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June 10, 2011
CEO Compensation Rose Sharply in 2010
    by Robert Kropp

GovernanceMetrics International reports that annual compensation at S&P 500 companies increased by 35% in 2010, and the United States Proxy Exchange issues draft guidelines to help shareowners vote their say-on-pay proxies.

In the aftermath of last year's passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act and its requirement that public companies hold shareowner votes on executive compensation in 2011, many sustainable investors and other shareowner activists anticipated that this year's proxy season could result in a watershed year for corporate governance. As Lisa Woll, CEO of the Social Investment Forum (SIF) said following the bill's passage, "The most recent financial crisis highlighted for all Americans the urgent need to instill greater discipline among corporate boards and in financial markets…say on pay will help address these failures and strengthen America's financial markets."

However, at this point in this year's proxy season it appears that the tipping point might have to wait for another year, as an overwhelming majority of resolutions addressing executive compensation have passed, and in many cases by wide margins. James McRitchie, the founder and publisher of and a member of the United States Proxy Exchange (USPX), told, "2011 could be a watershed year if next year people look back and wonder why the hell they didn't do anything."

The failure of most say-on-pay resolutions to gain significant shareowner support this year is especially problematic when one considers that as the US economy continues to struggle, CEO compensation in 2010 reversed the downward trend of the previous two years. According to GovernanceMetrics International (GMI), "While median realized compensation has not yet reached pre-financial crisis levels, it seems to be heading in that direction."

GMI's recently published 2011 Preliminary CEO Pay Survey found that in 2010, annual compensation across a sample of 600 CEOs increased by 18%, while realized compensation—which includes equity profits as well as annual pay—increased by 28%.

Among CEOs at S&P 500 companies, the report found, annual compensation increased much more in 2010, by 35%.

"A big part of it is equity, of course," Greg Ruel, a co-author of the report, wrote in a recent blog post. "There was no doubt when executives were granted large blocks of equity in a recession that they would soon bear fruit with a return to stock price normalcy. Or anything close to stock price normalcy."

In addition to finding that the percentage of CEOs who exercised stock options rose to 34%, the report also found that cash bonuses for the highest-paid CEOs were three times the pre-recession levels.

In an attempt to devise a strategy for addressing executive compensation more effectively, USPX has issued Draft Shareowner Guidelines for Say-on-Pay Voting. "To make informed say-on-pay voting decisions, shareowners must first assess the compensation packages boards propose," the Guidelines state. "That is not easy, since those packages tend to be staggeringly complex."

Referring to the complexity of most executive compensation packages, McRitchie told, "There are a lot of pages in the proxy devoted to pay issues, and it's unlikely that retail shareowners can go through them and be able to understand how they should be voting. But if individual investors have no idea of how to invest responsibly, then it becomes an issue of blind trust."

"Companies need to come up with a simple way to explain how they arrive at pay," McRitchie continued. "Excessive compensation is probably a bigger problem now than ever, because now it's been verified by the shareowners."

"If shareowners believe the vast majority of executives are excessively compensated, then collectively we should vote to reject the vast majority of compensation packages," the Guidelines state. "It is imperative that we avoid a situation where executives pay themselves $10 million, $20 million or $50 million after receiving say-on-pay approval from their shareowners. If that happens, shareowners will have become part of the excessive pay problem rather than part of the solution."

McRitchie said, "Most CEOs are overpaid. So why aren't we voting against most of these pay packages? We have to get to the point where we are voting against most of the pay packages, instead of hollowing out the middle class."

USPX refers to the ongoing increase in executive compensation as the "Lake Wobegone Effect," because companies are reluctant to describe their executives as below-average. A
2010 report from the IRRC Institute and PROXY Governance identified S&P 500 companies whose executive compensation was not aligned with performance, and found that those companies "choose as peers corporations that are larger and more successful than themselves," according to USPX.

"If shareowners want to use say-on-pay to slow or reverse the Lake Wobegone Effect," the Guidelines assert, "They cannot look to proxy advisory firms or the largest institutional investors for guidance." Proxy advisors tend to recommend votes against only the most outrageous pay packages, while many institutional investors express "little evidence they were concerned about skyrocketing executive compensation."

"CEO pay has gone from 5% to 10% of net profit, and people I talk with at pension funds are concerned about that," McRitchie said. "But their concern is that CEO pay going up can lift all boats."

"Dodd-Frank envisions shareowners voting on pay packages ex-ante—for the upcoming year," the Guidelines argue. "This means they won’t be voting for dollar figures but for compensation schemes, which are a convoluted mix of base pay, possible bonus payments, equity grants, equity options, retirement benefits, severance arrangements, tax gross-ups and perks."

As an alternative, USPX proposed that shareowners vote on pay packages ex-post; that is, shareowners should "base their analysis on the total value of compensation paid in the previous year." The Guidelines recommend that shareowners apply two tests in their decision on how to vote their say-on-pay proxies. The first test is based on a ratio of executive compensation to median worker compensation, and the second is based on median executive compensation.

"I advocated for paying executives below the median," McRitchie said. "If enough people vote against anything above the median, then pay will begin to be ratcheted down."

"A fundamental issue with pay for performance is that it has refocused CEOs on benefiting themselves," McRitchie continued. "We have incorporation laws so corporate activity can benefit society, but we've certainly taken the focus off of that. People focus too much on star power and not enough on the team effort that goes into making a great corporation."


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