Experts Tout U.K. Law to Allow Shareholder Voice on Pay

By Staff Report

Mar. 9, 2007

A British law that allows shareholders a nonbinding vote on executive compensation has helped to curb excessive CEO pay and better link remuneration to performance, according to experts who testified Thursday, March 8, before a House committee.

The British practice, in place since 2003, is similar to one outlined in a bill introduced by House Financial Services Committee Chairman Barney Frank, D-Massachusetts. Frank’s measure was the centerpiece of the March 8 hearing.

Under Frank’s proposal, public companies would be required to give shareholders an annual nonbinding advisory vote on executive compensation plans. It also would ensure a nonbinding vote on a “golden parachute” package if one is awarded while the company is being sold.

In Britain, such an approach has been a success, according to Stephen Davis, a fellow at the Millstein Center for Corporate Governance and Performance at the Yale School of Management. Davis’ organization studied the U.K. system.

“Advisory votes on executive pay policies are rational, timely, road-tested and practical for use in the United States,” Davis testified before the House committee.

Shareholder voting on compensation has resulted in “taming the rate of increase, curbing opportunities for ‘pay for failure,’ and linking compensation dramatically closer to performance,” Davis says.

A representative of the U.S. business community, however, warned that shareholder voting could undermine corporate governance by fostering proxy wars and distracting directors from other critical responsibilities.

John Castellani, president of the Business Roundtable, says he favors improved disclosure of executive pay. But the level of compensation should be set by corporate boards.

A 2006 survey of the Business Roundtable’s membership found that 85 percent of company boards are composed of at least 80 percent independent directors, who are elected by shareholders and act on their behalf.

“Corporations were never designed to be democracies,” he says. “While shareholders own a corporation, they don’t run it.”

Davis argued that a nonbinding advisory vote provides “shareholders tools they need to act as real owners of the corporation.”

Shareholders are getting more information on CEO pay thanks to enhanced disclosure rules promulgated last year by the Securities Exchange Commission. But transparency alone is not sufficient, according to one witness.

Reforming pay structures “depends on information and the ability to respond,” says Nell Minow, editor of the Corporate Library, a governance watchdog organization. A mechanism like advisory voting enables shareholders to align salaries with performance.

A survey by Minow’s organization of 1,400 CEOs showed that their median total compensation was $13.51 million in fiscal year 2005, up 16 percent over 2004.

But Steven Kaplan, a professor at the University of Chicago Graduate School of Business, said most CEOs are not overpaid and are judged by their firms’ performance.

He said the median salary for the boss of an S&P 500 company with more than 20,000 workers was $8 million.

One problem, Kaplan says, is that the best corporate leaders are opting to ditch shareholder hassles for the riches of the private equity world. The Frank measure would be another straw on the camel’s back.

“On the margin, the bill would reduce the attractiveness of being a public-company CEO,” Kaplan says. “Good CEOs and CFOs say, ‘I’d rather be doing something else.’ ”

Enhancing a CEO’s career path isn’t as important as addressing the yawning disparity between executive compensation and pay for other workers, a situation that undermines confidence in the economy, says Rep. David Scott, D-Georgia.

“I am concerned that executive pay has become dangerously outsized,” he says.

The Frank bill is a good response. “This is a modest, common-sense approach to dealing with a very serious issue that is threatening the fabric of our economic system,” Scott says.

At the March 8 hearing, Republicans were skeptical about the bill. They voiced concerns about government trying to influence business decisions and worried that shareholder voting on executive compensation would lead to direct voting on other aspects of company operations.

Frank has scheduled a March 21 committee vote on the bill. That will provide another opportunity for Capitol Hill comment on executive salaries—an issue that’s building momentum, Minow says.

“It’s quite clear that there is a tremendous amount of support for doing something about CEO pay,” she says.

—Mark Schoeff Jr.

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