The beginning of 2006 usually gives pause to look back on the past year and reflect. When CEOs look back on the past year their vision may be obscured by the stacks of cash that were bestowed upon them. It was reported last week that despite small stock gains and slowing growth executive pay continued to swell in 2005. [1] Always
a hot topic, and often over 400 time the amount earned by rank-and-file
employees at large companies, executive pay is on the top of many
people’s watch lists for 2006.[2] This article
will take a look at how some justify executive pay, what recourse
shareholders have to stop executives being paid too much and the
proposal the SEC has made regarding disclosure of executive
compensation.
Compensation On the Rise
Although
much of the data of 2005 executive pay will not become available until
March or April when the majority of proxy statements are filed with the
SEC, indications are already showing that executive pay continued to
rise in 2005.[3] Already at exorbitant level
after rising 30% in 2004, executive compensation is expected to
increase at similar rates this year. Some investors claim not to care
about high executive pay so long as the company is yielding high
returns to shareholders. However, neither stock prices nor profits rose as much in 2005 as they did in 2004.[4] Thus, this justification does not seemed warranted in explaining 2005’s increase in pay. Others
explain the need for high executive compensation in order to retain
talent and prevent turnover, claiming that without the high payout many
current executives would move to other professions.[5] This claim has
slightly more merit as many sectors experiencing serious labor
shortages have increased wages to retain talent.[6] Yet, even proportional to wage increases in other sectors, executive pay continues to grow exponentially.
Another
one of the major problems regarding executive pay is that investors
often do not realize how much executives are getting paid. In corporate filings it is fairly easy to locate the salary and bonus of CEOs averaging $2.4M in 2004.[7] Tougher to track is the perks and stock options also give to CEOs and other executives as compensation. In 2004 the median fair market value of these perks and stock options was a staggering $3.6M.[8]
Current Disclosure Rules
Section 402 of Regulation S-K expressly governs the disclosure of executive compensation packages.[9] Section 402 is inclusive of all disclosures that must be made under several Acts.[10] Disclosure
in mandated for the CEO and four highest paid executives other than the
CEO unless their total of such salary and bonuses is $100,000 or
less.[11] The disclosure requirements apply to any cash, stock, stock option, or other compensation payment.[12] Furthermore,
the section “requires clear, concise and understandable disclosure of
all plan and non-plan compensation awarded to, earned by, or paid to
the named executives officers … and directors.” Perks must be reported
as a lump sum when they total more than $50,000 or 10% of salary. Individual perks only need to be listed if it amounts to 25% of all perks the executive receives.[13] The regulation also specifies that such disclosures should be made in form that shareholders can understand. To facilitate this goal section 402 requires the information is provided in a table format.
Current Recourse
Even when shareholders do realize just how much executives are being paid, it is very difficult for change to be implemented. Excessive compensation generally falls into the category of corporate waste. However,
when boards of directors have made a decision such as how much an
executive should be paid courts apply the business judgment rule (BJR). BJR
is a principle applied by the courts (as opposed to a statutory rule or
common law) which states, absent fraud illegality or conflict of
interest, the court will defer to the judgment of the board. Resultantly, it is exceedingly difficult to get a finding of corporate waste.
However, executive compensation continues to gain more media attention. And with the rise of corporate scandals the belief that executive compensation schemes need to change is widespread. While
shareholders have tried to induce change through shareholder proposals
and there is much skepticism over the number of investors actually
taking this initiative and how effective they are at actually getting
through to the Board compensation committees.[14]
Proposed changes by the SEC
The
SEC has not been deaf to the public cries for changes in executive
compensation and has recognized that current rules are out of date.[15] The SEC admits that companies may not be disclosing all compensation under current requirements.[16] While
it is not in the authority of the SEC to restrict payments to
executives, in January the SEC has published for comment proposed rule
that would amend disclosure polices related to executive compensation. The
changes would not determine how Boards determine executive compensation
packages, but they would require disclosure of “a clear explanation of
how they arrived at both the amount and the measurement.”[17] These proposed changes “would affect disclosure in proxy statements, annual reports, and registration statements.”[18] The
proposed rules provide for a narrative disclosure to accompany the
tabular disclosure of compensation in the form of a Compensation
Discussion and Analysis. Three main categories
would be included in this section: 1) compensation over the last three
years, 2) holdings of outstanding equity-related interest received as
compensation that are the source of future gains, and 3) other
post-employment payments and benefits. [19] Additionally the proposal
requires that the perks be itemized if they total $10,000 or more.[20] Also, the proposal improves disclosure of retirement benefits. New tables reflecting this information would be added to the disclosures.[21] The
proposals would expand the 8-K disclosure requirements to include
employment arrangements and material amendments made regarding named
executive officers.[22] Additionally, the proposals would require the use of disclosures in plain English.[23] The
goal is for investors to have one bottom line figure for total annual
compensation that is an accurate representation of salary, perks and
bonuses.[24]
[1] CEO Pay Soars, Even Higher Than Before (Feb. 3, 2006), http://money.cnn.com/2006/02/03/news/companies/ceo_salary.reut/index.htm.
[2] Nathan Knutt, Executive Compensation Regulation: Corporate America, Heal Thyself, 47 Ariz. L. Rev. 493, 500 (2005).
[3] CEO Pay Soars, Even Higher Than Before (Feb. 3, 2006), http://money.cnn.com/2006/02/03/news/companies/ceo_salary.reut/index.htm.
[4] Id.
[5] Full Disclosure, Fortune, Feb. 6, 2006, available at http://money.cnn.com/magazines/fortune/fortune_archive/2006/02/06/8367966/index.htm
[6] Chris Isidore, Are Bigger Paychecks Around the Corner (Feb. 3, 2006), http://money.cnn.com/2006/02/02/news/economy/jobs_wages/index.htm.
[7] Full Disclosure, Fortune, Feb. 6, 2006, available at http://money.cnn.com/magazines/fortune/fortune_archive/2006/02/06/8367966/index.htm
[8] Id.
[9] 17 C.F.R. 229.402 (2005).
[10]
Section 402 incorporates the disclosure requirements of the Securities
Act of 1933, 15 U.S.C.A. 77a (West 2005), the Securities Act of 1934,
15 U.S.C.A. 78a (West 2005), and the Energy and Policy Conservation Act
of 1975, 42 U.S.C.A. 6362 (West 2005).
[11] 17 C.F.R. 229.402(a)(3)(ii) (2005).
[12]
17 C.F.R. 229.402(a)(7)(ii) (2005) (the regulation includes any “plan,
contract, authorization or arrangement, whether or not set forth in any
formal documents.”).
[13]
Christopher Cox, SEC Chairman, Chairman’s Opening Statement; Proposed
Revisions to the Executive Compensation and Related Party Disclosure
Rules, Jan. 17, 2006, available at http://www.sec.gov/news/speech/spch011706cc.htm
[14] CEO Pay Soars, Even Higher Than Before (Feb. 3, 2006), http://money.cnn.com/2006/02/03/news/companies/ceo_salary.reut/index.htm
[15] Cox, supra note 13.
[16] Id.
[17] Id.
[18]
SEC Votes to Propose Changes to Disclosure Requirements Concerning
Executive Compensation and Related Matters, Jan. 17, 2006, available at http://www.sec.gov/news/press/2006-10.htm.
[19] Id.
[20] Cox, supra note 13.
[21] Id.
[22]
SEC Votes to Propose Changes to Disclosure Requirements Concerning
Executive Compensation and Related Matters, Jan. 17, 2006, available at http://www.sec.gov/news/press/2006-10.htm.
[23] Id.
[24] Cox, supra note 13.