Our individual savings generate the entire capital market. Either through direct investment in public corporations, or indirectly through intermediaries such as pension funds, IRA’s, mutual funds, savings banks, investment banks, insurance companies and the like. Indeed the Government itself is an intermediary as it redistributes our taxes as the source of the recovery program. All intermediaries are in fact dealing as fiduciaries for other people’s money, ultimately—ours. No matter how long the ownership chain, we are still the principals.
Together “we”, the whole investment chain, are the owners of corporate America and we should act like it. “We” have ducked our responsibility to halt compensation excesses in the financial sector and, to a certain extent, sections of the rest of corporate America. Now that compensation has come front and center in the wake of a crisis which has not only exposed its flaws, but did so on national network television, activation is essential. Not just because compensation at excessive levels is unacceptable to most of the beneficiaries—us—(which is reason enough), but because compensation is a politically attractive ground for regulation.
We should act now to re-establish the public trust in business and our enterprises. If we do not, we will face a regulatory response that can never accommodate all the unique individual circumstances of every company and industry. I believe any regulation will be so “swiss cheesed” in content, or by innovative interpretation, as to be ultimately ephemeral and ineffective.
“We” have ducked our responsibility to halt compensation excesses in the financial sector and, to a certain extent, sections of the rest of corporate America. Now that compensation has come front and center in the wake of a crisis which has not only exposed its flaws, but did so on national network television, activation is essential.
But unless we act swiftly, history teaches that regulation seems inevitable given the public anger at excessive compensation. This is not just because it is a part of the economic downturn, but because it is the part the public understands best.
There seems to be a natural recurrent cycle for corporate governance crises: crisis, regulation; another crisis, more regulation; yet another crisis, and still more regulation. Today’s crisis involves the one issue the public is in total agreement about, excessive executive compensation, so naturally, regulation is hovering.
The regulation which followed each crisis might have been avoided. Boards of directors would have needed to be attuned to, or at least just aware of, the temper of the times and perhaps, simply, a common sense of right and wrong.
Examples abound but I will just mention two. The Foreign Corrupt Practices Act of 1977 was enacted following an SEC investigation and subsequent public disclosures of bribery. Was a statute carrying criminal penalties needed to convince boards that bribing was not an acceptable method of doing business? More recently, the regulatory response to crisis included passage of the Sarbanes-Oxley Act in 2002, an event which is particularly painful to me. Just a few years before Enron, John Whitehead and I chaired a Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. The Committee unanimously recommended improvements in audit committee practices to reform the growing bookkeeping gyrations that were in use at the time. The recommendations were not generally adopted. Then came Enron et al. and the Congressional hearings that ensued. What began as our suggested voluntary practices quickly became legislated “musts” for board audit committees.
And here we are again. Who didn’t know that compensation practices had grown out of hand? Certainly the public did and complained, to no avail. As did a number of major shareholders often derided as “activist” troublemakers, but they were essentially ignored. Meanwhile all forms of compensation, in and beyond the financial sector, continued to grow, as did the distance in compensation between executive management and the factory floor.
Why did many boards fail to respond? Principally because, I believe, they chose to be tone deaf, and paid little attention to the too quiet voice of shareholders. Instead they were complicit, relying on the easy “everyone else is doing it” excuse during the high-flying era which has just collapsed.
Now the new crisis, and the bonus practices of some top-drawer bankers has brought in a troubled President ready to act on our behalf. The President, quite understandably, set forth new regulation containing direct compensation caps and related restrictions for bailed-out corporations.
Moving forward, it would be useful for us to remember the end of the ownership chain is the board of directors, the ultimate fiduciary for shareholders of every stripe. Compensation has always been the board’s responsibility. If they cease to be tone deaf, boards across the corporate spectrum will pick up the challenge and voluntarily bring compensation back to earth, before Congress, which isn’t tone deaf on this issue, moves in with broader “reforms.”
What may it take to drive spine into the board room on the compensation issue? First and foremost, pressure from the institutions that represent all of us as their beneficiaries. Those institutions, individually and as a group, generally own enough stock, directly or indirectly, to be “heard” by their investees. And we, the provider of savings to the institutions have the voice, and legs, to encourage them to be heard.
Communication with boards is available to the institutions through informal and more formal means such as proxy resolutions. Majority voting is available to shareholders of many corporations to remove compensation committee members. Public bull horns are effective. A nudge from government may come in legislated rights for shareholders to have a “say on pay” which I believe is useful, but not critical, for those institutions who seriously want to communicate with a Board. Those institutions need not await legislated “access” to place their own directors on a board, if they are serious about protecting us, their beneficiaries, rather than the boards and managements of their investees.
We know that all shareholders and taxpayers have the voice to act on compensation now.
Do they have the will?
Ira M. Millstein is the senior associate dean for corporategovernance at the Yale School of Management, and senior partner, Weil,Gotshal & Manges LLP. He is a member of the board of the National Association of Corporate Directors and has lectured and written extensively on corporate governance.