If the CEO’s High Salary Isn’t Justified to Employees, Firm Performance May Suffer

Dina Gerdeman writes about the other meaning of equity compensation — the perception of fairness in pay throughout the company, as seen by both employees and investors:

The gap between the large sums that CEOs take home versus average employee pay is taking on added importance in 2018, as public companies in the United States are mandated for the first time to disclose pay ratios between the CEO and employees. Harvard Business School Assistant Professor Ethan Rouen warns that if those disclosures are not made with proper context, they could ignite worker backlash and harm productivity.“

When you hear the amount that a CEO makes, it is going to seem outrageous. People are going to react with passion,” Rouen says. “So, it’s going to fall on every company that has to disclose these figures to provide some explanation and give a measured response justifying the pay disparity.”

Connections between wage disparity and company performance are detailed in Rouen’s recent working paper, Rethinking Measurement of Pay Disparity and its Relation to Firm Performance.

In essence, firms can flourish when they pay their workers fairly—and struggle when they don’t, the research suggests.

Source: If the CEO’s High Salary Isn’t Justified to Employees, Firm Performance May Suffer

Netflix raises executive salaries, proving that ‘performance-based’ pay always was a sham – LA Times

One of our favorite reporters, Michael Hiltzik, writes a very important story about what the new tax bill reveals about the failures of CEO “incentive” pay.

The big news Friday on the executive compensation front is that Netflix is converting some of its “performance-based” pay for its top executives to straight salaries, thanks to the recently-passed tax bill.But people may be taking the wrong lesson from the change. On the surface, it looks like the five executives covered by the change are getting big raises thanks to the tax bill. But the reality is a bit more complicated. And what the new policy at Netflix really tells us is that the old “performance-based” executive compensation system always was a sham, anyway….[Under the Clinton-era rule that exempted “performance-based” pay (stock options) from the ceiling on deductibility companies and board comp committees became] adept at tailoring performance targets to guarantee maximum pay for top executives. The definition of “performance” became suspiciously flexible, as if corporate boards first decided how much to pay their executives, and then cobbled together performance targets to make sure they hit the mark. A great example was the pay of IBM’s chief executive, Virginia Rometty.

As we reported, in 2016, the fifth year of her tenure, IBM’s revenue declined 2% to $79.9 billion; the company turned in four more quarters of shrinking revenue, making 19 in a row; and its full-year profit was down 11% to $11.9 billion. Based on this “performance,” Rometty’s bonus rose to $4.95 million from $4.5 million — her largest bonus ever.

Source: Netflix raises executive salaries, proving that ‘performance-based’ pay always was a sham – LA Times

Will New Pay Ratio Disclosure Lead to “Public Infamy?” – CEO Pay Updates: 2017 Proxy Season

Rosanna Landis Weaver writes about pay ratio disclosures for As You Sow, quoting Alexander Hamilton: “Public infamy must restrain what the laws cannot.”

CEO pay has continued to rise sharply in the years since Mackey said a pay cap was not an impediment to hiring. Perhaps greed and executive entitlement have increased markedly since 2009. Still, it is worth recalling that an arbitrary limit of 17:1 was not a problem less than a decade ago as you see ratios of over 170:1 in 2018.  I expect to see an astonishing range of data come out on pay ratios this year. The SEC has given companies broad discretion on how to calculate the data, and broadened it even more with additional interpretive guidance in September. Because the data will be variable it will make it more difficult to compare company to company, within industry, or by size. That may backfire on those that hoped to add complexity to cloud data comparisons. The overall ratio will stand out even more glaringly.<P

Perhaps public infamy – which should be focused on the directors who design the packages, the shareholders that approve them, as well as the executives themselves – may yet restrain what this disclosure will now clearly illustrate. In 2015, SEC Commissioner Gallagher, in his opposition to the rule wrote of “perceived income inequality” in the same tone that others in his party write of “purported climate change.”  In both of these matters, numbers don’t lie.

Source: Will New Pay Ratio Disclosure Lead to “Public Infamy?” – CEO Pay Updates: 2017 Proxy Season

Vlerick research: Overpaid CEOs may worsen corporate performance — Quartz

As we have been saying for more than 20 years….

[O]verpaying executives can also be a sign of weaker corporate governance, [Xavier] Baeten said. Overall, companies whose chief executives are paid relatively less tend to have a higher return on assets, according to a study by Vlerick [Business School]. The research looked at companies in the UK, Netherlands, Sweden, Belgium, Germany, and France, from 2010 to 2016. As market capitalization increases, executive compensation also rises.

Baeten says there’s little-to-no correlation between higher executive pay and improving corporate performance. While that may be so, the strategy remains popular: In France, the median remuneration of CEOs running the 40 biggest public firms increased 31% last year from 2014.

Execs are also well compensated in the UK, where Vlerick found that CEOs at the largest corporations take home 100-times more than the average employee at their firms, compared with 86-times for continental European companies in the study, which excluded Sweden.

And women are almost entirely locked out of the executive suite: only 5% of European CEOs are female, according to the research. This imbalance, too, deserves scrutiny for many reasons, not least because research by Scandinavian bank Nordea has shown that women CEOs tend to beat the broader market, according to Bloomberg.

Source: Vlerick research: Overpaid CEOs may worsen corporate performance — Quartz

Bosses pay smackdown: A fifth of FTSE companies named and shamed but where is Persimmon? | The Independent

It’s billed as a world first: Today the Investment Association has named and shamed 143 UK listed companies that endured shareholder rebellions of at least 20 per cent in the last year. That amounts to more than a fifth of the constituents of the FTSE All Share Index finding themselves corporate naughty step, including some very big names. Corporate aristocracy such as WPP, BT, Morrisons AstraZeneca, Thomas Cook, HSBC, Reckitt Benckiser, Ladbrokes, Man Group, Pearson, William Hill, Foxtons, Balfour Beatty, Sports Direct and Sky are all there.The creation of the register is a key plank in the Government’s package of corporate governance reforms, driven largely by outrage over bosses pay. 

