The Sarbanes-Oxley Act of 2002 (SOX) empowered audit committees to take greater control of financial reporting oversight. Nearly a decade later, passage of the Dodd-Frank Act of 2010—and the subsequent regulations being written by the Securities and Exchange Commission—has transformed the role of the compensation committee in much the same way. Just as SOX rules for greater independence, expertise and auditor-hiring clout increased the power and visibility of audit committee members, so too do the new rules on approving and justifying pay put compensation committee members in a new and influential light.
Directors like to joke that in the “old days” before Dodd-Frank, the audit committee handled most of the board’s heavy work. Not any more. Some compensation committee members, investors and their advisors believe the most profound and lasting impact of Dodd-Frank is to shift the balance of power from management to the shareholder, as new and pending regulations empower compensation committees as never before.
“We have to keep the intent of Dodd-Frank front and center,” says Robin Ferracone, the founder and executive chair of the compensation consulting firm Farient Advisors. “The intent was to encourage shareholder communication more directly, frequently and openly with their directors and Dodd-Frank is the catalyst for that. The law is not trying to become the dominant force. The law is trying to facilitate this communication. And we should not lose sight of that.”
There’s no doubt, however, that the effect of Dodd-Frank on boardrooms—more specifically the pay-for-performance proxy disclosures effective last year and the new rules expected this year for “say on pay,” clawbacks, and compensation committee and advisor independence—“is a seminal change,” says Catherine R. Kinney, a public company director who retired from NYSE Euronext in 2009 as president and co-chief operating officer and now serves on the boards of MetLife, MSCI (the parent company of ISS Governance Services) and NetSuite. “I think it’s a huge power shift in the boardroom… The fact that an investor can look at the CD&A and vote against a director is one of the biggest changes relative to performance around the boardroom table.” She sees it as one more step in the direction of progress, that is, “management and the board working together to find the right performance for the shareholder.”
Says one Fortune 100 director, who asked not to be quoted by name, “Management can no longer ask the HR person and the top three directors they like to serve on the compensation committee. Today, the compensation committee is chosen by the independent directors and working on behalf of the shareholder. It’s dramatically different and as a result, most compensation committees today are scrambling for information and education.”
Stephen W. Sanger, retired chairman of General Mills and a prominent public company director whose board service currently includes Target, Pfizer and Wells-Fargo, concurs. He says Dodd-Frank dramatically transforms the compensation committee role from “compliance to advocacy.” David Lynn, a partner at the law firm Morrison Foerster, notes that in addition to new disclosure, “what shows up in the proxy statement is more important because of the environment we’re in.”
Most compensation committee chairs are seeking direction and education on implementing both new and pending rules, and how the language of disclosure in the annual proxy statement should read. Like their audit committee brethren, compensation committee members are being encouraged to set their own budgets and retain independent compensation consultants and advisors.
“There’s a lot of trial and error—and learning— in the compensation process right now,” observed Ferracone during a meeting of the NACD Advisory Council on Compensation (See below for complete participants’ list). “As a compensation committee member, you have to be sensitive and attuned to the issues being faced from an emotional and dynamic standpoint. It takes a lot of skill to not let the mechanics of the discussion overwhelm the process and leave you with a dysfunctional result.”
New rules for all publicly traded companies— including say on pay and say-on-pay frequency in effect for the upcoming proxy season—stipulate greater disclosure, while opening the door for boards to communicate more often with shareholders. By one count, Dodd-Frank requires regulators to create 500 rules, conduct 81 studies and issue 93 periodic reports. The stated objective of the legislation is “to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices and for other purposes.”
One of the “other” purposes is to rein in risktaking promoted by excessive compensation or by compensation that is tied too closely to short-term financial performance—especially in the financial services sector, the main focus of the law.
A Long Way to Go
A recent study commissioned by the Council of Institutional Investors (CII) found that while the pay-forperformance link on Wall Street has strengthened somewhat since the global financial crisis, banks still are not tying compensation to long-term gains in performance. CII comissioned the report, “Wall Street Pay: Size, Structure and Significance for Share-owners,” to gain a better understanding of pay at big Wall Street banks and how it differs from executive compensation at other large U.S. companies. “While many banks have strengthened their pay practices, there’s still a long way to go,” says Ann Yerger, CII executive director. “The report suggests they need to do more to make sure that executive compensation rewards performance over the long term.”