October 14, 2004
Book Inspires Symposium on How Governance Codifies Excessive Executive Pay
by William Baue
The book is written by Harvard Law Professor Lucian Bebchuk and Berkeley Law Professor Jesse Fried,
and the Symposium is hosted by Columbia Law School.
Average compensation of CEOs of S&P 500 companies quadrupled from 1992 to 2000, from $3.5 million
to $14.7 million, and the value of stock options granted to them rose ninefold, according to the
new book Pay Without Performance. Such increases in executive compensation
are not necessarily problematic, according to the book's authors, Harvard Law Professor Lucian Bebchuk and Berkeley Law Professor Jesse Fried, if they correlate to
concomitant rises in shareholder value.
Unfortunately, the lack of true
arm's-length bargaining between corporate boards, which are supposed to represent shareholders'
best interests, and executives, who represent their own best interests, impedes even-handed
bargaining of reasonable financial incentives. Far from being an isolated issue, the problem is
encoded in corporate governance genetics, according to Profs. Bebchuk and Fried. Hence, the
authors prescribe systemic corporate governance overhaul as the cure.
The book serves as
the launching pad for a "Symposium on Executive
Compensation" convening tomorrow at Columbia Law School. Speakers include academics, investors
(such as former TIAA-CREF CEO John Biggs),
regulators (such as former SEC Chair Arthur
Levitt), executives (such as former Harris
Trust CEO Kenneth West), and advisers (such as compensation consultant Brian Foley).
"One aim of our book is to persuade readers that flawed compensation arrangements have been
widespread, persistent and systematic, and they have stemmed from defects in the underling
governance structures," Prof. Bebchuk told SocialFunds.com. "We hope the symposium about the book
will contribute to such recognizing of these problems and the reforms they require."
"official view" supporting current executive compensation structures rests on the notion of arm's
length bargaining between executives and the board, but Profs. Bebchuk and Fried argue that this
assumption of distance does not match reality. In fact, managerial power exerts persuasive
influence over directors.
"Although many directors own shares in their firms, their
financial incentives to avoid arrangements favorable to executives have been too weak to induce
them to take the personally costly, or at the very least unpleasant, route of haggling with their
CEOs," the authors write.
The authors describe how executives seek to surreptitiously
extract "rents," or benefits greater than those obtainable under true arm's-length bargaining,
masking what would otherwise be revealed as outrageous compensation.
evidence that compensation arrangements have often been designed with an eye to camouflaging rent
and minimizing outrage," the authors state. "Firms have systematically taken steps that make less
transparent both the total amount of compensation and the extent to which it is decoupled from
managers' own performance."
Profs. Bebchuk and Fried recommend that institutional
investors pressure firms to improve executive compensation structures. Such measures include
increasing pay scheme transparency and comprehensibility, adopting pay-for-performance plans that
filter out stock price rises attributable to anything other than manager performance, and limiting
managers' ability to unload stock options.
"Shareholder resolutions can also help, but
their potential effect is limited because they are non-binding," said Prof. Bebchuk. "A main
thesis of our book is that the most effective way to improve executive compensation in particular,
and corporate governance more generally, is by changing the arrangements that now make boards so
insulated from shareholders."
The corporate governance reforms enacted thus far in
response to the Enron-related scandals, such as requiring increased board independence, "would
likely improve matters but . . . much more needs to be done," according to the authors. Foremost
is shareowner access to the corporate proxy to nominate director candidates, a rulemaking proposal
that is currently stalled at the Securities and Exchange Commission due to the same problem
plaguing executive compensation: undue influence from corporate executives.
power to remove directors is now largely a myth," said Prof. Bebchuk. "Shareholder access to the
corporate ballot will help make shareholder power to replace directors a viable option that would
operate to make boards more accountable and more attentive to shareholder interests--both in
general and in setting compensation schemes."