Corporate Governance

Compensation and National Culture (Part 2)

By J Robert Brown Jr.

As noted, the Europeans have taken an approach to executive compensation that focuses mostly on caps.  The policies rely on caps on the size of the bonus relative to total compensation, caps on the amount of the bonus that can be paid in cash, and limits on the availability of the bonus.

What is the approach taken in the United States?  Process, process, process. 

The Dodd-Frank Wall Street Reform Act (DFA) contained several provisions related to executive compensation. 

First, was say on pay.  Shareholders received the right to an advisory vote at least every three years (we will review this provision in more detail in a subsequent post). See Section 951. 

Second, the Compensation Committee was strengthened, mostly by giving the SEC the authority to define "independent" for purposes of the Committee (by setting out "relevant factors" that the exchanges must consider) and by allowing the committee to act on its own in selecting compensation consultants, without the approval of the full board.  See Section 952.

The Act stops short of requiring independent compensation consultants.  It only requires that the committee consider the factors set out by the Commission (some of which are in the statute).  The provision is, therefore, far weaker than the independence requirements for auditors contained in SOX.  See Sections 201 & 202 of SOX.  In theory, committees could consider the factors and ignore them.  As a practical matter, however, this is likely to result in the widespread use of independent compensation consultants. 

Finally, the Act heightened to disclosure required for compensation.  While several provisions touched on the issue, the most interesting is the one that requires the company to disclose the ratio between the CEO's compensation and the compensation of the average worker employed by the company.  Ratios have often been used to demonstrate the escalating nature of executive compensation. 

As this provision is implemented, it will likely vary widely among companies, particularly given the anticipated variation in the median of total annual compensation of all employees (minus the CEO).  Nonetheless, it will provide another metric for judging the fairness of the compensation. 

In short, the DFA provides no caps and no substantive limitations.  The only possible exception is Section 956 of the DFA provides that federal regulators must adopt regulations or guidelines that prohibit incentive-based compensation arrangements from resulting in 'excessive compensation' or lead to 'material financial loss."  Covered financial institutions include broker-dealers and investment advisors but do not include any financial institution with assets of less than $1 billion.  The provision does not, therefore, impose caps but it does provide some authority to ban certain types of compensation practices or arrangements.

Full post as published by The Race to the Bottom on July 13, 2010 (boomark / email).