On April 20, 2007, the House passed H.R. 1257, the Shareholder Vote on Executive Compensation Act. The bill will require that public companies ensure that shareholders have an annual nonbinding vote on their company's executive compensation plans. It also requires a nonbinding advisory vote if the company awards a new golden parachute package while simultaneously negotiating the purchase or sale of the company.
This bill is a response to the increasing disparity between pay between workers and executives in recent years. In 1991 the average large company CEO received roughly 140 times the pay of an average worker, according to Lucian Bebchuk, Professor of Law, Economics, and Finance at Harvard Law School. In 2003, the average CEO received 500 times what the average worker made. In 2005 the median CEO received $13.51 million in compensation, up 16 percent from 2004, according to the Corporate Library's 2006 CEO Pay Survey. This was after a 30 percent increase over 2003, a 15 percent increase over 2002 and 9.5 percent over 2001.
Costs of Executive Compensation
The amount of money involved reflects real costs to shareholders and has real consequences. In 1993, the aggregate compensation paid to the top five executives of U.S. public companies represented 5% of company profits; by 2003 the ratio had more than doubled to 10% and the total amount paid to these executives during this period was roughly $350 billion. The size and triggers in these packages also appear to be giving executives incentives that undermine shareholder value and market confidence, such as manipulating earnings or engaging in unprofitable mergers and acquisitions.
Increasingly, research indicates that executive compensation does not appear tied to company performance. Others have noted that in many instances senior executives appear to be being “paid for failure.” As this Committee has seen first hand, even executives of institutions that lose money, restate earnings, and face extensive regulatory scrutiny have received (and retained) substantial compensation packages.
Recent Securities and Exchange Commission Compensation Disclosures
Last year, the Securities and Exchange Commission (SEC) revised its disclosure rules to require that public companies provide more disclosure of executive compensation than had previously been the case. The SEC's final rules will require that companies disclose to shareholders, in clear and detailed language, their executive compensation practices. In particular, it will require greater disclosure of the company's compensation plans for the CEO, CFO and highest paid executive officers and board members.
Although the executive compensation rules have made substantial progress on disclosure, it does not provide any new tools for owners to tailor/improve their company's compensation approach, nor change the fundamental relationship between CEOs and Boards that gives rise to high CEO pay: in general, CEOs select the Boards that set CEO pay. Building off these new SEC disclosures, H.R. 1257, “The Shareholder Vote on Executive Compensation Act” will require that public companies ensure that shareholders have:
- An annual nonbinding advisory vote on their company's executive compensation plans;
- An additional nonbinding advisory vote if the company awards a new golden parachute package while simultaneously negotiating the purchase or sale of the company.
This second vote is designed to help address a CEO's natural conflict of interest when negotiating the selling price of a company while simultaneously negotiating an additional personal exit package (e.g., as noted above, a CEO may be willing to sell the company for less if he/she personally receives more - thereby reducing shareholder value). This provision would not apply to long disclosed “change in ownership” agreements - and would only apply to new provisions added while negotiating the sale/purchase.
The nonbinding advisory vote will give shareholders a mechanism for supporting or opposing a company's executive compensation plan without micromanaging the company. Knowing that they will be subject to some collective shareholder action will help give boards more pause before approving a questionable compensation plan.