Shareholder revolt

Wednesday, July 16

Increasingly poor corporate performance, during a US economic downturn, has irritated shareholders over governance and executive pay issues. This has fuelled a slew of proxy challenges, and demands for reforms to promote 'shareholder rights'.

Several proposals have been floated in recent years to rein in 'excessive' executive compensation, as part of a general trend towards increased shareholder control and oversight over corporate decision-making:

• The activists. These initiatives have been led by institutional investors -- including large pension funds, such as CalPERS -- and investor advocates such as Nell Minow of the Corporate Library, and John Bogle, former CEO of the Vanguard Group of mutual funds.
• Company resistance. Corporations have resisted greater constraints on their decision-making, claiming that greater shareholder control exacerbates 'short-termism'-- an excessive focus on short-term performance of a company's share price.

Executive pay controversy

Under Chairman Christopher Cox, the Securities and Exchange Commission (SEC) has generally favoured business-friendly approaches, with an emphasis on improved disclosure. The SEC implemented new executive disclosure rules in time for the 2007 proxy season. In theory, greater mandatory disclosure of executive pay was supposed to moderate it, but this hasn’t proved to be true.

The Democratic party-controlled Congress has targeted executive compensation and has also sought greater measures to increase shareholder power relative to corporate boards and management. However, these bills have yet to be implemented.

The economic rationale for high executive pay packages is to reward effective corporate officers for exceptional performance. The current market downturn is calling this rationale into question -- particularly in troubled sectors such as finance. Some executives have voluntarily agreed to reduce their pay levels, by refusing, foregoing, or delaying bonus packages -- including Lehman Brothers CEO Dick Fuld and Morgan Stanley's John Mack. Yet these 'voluntary' actions are unlikely to thwart clamour for legislation on executive pay -- even if it is largely cosmetic.

Performance pay reconsidered

While there is some indirect evidence that greater shareholder control over executive pay is regarded by shareholders themselves as undesirable or beside the point, a consensus seems to be forming that current compensation systems are due for an overhaul. In particular, the credit crisis has focused the attention of companies themselves on deficiencies in their compensation models:

• In the finance industry in particular, annual bonus schemes have been identified as encouraging a short-term focus, and excessive risk taking.
• Citigroup has announced a wholesale review of its compensation policies, including the widespread practice of setting bonuses based on the performance of specific business units.
• It is likely that Wall Street will shift toward compensation policies that defer payment of bonuses over several years, and that place greater emphasis on overall corporate performance (rather than the employee's particular business unit).

Changes in corporate compensation practices are likely, but the most far-reaching moves are likely to be implemented by companies themselves, rather than by government regulation. In the case of troubled sectors such as finance, reforms may be applied to compensation standards for all employees, rather than focused on the senior executive level.

Increasingly poor corporate performance during a US economic downturn, has irritated shareholders over governance and executive pay issues - this has fuelled a slew of proxy challenges, and demands for reforms to promote 'shareholder rights'.