Fray on Pay

When it comes to the public outcry over executive compensation, the sounds of protest may have faded but the fury lives on. Bands of placard-carrying citizens have disappeared from lower Manhattan, but efforts to rein in what many perceive as outrageous paydays are, if anything, intensifying. From Capitol Hill to boardrooms across the country, efforts are under way to restrict the compensation of executives of all publicly traded companies, even those far removed from any form of bailout.

"People have been excoriating executive-pay practices for decades, and this is their 'pitchfork' moment, with mobs literally taking to the streets to protest the bonuses at AIG, Merrill Lynch, and other firms," says Ira Kay, director of executive compensation consulting at Watson Wyatt.

Already the repercussions are being felt far and wide, from Silicon Valley, where Apple shareholders pushed through a "say-on-pay" proposal despite board members advocating for its rejection, to The Netherlands, where the CEO of ING made a "moral appeal" to executives to return their recent bonuses. A Watson Wyatt survey found that nearly two-thirds of board members believe companies need to change their executive compensation plans in response to current political and market pressures.

A Volatile Mix
It is political pressure in particular that has many observers, not to mention CFOs, seeing red. Soon Congress is expected to unveil a slate of executive pay legislation that could extend the government's recent rules for companies receiving federal dollars from the Troubled Asset Relief Program to other publicly traded companies. "The sad thing about AIG and the TARP regulations on executive pay is that successful, careful companies will be painted with the same broad brush, affecting their ability to compete in the global marketplace," says Jeffrey A. Burchill, senior vice president and CFO of FM Global, a large business-property insurer.

If the remarks coming from the two primary movers in Congress — House Financial Services Committee chairman Barney Frank (D–Mass.) and Senate Banking, Housing, and Urban Affairs Committee chairman Christopher Dodd (D–Conn.) — are any indication, companies can expect substantive changes, although the full scope is anyone's guess. "Specific caps on compensation are not very likely," says Alexander Cwirko-Godycki, research manager at compensation benchmarking firm Equilar Inc., "but there is definite momentum behind say-on-pay provisions, mandates for wider clawback policies, and increased compensation disclosure requirements, among others." It remains to be seen which of these, if any, will become law, but in Cwirko-Godycki's view, "there has certainly never been a stronger case for these proposals to become reality."

"Situations of excessive pay are not rampant," says Brent Longnecker, chairman and CEO of Longnecker & Associates, a Houston-based compensation consultancy. "Only about 2% of companies have rewarded failure, but the government is keen to do something to appease the public's outrage." He is not alone in this view. "Nobody knows what the rules will be or how the Treasury Department will write the regulations, but they're coming," says Patrick McGurn, special counsel to the institutional shareholders services unit of RiskMetrics.

In a worst-case scenario, some or all of the compensation provisions in TARP would be extended to all public companies (see "Laying Out the TARP" at the end of this article). While that's a long shot, even the possibility has many people raising a battle cry. "If companies don't get out in front of this issue now, with their compensation committees leading the charge, the government will get in and make things worse," says Ben W. Heineman Jr., former General Electric senior vice president and general counsel and currently a senior fellow at Harvard University's schools of law and public policy. "This is not the time to go into the bunkers."

"The question is how far Congress will go," says Claudia Allen, chair of the corporate-governance practice at Chicago-based law firm Neal, Gerber & Eisenberg. "You have politics and the law getting stirred in the same pot, and it is a volatile mix."

Many observers fear the law of unintended consequences, and point to the 1993 creation of Section 162(m) of the Internal Revenue Code as Exhibit A. The regulation forbade corporate tax deductions for salaries exceeding $1 million, but made an exception for performance-based incentive compensation, such as stock options vesting at a particular date. Not surprisingly, or so it seems now, companies shifted from high salaries to high stock options and bonuses, while also lifting the salaries of many seemingly underpaid CEOs and other senior executives to $1 million. Now the Obama Administration is considering revising 162(m) downward, disallowing tax deductions above $500,000 and closing the loophole for stock options. "As we've seen happen in the past with respect to executive pay, the government has a way of making things worse," Longnecker says.

CFOs React
CFOs certainly seem disinclined to burrow into the bunkers. "This country was built on capitalism, on people wanting to better themselves, working long hours to achieve cherished dreams of success," says Marc Rosenblum, CFO of cosmetics company Clarins USA. "Unlike socialist societies, people could become rich if their companies became successful. We have to be very careful not to make this country a place where dreams can no longer be realized."

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