June 08, 2010
Excessive Focus on Excessive Compensation?
Posted by Lisa Fairfax

Last week GW's Center for Law, Economics and Finance hosted a conference on Executive Compensation and Risk at which I presented.  In addition to panels, the conference had an opening lecture by Special Master for TARP Executive Compensation Kenneth Feinberg, and a keynote address by AFL-CIO's Damon Silvers.  Needless to say, it was an engaging conversation not only about current legislation in this area, but also about the federal government's role in executive compensation and how it hopes to shape incentives associated with that compensation.  One audience question in particular sparked a lot of conversation.  That is, given the myriad of other issues confronting corporations and the markets, are we too focused on executive compensation?  It is certainly a question that has sparked considerable debate in the academic community.

And it is not an idle question.  One study found that from 1994-2002, compensation-related articles in major newspapers and magazines grew by 900%.  You can only imagine what that figure would look like for more recent time periods.  Proxy data shows that since 2004, executive compensation has been the number one subject of shareholder proposals.  And the 2009 Spencer Stuart study of S&P 500 companies reveals that when asked how much focus their board had given to various governance issues over the past year, 79% of directors ranked executive compensation number one.  So from the public, to shareholders, to directors, everyone's talking about executive compensation.  Is the talk warranted?

Of course some conference participants said no, noting that the focus on executive compensation was both excessive and distracting.  Indeed, given the Spencer Stuart data, how should we feel about the apparent fact that last year boards' focus on executive compensation outstripped their focus on risk management, corporate strategy and addressing shareholder concerns?

Others agreed that the seemingly excessive focus can best be explained in political terms.  Unlike talks of mark to market and derivatives, executive compensation is an issue easily grasped by the public and seemingly (even perhaps deceptively) easy to fix.  Interestingly, in his talk about the principles used to guide executive compensation decisions, Feinberg noted that the process was not rocket science.  At core, those principles consisted of starting with a relatively low base salary, and then providing that there would be no further guaranteed payments beyond the base; anything else would be in the form of stock (not options), and tied to long-term performance.    Feinberg did say that it was hard to assess how any principle would impact incentives.  Nevertheless, the public seems to believe that you can in fact tie pay to performance in a meaningful way, and in a way that will "fix" the executive compensation problem.

After pointing out that in many cases executive compensation involves less than 5% of a company's earnings, and that in all cases, executive compensation directly impacts less than 10,000 people, Silvers went on to say that there are at least three good reasons to care about executive compensation.  First, because it highlights issues of inequality of which we should all be mindful.  Indeed, several conference panelists noted data indicating that while CEO pay used to be 25 times the salary of an average worker, recent years has seen it climb to 500 times the pay of an average worker.  Second, because it is potentially a form of waste.  Third, and likely most important, because it does reflect inappropriate incentives.  In Silvers' view, executive compensation represents a signal about how CEOs and executives should behave, and given that most of the resources in our society are controlled or managed by corporations, getting the signal right is vitally important.

So is the focus on this issue excessive?  I think that most people believed so.  However, there also was agreement that the subject warranted attention, such attention would not subside in the near future, and that it was important for all of us to have a voice in the debate.  Thus, even amidst concern that there is excessive focus on excessive compensation, I thought it worth sharing some more voices.

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