In 2009, public furor, in the form of outrage in the press, erupted over executive pay packages and steep executive bonuses, especially for companies that received bailout money from the American taxpayer, including the executives from American International Group Inc. (AIG).
“The Congress and the public expressed significant concerns over reports of AIG making approximately $168 million in retention award payments ... payments being made by a company receiving large-scale Government financial assistance ... [and to] the group whose financial losses largely had led to the need for federal assistance,” according to a SIGTARP (Office of the Special Inspector General for the Troubled Asset Relief Program) 2009 study.
In July 2010, the U.S. Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which included a provision about executive compensation. In January 2011, the U.S. Security and Exchange Commission (SEC) adopted rules allowing stockholders to share their thoughts on executive compensation. The emphasis is on ’share.’
“As with the say-on-pay vote and the shareholder vote on the frequency of such votes, this shareholder vote ’shall not be binding on the issuer or the board of directors of an issuer,'” according to the SEC’s Final Rule effective April 2011. In plain words, the shareholders are allowed to participate, but without necessarily gaining anything, making the issue just empty talk.
Shareholders, incensed about executive pay packages that were approved despite having voted against them, have taken corporate boards unsuccessfully to court. In March, a stockholders’ suit against Jacobs Engineering Group Inc. concerning a 2010 bonus package was dismissed because the SEC ruling is nonbinding.
Rulings in court cases in California and other states using the say-on-pay SEC ruling were many times dismissed, such as the case of Intersil Corp. of California, because “the shareholder vote alone is not enough to rebut the presumption of the business judgment rule,” according to a March Law.com article.
Stockholders are “learning the hard way that the non-binding shareholder votes don’t mean all that much to the courts,” the Law.com article said.
Historical Perspective of Executive Compensation
Between 1932 and the early 1970s, “the average American worker’s income more than doubled. ... Growth benefited everyone?except for those at the top,” according to a recent report on the Truthout website, a not-for-profit research firm.
Between the 1970s and the mid-1990s, U.S. corporate wealth went to one-fifth of those with the highest earning potential. Employees with college degrees could count on a decent income, while earnings for the working class came to a standstill.
From 1999 to 2007, earnings for the majority of people didn’t improve much, while income for the top 5 percent of earners rose rapidly. After 2007, only the top 1 percent of earners could count on increases in income, despite the economic turmoil.
“The average CEO pay of companies in the S&P 500 Index rose to $12.94 million in 2011. ... Overall, the average level of CEO pay in the S&P 500 Index increased 13.9 percent in 2011, following a 22.8 percent increase in CEO pay in 2010,” according to the AFL-CIO Executive Paywatch website.
The AFL-CIO report bemoans that average CEO earnings rose by 13.9 percent at Standard & Poor’s (S&P) 500 Index companies, while the S&P 500 Index remained the same from the beginning to the end of 2011.
The S&P 500 is an index of the most widely traded 500 stocks on the New York Stock Exchange. If the index stays at the same level, the market value has not changed, and there are no discernable shareholder gains.
The “double-digit increase in average CEO pay for the second consecutive year shows just how disconnected the top 1 percent is from the 99 percent,” the AFL-CIO report said.
Proxy Season Votes in 2011
“During the 2011 proxy season so far approximately 40 companies in the Russell 3000 have reported that a majority of their shareholder votes disapproved of the executive pay program at the company. This represents about 2 percent of the approximately 2,300 companies in the Russell 3000,” according to a Harvard Law School Forum discussion, published in September 2011.
A proxy season is the time period when most firms hold their shareholder meetings.
The Harvard discussion questions the value of the say-on-pay SEC ruling. It said that shareholders, the ultimate owners of a traded firm, consist mainly of various institutional investors (75 percent). Institutional shareholders generally are mutual funds, retirement funds of federal and local governments, and corporations.
“Most of the votes being cast in say-on-pay votes are cast by institutional shareholders,” the Harvard discussion said.
Setting executive pay is the responsibility of the board of directors. The shareholders add another dimension to the formula, which may not, due to different objectives, be in the best interest of the respective firm. Any interference by this third party may result in costs that reduce the earning power of the company.
To address biases brought into the equation, the Harvard discussion suggested that “a rule be adopted that a negative say-on-pay vote cannot be introduced as evidence of a breach of fiduciary duty in connection with the management and oversight of executive pay unless two successive votes by shareholders at the corporation have resulted in majority votes against the executive pay program.”
Shareholder Activism Spreading
“There has been a significant increase in shareholder activism since the 2008 financial crisis,” according to an article on the Interactive Investor website.
Gavin Oldham, CEO of The Share Centre Ltd., based in the United Kingdom, said in the Interactive Investor article that corporate boards don’t want to be drawn into a fight with shareholders, especially given the easy access to social networking and the ability to drum up support from other shareholders.
An Interactive Investor timeline identifying shareholder activism between April 12 and May 24 identifies a great number of firms that experienced shareholder revolts, including Facebook, PepsiCo Inc., and JPMorgan Chase and Co.
“Statistics seem to back up the idea that shareholders have been more willing to raise their voices in recent years. In 2011 there were 16 occasions when more than 20% of shareholders voted against remuneration reports of FTSE 100 companies, compared with just seven instances in 2010,” according to the Interactive Investor article.
Germans Applauded for Shareholder Treatment
“In Germany, executive-pay polices are much simpler and more transparent and often are directly linked to recognizable financial metrics, like operating profit and return on sales,” according to an Investors Chronicle blog, quoted in a recent article on the Motley Fool website,
The Germans use revenue growth, capital employed, and free cash flow, which should be easily recognizable.
Referencing an annual report of a large German corporation chosen at random, the Motley Fool researcher said, “In just a few seconds, I found a table containing the criteria, target figures, and actual figures used for calculating the executive directors’ bonuses in 2011. The measures used were both familiar and relevant to shareholders.”
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