October 28, 2008
Executive Pay Comes Under Fire from Activist Shareholders for Contributing to Financial Crisis
by Robert Kropp
Study of shareholder voting by mutual funds shows SRI funds leading the way to increased
shareholder activism on matter of executive compensation.
Questions abound in the wake of the current meltdown of the financial industries. How could
presumably knowledgeable corporate executives ignore the dangers inherent in mortgage-backed
securities consisting of loans that were often bound to fail? Either through passivity or
self-interested compliance, did boards of directors shirk their oversight duties, thus allowing
corporate managers a free hand in contributing to the economic downfall? And what role could
shareholders have played in order to bring executives to account for their activities?
Much has been made of one condition of the $250 billion federal bailout of nine of the
nation's largest banks: that severance pay and recouping incentive payouts based on ‘inaccurate’
performance measures be reduced. In the current climate, in which the performance of many CEOs has
clearly been abysmal, the fact that CEOs of large U.S. companies averaged $10.8 million in total
compensation in 2006, more than 364 times the pay of the average US worker, especially rankles.
But excessive executive compensation has been a target of resolutions by shareholder
activists for years. A recent study by Fund
Votes, which provides in-depth analysis of investment fund proxy voting, analyzed mutual fund
voting patterns on shareholder-sponsored compensation resolutions across 47 mainstream fund groups
and 6 SRI groups over five years of voting records.
Jackie Cook, the founder of Fund
Votes, told SocialFunds.com, "Executive compensation is at the heart of a growing problem between
shareholders and management. Corporate structure is supposed to be a system of checks and balances
among shareholders, boards of directors, and management. So why does executive pay continue to
grow, even in times of economic downturns?"
The Fund Votes survey found that the number of
"say-on-pay" shareholder resolutions—which seek to afford shareholders the opportunity to ratify
executive compensation packages—increased from three in 2006 to 79 in 2008. Overall support among
mutual fund families reached 51% in 2008. Also significant is the fact that in 2008 only six of the
47 mainstream fund families gave no support to say-on-pay resolutions.
the Fund Votes survey found that the six SRI funds included led the way in bringing attention to
the issue of runaway executive compensation. Among the SRI funds, average support for all
shareholder resolutions on compensation was 84% in 2008. The average for mainstream mutual funds
was 41% in 2008.
Cook said, "The number of advisory resolutions on executive compensation
among S&P 500 companies reached 79 this year. The question that shareholders raise in light of
these numbers is, are boards of directors now prepared to engage in constructive dialogue with
shareholders on this issue?"
The Fund Votes survey notes, "Shareholder activists argue
that tighter pay practices would follow if shareholders could annually cast a vote on an advisory
resolution to ratify the boards’ compensation reports. The ‘say-on-pay’ proposals would effectively
allow us to gauge the degree of shareholder satisfaction with the board’s compensation structure
and incentive pay allocations from year to year. Clearly boards could use some constructive
feedback from those whose interests are most aligned with the performance of the company."
In light of the current financial crisis, what is especially interesting in the Fund Votes
report is the existence of say-on-pay resolutions in 2008 that targeted eight of the nine banks on
the receiving end of the $250 federal bailout. In a research brief published on October 21, an
analysis by Fund Votes found that "fourteen of the 61 fund groups surveyed failed to support even a
single say-on-pay resolution at the eight bail-out banks targeted with this resolution in 2008.
Twelve opposed all such resolutions and two abstained on all."
On the other hand, the
research brief found, "Many large fund groups and all of the socially responsible investment groups
surveyed supported every such resolution at the eight bail-out banks."
failure of mainstream mutual funds to act on the issue of executive compensation at a time when the
economy was already beginning to unravel, Cook of Fund Votes could only speculate, "Perhaps they
might not have opposed such resolutions if they had come to a vote now."
Could it be that
outrage over the glaring discord between executive pay and executive performance finally lead
shareholders and boards of directors in the direction advocated by the SRI community for years?
There is some evidence that such might be the case.
The National Association of Corporate Directors (NACD), an
organization dedicated to serving the corporate governance needs of corporate boards, responded to
the current crisis by publishing a 10-point plan to strengthen corporate governance. Acknowledging
that "the current economic crisis has eroded public and investor confidence in corporate
governance," and that "American corporations must take action to restore the public trust," the
NACD argued for such correctives as board responsibility for governance and accountability,
corporate transparency, and director competency and commitment.
However, on the matter of
shareholder involvement, the NACD called for no more than that "governance structures and practices
should encourage" shareholder involvement and directors' communication with shareholders. Given the
ease with which corporate management has sidestepped the concerns of activist shareholders and
drawn the global economy into its current malaise, such advisory recommendations may fall short of
their goal of regaining shareholder confidence.
A movement that may do more to bring
corporate boards into line with the concerns of shareholders has originated with no less colorful a
public figure than Carl Icahn, the corporate raider turned shareholder activist. Claiming that "one
of the biggest problems we face today is the egregious mismanagement and reckless incompetence of
many American corporate boards which utterly fail to do their primary job of holding managements
accountable," Icahn called for the formation of the United Shareholders of
America to "push back against board entrenchment and make it easier for shareholders to promote
change in companies they own."
Perhaps desperate times call for strange bedfellows. But if
such an advocate of profitability above all else as Carl Icahn comes to share the goals of an SRI
community with long experience in calling for improved corporate governance, then a renewal of
genuine checks and balances as espoused by Jackie Cook of Fund Votes may turn out to be a
beneficiary of the current crisis.