One of the world largest fiduciary asset managers, APG recently issued remuneration guidelines that will be applied to its portfolio of European listed companies. APG believes that the innovation in the new guidelines is twofold. First in that they are based on its practical experience of company engagements and therefore reflect an integrated investment and governance outlook. More specifically, the guidelines place a clear emphasis on value creation. By issuing the guidelines APG is aiming to make its ongoing discussions with companies around pay more effective, thus freeing up time for it to focus on other important corporate governance areas such as board structure, succession and nominations.
Posts Tagged ‘Compensation guidelines’
The issue of executive compensation has been on the forefront of corporate governance discussion around the world in the past few years. Israel is no different. In previous years there was a significant rise of executive compensation in public companies that cannot be explained or linked to the companies’ performance.
Like many capital markets in continental Europe and other countries around the world,  most of the companies traded on the Tel-Aviv Stock Exchange have a controlling shareholder. A significant portion of these companies are controlled by a limited number of business groups, the majority of which are characterized by pyramid control structures.
Concentrated ownership and dominance of company groups raise a key agency problem: the relationship between controlling shareholder and the minority shareholders. The issue of protection of minority shareholder rights and the prevention of abuse of the controlling power is therefore a subject of main consideration in Israel.
Related to the recent op-ed piece from Professor Bebchuk regarding the new Treasury executive guidelines, here are key fixes to those new guidelines recommended by Jesse Brill, Chair of CompensationStandards.com:
One key aspect of the Obama Adminstration’s new $500,000 cap that has not gotten sufficient attention is the unlimited amount of restricted stock and stock options that still can be granted under the latest “restrictions.” Equity compensation is the pay component that has gotten most out-of-line over the past 20 years. It (as well as severance/retirement/ golden parachutes) has caused the greatest disparity between CEO compensation and that of the next tier of executives (and employees generally).
The new $500,000 cap provision does prevent executives from realizing the gains in their equity compensation until after the government is paid back. But there are two major problems with how this applies:
1. It does not apply to past equity compensation. Warren Buffet imposed a similar cap on Goldman Sachs’ executives, but his restriction applies to all the equity held by the top executives. It is not limited just to future grants, as is the case with the new government restriction. So Buffett’s provision wisely requires that the key decision-makers keep all their “skin in the game” until he gets paid off.
2. Although it may help protect the government’s investment, it is short-sighted and fails to protect the shareholders’ best long term interests. The holding period should be the longer of age 65 or two years following retirement. That will ensure that the key executives make decisions that truly are in the long-term best interests of the company (as opposed to decisions aimed at a shorter period – after which an executive could depart, taking all his marbles with him).Note that holding-through-retirement also addresses the major concern about top executives’ unnecessary risk taking.
Holding equity compensation through retirement is perhaps the single most important—and fundamental – fix to getting executive compensation back on track because it also addresses all the past outstanding excessive option and restricted stock grants. And, by requiring CEOs to keep their skin in the game for the long term, it will go a long way to restoring public trust in our companies and our market, which is so important to restoring stability to the markets.
I also agree that the proposed salary caps are mainly symbolic. In 2008, Wall Street paid out $18.4 billion in bonuses to its approximately 164K plus employees. Based on this data and the limited number of firms and number of employees (5 per firm) the pay caps could apply to, I would say that 99.9% of Wall Street employees are safe from the wrath of the proposal. If you want to reduce large company wide bonus payouts in bad years, which I believe was the original intent of these proposed guidelines, that is not the way to do it. However, the real significance of the proposal may be as an implied threat to Wall Street to get its compensation act together or else face something real later on.
For a recently posted paper on how corporate law should respond to Wall Street compensation policies, see Bernard S. Sharfman, “Enhanced Duties for Excessively Risky Decisions.”
Another reaction has come from David Wilson, who writes:
A symbolic $500k salary cap may have unintended consequences. As Mr. Bebchuk points out, firms are still “free to make up for this reduction” with other forms of compensation. Because of this, the cap will alter the form in which executives are paid. Executives will require higher levels of incentive-based compensation to make up for the reduction in their “guaranteed” cash salaries.
