Is there a relationship between executive pay and the risky financial instruments linked to subprime mortgages? Nell Minow, corporate governance expert and editor-in-chief of The Corporate Library makes the case that there is during an interview featured in the February 19 issue of Strategy+Business.
In an excerpt from that interview:
S+B: In what ways were the boards responsible for the current debacle in the financial-services sector?
MINOW: There were a couple of precipitating factors. One is that the boards weren’t paying enough attention. They weren’t asking the right questions. And the other is that they were creating executive compensation plans that had the effect of pouring gas on the fire. You can see how it worked by looking at it in hindsight. All of the CEOs who failed got paid very well. Therefore, the pay plans had very perverse incentives. Yes, the CEOs did receive incentive compensation, but incentive to do what? If the incentive was to essentially offload risks — which is what happened, because the CEOs were pushing much of the risk off to shareholders — then this is what you get.
And further in, when the question was posed about what boards could have done to prevent executive compensation from contributing to the crisis, Minow quotes Warren Buffett:
S+B: What could the boards of financial-services firms have done to help avoid situations like the subprime meltdown?
MINOW: You can’t do better than what Warren Buffett said to the people at Salomon Brothers many years ago: “If you lose money for us, we will be forgiving. If you lose reputation for us, we will be ruthless.” You make the situation clear by stating your intentions and you back them up in the design of your compensation program. If there’s any suggestion of bad behavior, the money goes back to the company. That’s the only fair and credible way. Any CEO who won’t come in on that basis is somebody you don’t want to bet on because he is not willing to bet on himself. The moral of the story is that you get what you pay for. If you tell the CEO he’s going to get paid tremendously for short-term gains even if he has an “après moi, le deluge” philosophy, then he’s going to go for it.
While expressing dismay about the stated aspects of executive pay that she believes contributed to the subprime mortgage mess, Minow also acknowledged - in closing - that there have been tremendous improvements in U.S. corporate governance (exceptions in the financial services sector notwithstanding) and that she is particularly enthusiastic about a number of forces for positive change that are converging on the corporate governance scene:
MINOW: ...three different forces for positive change are coming together at the same time. One is majority voting. I think that’s going to be very powerful as it gets widespread adoption. Right now, under the law, a director who is unopposed can get elected with one vote because voters have only two options: to affirm a candidate or not to vote at all. Thus, it’s not very meaningful to withhold a vote. But as companies adopt the rule that a director must receive a majority of the votes cast in order to win, directors will know they can be voted out if there are a lot of abstentions. Second, the broker vote change will eventually go through so that actual shareholders, or beneficial holders, will vote for directors. (Currently, in many cases, large brokerages hold shares for individual investors and vote on their behalf without consulting with their clients; frequently, they join management in supporting their board slate and opposing shareholder resolutions.) Third, mutual funds and money managers now must disclose which way they voted on board appointments and resolutions under a ruling by the Securities and Exchange Commission.
We do a “naughty and nice” list every year of who votes for shareholder value and who does not. So that will put pressure on mutual funds to vote more thoughtfully. One way or another, votes are going to become much more meaningful. If compensation committees start getting voted out for signing off on outrageous pay packages, then I think boards will start to do a better job.
Ann,
I'm not interested in the topic, but thanks for making me aware of a great periodical, Strategy+ Business.
Frank Giancola
Posted by: Frank Giancola | February 26, 2008 at 01:50 PM