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Will threat of disclosure keep lid on pay?

New rules passed unanimously by the U.S. Securities and Exchange Commission will force companies to reveal more information about executive compensation.  But will these changes have the necessary impact and allow for real transparency?
/ Source: Forbes

If every detail of an executive's compensation package is revealed, will boards be embarrassed enough to keep pay low? Next year, investors may learn the answer to that question, thanks to new rules passed unanimously Wednesday by the U.S. Securities and Exchange Commission.

Details about lavish pension plans, perks and severance packages can no longer be withheld under the new rules, which force companies to reveal more information about executive compensation than ever before.

The stakes are high for corporate America. Since the rules were proposed in January, they have generated more interest than any other regulation in the SEC's history, SEC Chairman Chris Cox said at the open meeting Wednesday where the agency's commissioners voted on the proposals.

The rules don't place limits on executive pay. "It's not the job of the SEC to judge what constitutes the right level of compensation for an executive, or to place limits on what executives get paid," Cox said. Nevertheless, Wednesday's vote will probably change the way boards design pay packages. In the last decade, compensation has increasingly flowed into pension plans and severance packages, partly because those areas were relatively free from shareholder scrutiny.

Once that incentive is removed, firms may tie pay more closely to performance, says Lucian Bebchuk, a professor at Harvard Law School and author, with Jesse Fried, of "Pay Without Performance: The Unfulfilled Promise of Executive Compensation."

"I think [the rules] are a definite plus," Bebchuk says. "They're not going to be sufficient by themselves to solve the problems of executive compensation."

Some firms have already trimmed their compensation packages in advance of the regulations. "Companies are thinking, 'Is this perk really worth the disclosure involved?' " says Laraine Rothenberg, chair of the executive compensation practice at law firm Fried Frank.

The rules have changed somewhat since the SEC proposed them last January and opened them for public comment. The agency nixed the so-called Katie Couric rule, which would have forced companies to disclose the names and salaries of highly paid nonexecutives, such as television stars and other top talent.

Now, the SEC has revised that rule and reissued it for public comment. Under the new proposal, large companies would have to reveal the salaries, but not the names, of their three highest-paid employees. The proposed rule will apply only to employees with policy-making responsibilities, so Couric is probably safe.

The final version also requires companies to divulge more information about their stock option granting practices, because of the backdating scandal that has exploded over the last few months.

Some of the regulations, however, passed relatively unchanged. Companies will have to disclose perks if their total value is more than $10,000; currently, the threshold is $50,000. Dividends on restricted stock grants, which can total tens of thousands of dollars, will also be disclosed in companies' proxy statements. "Under these proposals, every piece of compensation will be shown and will have a dollar value assigned to it," says Paula Todd, managing principal with Towers Perrin, a compensation consulting firm.

Each executive's total pay will also be easier to find. Currently, investors must hunt for information in the pages of the proxy statement, which can be almost 100 pages long. Now, the Summary Compensation Table will include a column for total pay. "There will now be one bottom-line number, including options, for an executive's total compensation, and that number will be comparable from company to company," Cox said.

The SEC rejected one of the chief corporate complaints about the rules. The narrative section, which describes how the board determined pay levels, will be "filed" with the SEC. Currently, the report is "furnished" to shareholders. It's an important legal distinction, because filed documents open companies to increased legal liability.

Moving toward transparency
Investors may be in for some big surprises. This year, Pfizer provided a taste of what's to come, disclosing that Chief Executive Hank McKinnell will receive a retirement package worth more than $83 million total, or $6.5 million a year. Next year, every company will be forced to disclose such compensation. Under the current rules, by contrast, companies must provide only vague information about their retirement plans, making the value virtually impossible for anyone other than a pension actuary to determine.

But the question remains: Will the threat of disclosure keep a lid on executive pay? The SEC has mandated greater pay disclosure before, with mixed success. In 1992, in the midst of another wave of furor over executive pay, the SEC passed new rules designed to make compensation information easier to find. Previously, companies presented almost all pay information in paragraph form. The 1992 rules required companies to put most pay information in one easy-to-read table.

That didn't induce companies to keep pay low, says Mark Borges, a principal with Mercer Human Resources Consulting. Borges blogs about executive pay for "To the extent that the SEC thought by disclosing high pay levels it would influence behavior, it didn't seem to really have that impact," Borges says.

As more data are disclosed, executives learn what their colleagues are really making. And compensation consultants, who advise boards on executive pay, can use the extra data to argue that CEOs should be making more money. In other words, a rising tide lifts all yachts.

The 1992 rules also left open several loopholes. Severance packages and pension plans remained obscured, which is one reason why they've grown so large. "If you create these dark recesses, the companies will find a way to put a lot of the compensation in those areas," says Pat McGurn, executive vice president and special counsel at Institutional Shareholder Services (ISS), a corporate governance watchdog.

The new rules, however, close the most important loopholes. "It's going to take truly inventive, creative, dare I say illegal, behavior to evade disclosure," McGurn says.

The world, of course, has changed since 1992. The corporate scandals that heralded the end of the Internet bubble, and the Sarbanes-Oxley Act that followed, left investors feeling feisty.

In the last few years, shareholders have tried to oust board members who approved huge pay packages, and their efforts are garnering more and more support. This year, shareholder proposals related to executive pay received more than 50% of the votes at firms like JPMorgan Chase, Lucent Technologies, and Wachovia, according to ISS.

"We obviously saw a handful of companies that faced pretty strong opposition from investors related to problems in the pay arena," McGurn says. "I expect, armed with these disclosures, we'll see a lot more activity."