Follow the link above.

[Slartibartfast]

Not that anyone cares, by now, but I've erased Thomas Lopez' comments here and elsewhere. The guy is clearly engaging in carpetGooglebombing.