Corporate Governance

The SEC, Corporate Governance, and Executive Compensation (Part 2)

By J. Robert Brown

The staff of the Commission has been working hard at improving compliance with the new executive compensation disclosure requirements adopted last year so reports the WSJ.  A new round of comment letters on the inadequacy of the disclosure have been issued.  The efforts have apparently concentrated on increasing the transparency in how companies actually translate "individual performance" of top officers into actual compensation.  

As we have pointed out in a paper on the subject (Corporate Governance, the Securities and Exchange Commission and the Limits of Disclosure), the Commission has for a number of years been using disclosure not to provide necessary information to investors but to affect the corporate governance of public companies.  This is an example.  Under state law, boards are not required to show a relationship between compensation and actual performance.  It is enough that the compensation is approved by independent directors.  As a result, compensation may be based on some subjective analysis of performance but it is also based on what the CEO wants and expects. 

By forcing boards to disclose the relationship between performance and compensation, the staff is not really just trying to induce more disclosure.  Instead, it is forcing boards to actually ensure that there is a relationship.  In other words, the disclosure requirements are designed to induce a board to change the way it determines compensation.  This goes to substantive standards of governance, not disclosure.  As we have noted, however, there is a limit to how much the Commission can change through the use of disclosure.  Moreover, this approach often has unintended consequences.  To meet the Commission's standards, companies may employ metrics that rely on short term occurrences such as an improvement in earnings or stock prices, metrics that can also provide an incentive to commit securities fraud.

What really needs to happen in this area is not increase the amount of disclosure but to make more meaningful the fiduciary obligations of the board in determining compensation.  But that would require rigour from the Delaware courts.  So for now, disclosure is the only albeit imperfect avenue to force boards to perform the proper analysis.   

Full post as published by The Race to the Bottom on January 30, 2008 (boomark / email).