Further, a dollar of incentive-based compensation is worth less than a dollar in cash. A CEO who sees his salary cut from $2m to $0.5m will not be in the same financial position if he receives an additional $1.5m in incentive-based pay. Michael Jensen, Kevin Murphy and Eric Wruck point this out in their 2004 paper “Remuneration: Where We’ve Been, How We Got to Here, What are the Problems, and How to Fix Them” ), in which they state “[r]isk-averse executives will ‘charge’ for bearing risk by discounting the value of the risky elements of pay.” If this is true, we can expect to see significant increases in equity-based incentives.
As Mr. Bebchuk points out, a myriad of issues that need to be addressed surround the use of equity incentives.
Critics of the administration’s proposed guidelines on executive compensation say they are a dangerous intrusion into corporate boards’ authority and would make it difficult for financial firms to fill executive positions. These criticisms are unwarranted. If anything, the guidelines are too modest and should be tightened.
Concern that the guidelines would undermine firms’ ability to attract or retain executives has been fueled by media coverage stressing the $500,000 cap on salaries. Because salaries commonly represent a small fraction of total executive pay, and firms would be free to make up for this reduction by providing additional compensation in other forms, the salary cap’s significance would be mainly symbolic. Indeed, I would have no problem with a somewhat higher salary cap, especially if that would facilitate tightening the elements of the guidelines that are practically more significant.
Companies falling under the guidelines will retain the ability to provide large compensation when necessary. The guidelines don’t impose any cap on the total pay; they only influence its form. Indeed, firms which get taxpayer funds under “generally available government programs”—which likely will constitute the lion’s share of firms receiving government capital—will be permitted to provide unlimited compensation in any form they choose provided they disclose it (as is already required) and allow shareholders to have advisory “say on pay” votes on the firm’s pay policy. Even firms that receive “exceptional assistance” (such as provided to AIG or Citibank in the past) will be permitted to compensate executives with unlimited amounts in restricted shares that can be cashed out after the government is paid back.
This is not excessive government meddling. As a major provider of capital to firms receiving exceptional assistance, the government has a legitimate investment interest in executives’ being properly incentivized. The proposed guidelines are a rather modest intervention relative to the control rights that private investors providing so much capital would likely seek.
Furthermore, this modest intervention can significantly improve incentives and performance. In a 2004 book and prior articles, Jesse Fried and I warned that common executive pay practices produce perverse incentives to focus on short-term results. To the extent that such incentives have contributed to the current crisis—as has now come to be widely suspected—the adverse consequences have been dire indeed.
Executives’ ability to profit from early dumping of their equity-based compensation can impose large costs on investors. To protect its investments in firms receiving exceptional assistance, the government is warranted in restricting executives’ freedom to unload their restricted shares quickly, before the government is repaid.
For executives to view any number of restricted shares that cannot be quickly unloaded as inadequate compensation, they must believe the firm will likely fail to repay the government, and that the restricted shares will lose their value if not cashed out beforehand. In such circumstances, the firm should be immediately taken over by the government or otherwise reorganized. It should not continue operating with a structure under which executives may be retained only if allowed to cash out before things fall apart.
After a period of public comment, the Obama administration will finalize the guidelines for firms receiving capital under general programs. I believe the final version should impose tighter restrictions, at least for firms receiving a substantial capital infusion from the government.
While the proposed guidelines seek to encourage companies participating in general programs to use restricted stock, they do not limit how quickly such restricted shares may be unloaded. This should be changed. To provide incentives to focus on long-term results, executives should be precluded from unloading restricted shares for a specified period, say three years, after they vest.
The proposed guidelines also make it too easy for firms participating in general programs to opt out of the restricted stock requirement and compensate executives in whatever form they choose. Companies that opt out only need to adopt “say on pay” votes.
While such votes may be a good governance arrangement for public firms in general, they are merely advisory and, moreover, take place in the year after compensation is awarded. Furthermore, and importantly, because the government can be expected to hold investment rights (such as preferred shares) that are senior to those of common stockholders, these stockholders may prefer executive pay arrangements that would induce more risk-taking and short-termism than would be in the interest of the government as an investor.
In short, the guidelines are a useful step in the right direction. To ensure that executives of firms receiving government capital are well incentivized, however, the administration should use the comment period to significantly tighten them.