Shareholder activism focuses on pay

Posted by Marc Hodak on January 12, 2009 under Executive compensation | Be the First to Comment

The rumblings have been clear for a while now.  This year will be big for activism on executive compensation.

The biggest complaint is “managers who walked away from the financial crisis with tens of millions of dollars despite big shareholder losses.”  While some of this reaction references managers who were paid last year for performance that turned out to be unsustained, much of the reaction is to managers who left with huge “severances.”

The fact is that most of those severances were not really severances in the traditional sense of being paid to leave; they were deferred compensation that was earned in prior years and left in the company, and accumulated pension and other benefits after years or decades of service.

The main proponents of the compensation proposals are, naturally, the unions.  The United Brotherhood of Carpenters and Joiners has submitted 23 resolutions to financial services firms.  American Federation of State, County and Municipal Employees has submitted 36 proposals, 32 of which address pay practices.  The proposals include ideas like having stock options indexed to peer performance, forcing managers to hold onto their equity until two years after retirement, and “bonus banking,” in which a portion of executives’ annual bonuses would be withheld for several years, and adjusted based on updated corporate results.

This last suggestion is actually a particularly powerful way to eliminate the short-termism that permeates much of corporate America.  We advocate a version of bonus banking for most of our clients, and have implemented it at a number of them.

None of these suggestions are bad ideas for a board to consider.  As specific shareholder resolutions, however, they attempt to force the hand of directors.  We wouldn’t dream of giving shareholders a voice in any other kind of strategy; why do they merit one when it comes to compensation strategy?

Boards, in order to be effective, must be free to consider all trade-offs in making compensation decisions.  For example, bonus banking can be a good idea, but it is expensive.  Consider telling the union, “we’re going to take half of your pay, and keep it banked for three years, then pay it out later, if you’re still with us.”  Right.  Then add, “by the way, that amount is at risk.  We’ll only pay it if we can afford to.”  Riiiiiight.

Unions aren’t the only people who negotiate risk averse contracts.  Whenever we’ve successfully implemented a bonus bank, we’ve had to offer higher target compensation in return for the extra deferral and risk.  If we didn’t, we would have been taking on additional risk of losing the manager because, unlike union employees who could not possibly find other jobs at the rates they are being paid, managers can.  That’s because of the most uncomfortable fact that union workers are paid way above market while managers are not, contrary to the impression given by the media.

But it’s easy to see whose side the media is on in all these stories about executive pay.  In the WSJ article cited here, they spent eight paragraphs on the complaints before they got to the thee paragraphs defending what is going on.  The WSJ is supposedly a business newspaper.