Uncircle the Wagons on Executive Pay - A commentary by Ira Millstein

“Uncircle the Wagons on Executive Pay”
By Ira Millstein, senior associate dean for corporate governance at the Yale School of Management
Published in the Millstein Center for Corporate Governance and Performance spring newsletter
Read the article in its original context on the Millstein Center website.

There is obvious public anger over reports, such as one in 2007, that CEOs of public companies made as much in one day on the job as average workers made over the entire year. Such “radical” papers as the Economist, the New York Times, the Wall Street Journal, USA Today, and others, continue to discuss the “pay gap,” “growing disparities,” “inequality,” and other less elegant expressions. Whether the gap is 600 times or 350 times is irrelevant, because the main point is it’s growing, not decreasing. The caption on a picture of departing CEOs at a House hearing said it all — “A Brighter Spotlight, Yet The Pay Rises.”

Once this administration is swept away and replaced by any of the presumptive Presidential candidates, the disparity between compensation at the top and bottom of the corporate ladder will become a legislative priority. Each of the presumptive candidates has insisted that “something” be done about CEO compensation. John McCain even went so far as to call for splitting the jobs of CEO and Chairman, the combined job being the cherished preserve of U.S. management.

There are sensible proposed reforms on the table. All revolve around stiffening the spines of boards of directors where, in reality, the fault lies. Boards control executive compensation, and if they remain supine, compensation will continue just where it is, out of whack with public expectations. Management won’t change its own compensation willingly.

How do you stiffen director spines? Ideas range from proposals to give shareholders advisory non-binding votes on compensation, to increasing the ability of shareholders to more easily remove directors by requiring majority voting, or granting shareholders the right to propose directors for election. These ideas and others will get a hearing, and something will get through which will somehow try to put non-caring directors at risk for their jobs, and maybe liability.

Yet, some businesses, according to recent sources, seem to have concluded that they must resist even the most benign reform suggestions, such as providing shareholders with an advisory vote on compensation. They revive the worn out ground of the “slippery slope.” Give on nothing. This is shortsighted and counterproductive; in the long-run it is likely to result in mandates far more distasteful.

This circling the wagons tactic must be a loser in the face of reality. Reasonable directors should be getting ahead of the parade by instituting processes which would bring shareholders into the compensation tent, rather than keeping them out entirely. Advisory “say on pay” is benign. Its purpose is to trigger communication between boards and shareholders. But it comes after the fact, after the compensation package is announced in the proxy materials, and hence some see it as adversarial. A prudent approach would be for directors simply to communicate with major long-term shareholders (every company knows who they are and they are not radicals) in advance of setting the package. Voluntarily seek their views in advance, and even if ideas are not adopted completely, be in a position to say shareholders were consulted, not ignored. No one disputes that boards always have the last word, legally. But they can and should listen, which is not the practice, at the moment.

Communication and consultation may not bring an immediate softening of public anger but, at the very least, it would change the picture of an arrogant management/board unwilling to listen to the people to whom they owe fiduciary responsibilities — their shareholders. Directors who don’t, can’t, or won’t change in the face of such reasonable criticism garnered through consultation with shareholders would then face a consequence: they might lose their seats in the next annual meeting election. Most S&P 500 corporations have rightly adopted some form of majority rule for such votes; any director who gets less than majority support is required to resign. Major shareholders whose views are regularly ignored will be in a position “to do something” — remove directors who have ignored them. As investors start exercising that power, it should stiffen lots of director spines.

Communication with shareholders in advance of the proxy, and assuring majority voting are “self help” devices easily and voluntarily adopted. Of course, they require courage and action by both boards and shareholders, characteristics sometimes noticeably lacking. But through such market-based actions, rather than circling the wagons, business will be able to address public anger, and the political opportunism it naturally sparks, intelligently and without apologies.