Australia (and the rest of the world) needs the USA to fix its executive pay governance
02/03/2009
mail.png

Global action to regulate executive pay will not fully achieve its aim. In fact, for already well-regulated and relatively well-behaved countries like Australia, it will just add to the regulatory burden with no consequential benefit.

Why? The source of the problem is US governance.

The USA is a destination for the world’s most talented; it is also a vast pool of executive talent for the world’s companies outside of the USA, including those in Australia. That means every company board outside of the US with the need to draw on this pool has to make exceptions and adapt pay to attract the talent and experience that can best manage their enterprise.

Australia has been fortunate in having a regulatory regime that provides companies with the flexibility to do this.

A free global executive labour market creates pressure for convergence of the price for labour. So, gradually, the US pay spiral impacts advanced economies around the world, with US pay levels and also good and bad practices in pay and incentive design being exported with the executives.

Why has US executive pay spiralled beyond reasonable relativity measures (i.e. to average worker pay, overseas counterparts, company cost bases, and company performance), when the “land of the free” has had arguably more executive pay regulation than most other OECD countries? This includes restrictions on termination payments brought in during the 1980s, limits on non-performance related pay in the 90s, and the most comprehensive disclosure regime of any country in the current decade.

In their well-researched and cogently argued “Pay Without Performance: The Unfulfilled Promise of Executive Compensation” (Harvard University Press, 2004), Lucian A. Bebchuk and Jesse M. Fried, Harvard and Berkeley law professors, respectively, argue that corporate governance in the US (unlike Australia’s more balanced model) is more realistically described by a “managerial power” model in which US CEOs have sufficient power over their boards to dictate their own compensation, subject only to what the authors call an “outrage” constraint.

Well, now it seems that the outrage constraint has been exceeded.

New regulations pushed through by Senator Dodd are being implemented that, while currently limited to companies receiving government support, may be extended to all companies. But, like virtually all US pay regulation, it has so many holes that it is easier for companies to drive through them than try to comply with its underlying principles.

For example, one aspect of the $500,000 cap within the new regulation that has not received enough attention is the unlimited amount of restricted stock and stock options that can still be granted under the latest restrictions. Insufficiently performance-focussed US equity compensation is the pay component that has become most out of line in the last 20 years.

The new $500,000 cap prevents executives from realising the gains in their equity compensation until after the government is paid back. A primary concern is that the provisions would prompt financial institutions to do whatever they can to pay back the government funds, undermining its efforts to stimulate lending and coax the economy into recovery.

While Senator Dodd pushed through the regulation, it was Treasury Secretary Timothy Geithner, like Hank Paulson before him, who strongly resisted calls for it to be tougher on executive pay. And the reason why Mr. Geithner resisted is at the nub of the US, and hence global, problem. It is the true reason that US executive compensation is out of kilter with how the rest of the world values executive talent. It is the root cause of the US pay disease that has infected a world that (correctly) puts up no barriers to executive mobility.

Simply put, US companies in need of a bail out would not seek it if the regulation was too onerous. The chairman of the board would have a fundamental objection to seeking government help that was too tough on the CEO’s pay. Scratch the surface and you realise that in the US the board chairman and the CEO are likely to be the same person.

And the board will be in violent agreement with their CEO/chairman. Why? Because the CEO gave them their jobs. They have not been elected by a majority of shareholders, as they would be in most OECD countries with a semblance of shareholder rights.

That also probably explains why the US has, over time, the lowest rate of CEO terminations among developed countries. The CEO does not fire the CEO. And the CEO’s director appointees approve his/her pay.

US boards lack true independence.

And no amount of black letter pay regulation will resolve this basic governance problem. Until the US bites the bullet and rights the balance of power between shareholders and management by allowing shareholders to choose their board members for true independence, the US executive pay ailment will continue to infect the world. This is what the politicians, governance experts, IMF, FSF, and the rest of the G20 should be saying to President Obama.

There may be some hope. Mary Schapiro, President Obama’s newly appointed head of the SEC (equivalent to ASIC), has said that Wall Street must repair itself after the financial crisis and that one way to do so is by “giving shareholders a greater say on who serves on corporate boards, and how company executives are paid.”

But many people have been trying for this since the time of Roosevelt’s New Deal and his Securities Exchange Act of 1934. At the time management successfully fought for restrictions on shareholder rights, and they have been successful since.

Washington politics is a tough battleground of vested interests and, as we have witnessed with Senator Dodd’s watered down executive pay restrictions (notwithstanding that they were based on a false premise), it is difficult to achieve true reform.

In the meantime, it is just an expensive political game of ever more regulation that only impacts the periphery of the problem. Fix the governance by providing shareholders with basic rights similar to those in other advanced economies, get rid of the thousands of pages of black letter pay regulation that has been expertly circumvented for decades, and replace it with a few pages of principles-based law.

The outcome will be better for shareholders, sustainable wealth creation, global executive mobility and capitalism.

© Guerdon Associates 2021
read more Back to all articles