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 CorpGov.net and a
member of the United States Proxy Exchange
(USPX), told SocialFunds.com, "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
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%.
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 SocialFunds.com, "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
"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."
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