Source: Bosses pay smackdown: A fifth of FTSE companies named and shamed but where is Persimmon? | The Independent

Pearson tops list of shareholder revolts on remuneration

The biggest shareholder revolt of the year in the UK over boardroom pay was at Pearson, the education group, where almost two-thirds rejected the company’s remuneration report.

According to a new public register of shareholder voting, hosted by The Investment Association, Pearson saw more shareholder votes against its pay report this year, at 65.59%, than any other listed company.

Source: Pearson tops list of shareholder revolts on remuneration

Mark Gilbert Has Forgotten the Meaning of Capitalism

On Bloomberg, Mark Gilbert asks:

Should the investment arm of one sovereign nation be using its financial muscle to influence salary policies in other sovereign nations, setting principles which then guide how it votes in particular examples?

It isn’t surprising that he gets the wrong answer, calling the sovereign wealth fund’s votes against excessive compensation “mission creep.” He’s asking the wrong question. It should be: “Should a major shareholders who is a sophisticated institutional investor have the right to exercise its independent judgement on matters legally required to be put to a shareholder vote?”

The answer is yes. That is what capitalism means. A provider of capital has certain rights granted to ensure confidence in the markets through transparency, accountability, and structural limits on conflicts of interest. To put it another way, who is in a better position to evaluate CEO pay, the board members selected by, paid by, and informed by the CEO him or herself or a fiduciary shareholder obligated to deploy its resources to maximize returns for its beneficial owners?

Gilbert presents no evidence that these actions are taken for any reason other than the creation of shareholder value, a case he cannot make for the design of most CEO pay plans. On the contrary, he quotes the fund’s policy approvingly, noting that

it would back remuneration policies that are “driven by long-term value creation and aligns CEO and shareholder interests.” Pay packages should be transparent, pension entitlements should be only “a minor part” of total packages, while a “substantial proportion” should be in the form of equity that’s locked in for “at least five and preferably 10 years.”

His objection is Norges’ conclusion that its efforts should “moderate pay levels in the longer term.” Of course, he has no basis for arguing that this goal, even if achieved, would be anything other than beneficial to shareholders.

Performance-Based Compensation May “Die” Under the Tax Cut Legislation

An amusing but telling “obituary” for performance-based compensation by Dan Walter outlines the consequences of doing away with the tax benefits for pay linked to stock price increases.

The proposed tax reform bill of 2017 would eliminate many of the time-tested and successful components of equity compensation, effectively removing one of the three legs of many companies’ three-legged stool of compensation philosophy.

Under the proposed rules:

Appreciation vehicles such as stock options and SARs would be taxed at vesting, instead of at the time of exercise. This would effectively shorten their useful lives from potentially 10 years to perhaps 4 or 5 years. It would also make the use of these tools for pre-IPO or other illiquid companies too risky to be a recommended practice.

Full value vehicles like RSUs, would be taxed much as they are today, but with far less flexibility in deferring income or linking vesting to performance conditions.

Performance vested awards would be taxed immediately, instead of at the time of performance achievement and associated vesting. While these are currently investors’ preferred tool for executive long-term incentives, the change in taxation would make them a punitive form of pay beginning in 2018.

It appears that all outstanding equity would be subject to these rules as of January 1, 2018. This would result in changes for both companies and employees that would include the death of long-term motivation and retention tools, immediate taxation for employees, acceleration of expense associated with all equity-based incentives and much, much more.

Presumably, cash bonuses tied to financial metrics or other performance goals would still be available.

Gretchen Morgenson: 20 Years of Corporate Governance

In her last column for the New York Times, Gretchen Morgenson summarizes the best and worst and most improved of the corporate governance issues she has reported on, quoting VEA Vice Chair Nell Minow:

Nell Minow is a corporate governance expert and vice chairwoman at ValueEdge Advisors, a firm that guides institutional shareholders on reducing risk in their portfolios. She has been rattling cages in the governance field since the mid-1980s and says she’s seen a definite improvement in boardroom makeup and practices.

“When I started in this field, O. J. Simpson was on five boards, including the audit committee of Infinity Broadcasting,” she recalled in an interview. “And at another company, the C.E.O.’s father was on the compensation committee. We’ve come a long way.”

That’s not to say that problems arising from sleepy and clubby boards have been eradicated. “Exhibit A is executive compensation,” Ms. Minow said. “The first C.E.O. pay package I ever complained about was $11 million. The very fact that that has gone completely berserk shows that boards are still a long way from where they should be.”

Do Performance Share Units Work?

Aubrey E. Bout and Blaine Martin of Pay Governance evaluate the effectiveness of a decade of performance stock units on shareholder value.

PSU plan payouts in aggregate were aligned with company total shareholder return (TSR): plans paying out above target showed significantly higher TSR than plans paying out below target during the same period.

There is no one-size-fits-all approach to pay-for-performance: PSU plans using both operating metrics and relative TSR metrics show strong alignment with TSR over the contemporaneous period.

We found that PSU payouts for plans implemented in and after the first year of say-on-pay (SOP) had higher payouts than plans before SOP, but this trend is likely influenced by broad stock market trends independent of SOP.

PSU plans based entirely on operating metrics had median plan payouts at or below plans that included Relative TSR metrics in 7 of 10 years reviewed. This finding suggests that Compensation Committees closely scrutinize goal setting when using operating metrics in PSU plans, which rebuts arguments that companies commonly set easy operating financial goals to get above-target payouts.