The reform effort arising from the financial crisis highlighted numerous concerns about executive compensation decisions.1 These concerns resonated in Congress during the debates. As a result, the Dodd Frank Wall Street Reform and Consumer Protection Act requires the Commission to strengthen the independence of the executive compensation decision making process. Today’s proposal is designed to give life to this idea.
There is one aspect of today’s proposal as to which I am particularly interested in hearing what commenters have to say. The proposal applies the enhanced independence requirements depending on how a company makes compensation decisions. If a company’s decisions are made by a compensation committee, the rules apply, but if decisions are made outside of such a committee, even if made by a sub-set of the Board of Directors, the rules do not apply. The proposal’s focus on form over substance has consequences and I wonder about whether this is the right approach.
For one thing, by basing the requirements on whether or not a listed company has a compensation committee, the proposal ultimately is reliant on voluntary compliance. This is because companies are not required by law to have a compensation committee, nor do the listing standards at every exchange require compensation committees. For example, NASDAQ allows a group of independent directors that is not a committee to be responsible for making recommendations regarding compensation. In the future if a company wanted to avoid compliance, it could, in theory, dissolve any existing compensation committee or avoid forming one. Even if a company were listed on an exchange whose listing standards require a compensation committee, it is conceivable that a company could move its listing to another exchange whose listing standards are more permissive.
Perhaps voluntary compliance is enough. Today, the vast majority of listed companies have compensation committees, and dissolving a committee or changing where a company is listed seems like a significant endeavor simply to avoid this rule. But I do not know what the future holds.
Voluntary compliance also creates the potential for an uneven playing field. If various companies don’t have compensation committees, it could harm both shareholders and companies. Shareholders would have the additional burden of continually monitoring how a particular company is making compensation decisions. And companies complying with the rules may find themselves at a competitive disadvantage. Neither of these results is appropriate but they are a possibility under the proposal.
I encourage commenters to carefully consider the proposal and whether the final rule should apply equally to all listed companies, regardless of whether their compensation issues are considered technically by a committee or in some other way.
Although there are questions about today’s proposal, I will support its publication.
Thank you.
1 See, e.g., Financial Regulatory Reform: A New Foundation – Rebuilding Financial Supervision and Regulation (2008) (Stating that “Among the many significant causes of the financial crisis were compensation practices. In particular, incentives for short-term gains overwhelmed the checks and balances meant to mitigate against the risk of excess leverage. We will seek to better align compensation practices with the interests of shareholders and the stability of firms and the financial system through the following five principles. First, compensation plans should properly measure and reward performance. Second, compensation should be structured to account for the time horizon of risks. Third, compensation practices should be aligned with sound risk management. Fourth, golden parachutes and supplemental retirement packages should be reexamined to determine whether they align the interests of executives and shareholders. Finally, transparency and accountability should be promoted in the process of setting compensation. As part of this effort, Treasury will support federal regulators, including the Federal Reserve, the SEC, and the federal banking regulators in laying out standards on compensation for financial firms that will be fully integrated into the supervisory process. These efforts recognize that an important component of risk management involves properly aligning incentives, and that properly designed compensation practices for both executives and employees are a necessary part of ensuring safety and soundness in the financial sector. We will also ask the President’s Working Group on Financial Markets (and the Council when it is established to replace the PWG) to perform a review of compensation practices to monitor their impact on risk-taking, with a focus on identifying whether new trends might be creating risks that would otherwise go unseen. These standards will be supplemented by increased disclosure requirements from the SEC as well as proposed legislation in two areas to increase transparency and accountability in setting executive compensation.
First, we will work with Congress to pass “say on pay” legislation – further discussed in a later section – that will require all public companies to offer an annual non-binding vote on compensation packages for senior executive officers.
Additionally, we will propose legislation giving the SEC the power to require that compensation committees are more independent. Under this legislation, compensation committees would be given the responsibility and the resources to hire their own independent compensation consultants and outside counsel. The legislation would also direct the SEC to create standards for ensuring the independence of compensation consultants, providing shareholders with the confidence that the compensation committee is receiving objective, expert advice.”)
http://www.treasury.gov/initiatives/wsr/Documents/FinalReport_web.pdf