Q&A talks about upcoming changes in executive compensation regulations with Patrice Luoma, professor and chair of entrepreneurship and strategy in the School of Business at Quinnipiac University.
Q: The most recent U.S. Securities and Exchange Commission regulatory agenda indicates that this October is the SEC’s target date for action on creating new guidelines for CEO pay ratio, which could force companies to disclose the ratio between CEOs and median pay. Any thoughts on what the SEC might be seeking to achieve when it implements the Dodd-Frank law on that matter?
A: I think the SEC is looking to get another way to compare executive pay across firms. The summary compensation table that lists executive pay, bonuses, and stock awards was previously designed as one way to get comparison, as well as having to compare with a peer group. The more information investors have, the better they can identify whether CEO compensation in a firm is appropriate and relevant compared to others.
Q: The SEC has also failed to propose rules under Section 954 of Dodd-Frank that requires public companies to, according to the professional services company Towers Watson, “develop and implement a policy regarding clawbacks of erroneously awarded incentive-based compensation” paid to executive officers following accounting restatements. How widespread do you think these proposed rules might be? What timeline do you think they might be achieved on?
A: There are a lot of questions to be answered in setting clawback provisions and this must be done carefully because it could result in unintended consequences. For example, it could impact the contracts new CEOs expect given that potential clawbacks could occur during their tenure as a result of activities that happened under previous leadership, which could end up affecting the price of their stock compensation.
The proposed rules also broaden the scope of the clawbacks to all executive officers, not just the CEO or chief financial officer and this could have wide ranging implications. For example, who is considered an executive officer? To what level would these clawbacks apply?
Q: A recent trend in long-term incentives is a move away from stock option rewards to performance-based rewards. What is driving this trend? Is it a better driver of results?
A: With potential new Dodd-Frank regulation looming, and past criticisms of executive pay when performance is not good, boards and compensation consultants are looking at better ways to link pay to performance (both financial and stock market performance).
Firms publish performance targets, but they are careful not to publish all of the CEOs performance targets, as it may potentially disclose corporate strategy that the firm doesn’t want its competitors to see.
As long as the performance targets are appropriate targets for the firm, then better linking of pay to these performance targets should result in better firm performance and a better link to CEO performance.
Research shows that when CEOs own more stock they tend to think more like owners. Thus stock compensation (not stock options) tends to influence better performance.
Q: What’s your perception on the “say on pay” non-binding votes? The trend this year, according to the Wall Street Journal, has been “companies are less likely to receive a thumbs-down from shareholders.” Do the say on pay votes matter any more? Did they ever?
A: Since 2011 companies have had to offer shareholders a non-binding vote on executive pay. Fewer than 5 percent of companies receive less than a majority vote.
However, firms don’t want to look bad, so they are paying more attention to executive compensation and how it is paid out and structured. While say on pay doesn’t have any legal implications for pay as it is non-binding, firms do want to look good in the press and not receive negative votes.
Also more recently, Coca-Cola was criticized for its executive compensation and Warren Buffet, a board member and major shareholder, didn’t come out against it. However, it appears that he and perhaps others are working within the board and the firm to make the necessary changes, rather than publicly having a negative say on pay vote.
Q: What is the trend in short-term incentive payouts for CEOs? Are corporations becoming more rigorous in setting standards for payouts?
A: Data shows that short-term bonuses tend to follow the firm’s annual performance, so if performance is up the bonus is up and vice versa.
