The Obama Administration’s principles for executive compensation reform, announced on Wednesday by Treasury Secretary Timothy Geithner, may lack the teeth of pay limits imposed earlier on companies receiving federal bailout money. But several aspects of the government’s stated intentions suggest significant changes ahead in executive compensation.
Perhaps most notably, the administration apparently plans to apply reforms to all public companies, not just those in the financial sector or those receiving assistance in the form of federal funds.
Geithner did emphasize that the government’s goal of better aligning compensation practices with sound risk management and long-term value creation was “particularly [important] in the financial sector.” But he noted that he is working on the matter with Mary Schapiro, chairman of the Securities and Exchange Commission chairman, whose oversight encompasses all public companies.
Plus, in announcing plans to make a pair of compensation-related legislative proposals, the government made no suggestion that the laws, if they are passed, would not apply across the board.
One of those proposals — a requirement that compensation committees be as independent from company management as audit committees currently are required to be under the Sarbanes-Oxley Act — by itself could cure most of the problems created by executive pay programs, according to John Martini, head of the executive compensation practice at the law firm Reed Smith.
Most large public companies, though fewer small ones, already require that compensation committees be composed entirely of outside directors. But what’s important about the proposed law is that the SEC would have to establish standards for ensuring that any compensation consultants or outside counsel that comp committees use are independent from company management. Companies would have to make sufficient funds available to the board to pay for the services.
In theory, that could eliminate widely criticized conflicts of interest whereby the same outside experts who help executives draft policies governing their own pay also consult with compensation committees on making final decisions on executive compensation.
“It’s a phenomenal idea, and probably the most important concept to come out of this [government involvement in compensation],” said Martini. “It will largely fix the compensation problems we have seen. It is difficult [right now for an advisor to management] to say that the CEO is making too much money. Compensation committees will be much more comfortable and get much more candid advice if they have completely independent consultants and counsel.”
Another attorney, Ken Raskin, head of the executive compensation, benefits, and employment practice at White & Case, said he’s the first one to suggest that an agreement he’s drafted with an executive be sent to the compensation committee for vetting before it’s brought to a vote. But he agreed that the proposed legislation is on the mark.
Of course, attorneys and consultants are far from bias-free on this issue. If management and the compensation committee have separate advisors, that means more work for the advisors. “Well, that’s true,” said Raskin. “Obviously that would be an effect of this. Notwithstanding that, it is simply a best practice for the compensation committee to divorce itself from the company in making these decisions.”