After the financial crisis that felled some of Wall Street’s biggest players, politicians vowed to take a hard line against one of the most prominent symbols of excess: lavish executive pay.
But don’t expect them to do that by actually putting a cap on how much executives take home.
The Obama administration’s proposals for regulating executive pay are focusing instead on making the process of determining compensation more public, including giving shareholders a nonbinding say in pay packages.
The hope is that such measures act as a kind of peer pressure, forcing executives and their boards of directors to be more fiscally responsible and less focused on risky bets, but stopping short of making government officials into pay police.
Members of Congress, who held a hearing on the matter in mid-June, appear eager to push for legislation to regulate executive compensation more tightly, perhaps even before their late summer break.
The attention to executive pay comes after years of watching salaries among top brass swell substantially, although that has ebbed amid the financial crisis and recession. An Associated Press analysis of pay packages for chief executives of companies in the Standard & Poor's 500 index found that the median pay package fell 7 percent, to $7.6 million, in 2008.
According to the AP analysis, the median cash payout of salaries and bonuses alone for CEOs was $2.4 million, a 20 percent drop from a year earlier. Still, that’s 48 times what the average worker makes, according to the AP.
While there has been an outcry over such disparity, Americans also may balk at the idea of the government setting salaries, especially if such pay caps trickled down below the executive suite.
“The idea of having a free labor market where your compensation isn’t controlled by a government authority is very much in keeping with the sort of liberal tradition in the United States,” said David Lewin, a professor at UCLA’s Anderson School of Management.
Administration officials also may be pushing for transparency instead of pay limits at least in part because it can be very difficult to design a law that puts a real cap on executive pay packages, without any loopholes. Politicians have learned that the hard way.
“The government’s previous attempts to kind of regulate executive pay have been colossal failures,” said Carol Bowie, head of the Governance Institute at RiskMetrics Group.
Perhaps the best-known example, an attempt at using tax laws to effectively limit executive salaries to $1 million, simply led to an increase in other forms of compensation, such as bonuses.
Also, any attempt to put a strict cap on executive pay would be difficult and costly to enforce, given the hundreds of high-ranking executives who are receiving a broad array of compensation, ranging from stock options to use of the company jet.
“It’s one thing to pass a law. It’s another one to enforce (it),” Lewin said.
Instead, administration officials are hoping that a combination of tougher market regulation and more avenues for shareholders to express their displeasure will force pay closer in line with long-term corporate performance.
One key aspect of the regulations laid out by Treasury Secretary Timothy Geithner calls for shareholders to cast a nonbinding vote on whether they approve or disapprove of how much the top brass were paid. The so-called “say on pay” proposal does not give shareholders any material say over what an executive gets paid, but many believe it would pressure board members to offer better disclosures about how pay is calculated, and perhaps even limit pay.
Ralph Walkling, executive director of Drexel University’s Center for Corporate Governance and a professor of finance, said his research has shown that executive compensation does tend to drop when shareholders give a lower percentage of votes to compensation committee board members. Besides simply selling their shares, that is the most overt way shareholders can show now that they are dissatisfied with how pay is being doled out.
Lewin said those companies that have voluntarily asked shareholders to vote on pay packages also, by and large, offered a more comprehensive discussion of how they calculated the packages. Still, she thinks it’s too early to say whether the “say on pay” proposal would be effective, if it became law.
In addition to the “say on pay” plan, the Treasury also is proposing tougher standards for ensuring the board committee that determines executive pay is made up of independent directors, who have their own budget and authority to hire consultants and lawyers.
The Securities and Exchange Commission also is proposing changes that would require companies to tell shareholders more about how the company manages risk, chooses board members and determines executive pay. But in a statement, SEC Chair Mary Schapiro took pains to say that the regulators had no intention of limiting what an executive can make.
“At the SEC, our role has not been to set pay scales or cap compensation. Our role is to protect investors by ensuring that they have the information needed to make sound investment decisions, whether those decisions impact proxy voting or a decision to buy or sell a stock,” Schapiro said in the statement.
Still, even the Obama administration’s more self-directed approach could have unintended consequences. Some compensation experts believe government regulations requiring executives to more clearly disclose their salaries and other forms of pay had the side effect of actually raising executive pay, since competing executives were more easily able to compare themselves to other CEOs and demand a commensurate salary.
“I think many times when the government tries to legislate economics (it) fails, just in the same way that often you can’t legislate forces of nature,” said Walkling said.