It was in the Dodd-Frank Act, so we knew it was likely to happen, although since it’s generally thought that not all things contemplated by the law will come into being, I was holding out hope that it wouldn’t. I wanted to feel a morsel of appreciation for the government’s intelligence.
But now that the SEC has actually proposed a rule to satisfy the Dodd-Frank requirement that publicly held companies reveal the ratio between their CEO’s compensation and the median pay of a sample of employees, I’ve got to say: this is mindlessness on an epic scale.
Why should we pander to every instance of knee-jerk hysteria that spews from the uneducated public? That’s what was really behind Dodd’s and Frank’s espousal of this rule. But what makes executives take wild risks in order to earn their incentive pay – risks like the ones financial firms took that helped trigger the economic crisis that began in 2008, and later Dodd-Frank – doesn’t have a lot to do with how much money they make. Let alone how much their rank and file makes. It has far more to do with the short periods of company performance, usually no longer than three years, on which such compensation is based. You’ve got to show results in a hurry to get your money.
Of course, you’ve got to be hitting your quarterly numbers all the while, which is even worse for causing bad behavior.
Last year I wrote an opinion piece decrying the silliness of “Say on Pay.” In it I said something that’s also appropriate to a discussion of this newly proposed rule: The loud debate and incessant hand-wringing over executive compensation have been disproportionate to more pressing corporate concerns.
This measure is being taken in the name of shareholders. But what really drives shareholder value in the long run, which is how savvy investors should be keeping score? It’s long-term financial performance. And what drives long-term financial performance? I would say it’s things like innovation, customer satisfaction and employee loyalty. Those things are cultivated over time spans much longer than three years.
I was invited to talk about this issue with David Greenberg, executive vice president of knowledge and solutions for LRN, a company that says it has a singular mission: to help “inspire principled performance in business.” In other words, it helps companies and the people who run them “do the right thing,” not only to achieve business results but to do it ethically and morally.
Now, Greenberg was chief compliance officer at Altria Group from 2002 to 2008, when it owned Kraft Foods and Miller Brewing, as well as its remaining flagship enterprise, Philip Morris Companies. I suppose it was an important job, given all the things alcohol and tobacco companies (rightly, for the most part) have to comply with. But I was thinking I might have to do some battle with this ethics guy; the email I got from his p.r. reps made me think he was in favor of the SEC’s proposed rule.
Instead, he said some things I wish I’d said myself.
“There is plenty of disclosure about executive compensation already,” Greenberg said. “Every proxy statement shows what the top five compensated executives earn, the basis for that, the formulas used to calculate it, how competitors in the same compensate their executives. [Figuring out the ratio of CEO pay to employee pay] is a poor use of resources.”
He added, “A bigger question is, once you have that ratio, what does it mean? It means nothing. If the ratio is high, is that bad? What if employees are earning more every year because the company is doing better and the CEO and his or her team are earning more too? Isn’t that good? And, if the ratio is low but the company is not doing well and having to lay people off, isn’t that bad? This is so wrong-headed.”
But, I asked, what harm would adding one more bit of disclosure do? I mean, OK, it may not be the best use of resources, but it wouldn’t actually be too time-consuming to calculate the ratio, would it? “No,” he said. “But in business, what we measure matters. Do we want to establish what looks to be an important metric for CEO compensation when we know it adds little of value to the way companies are managed?”
I suspect most CFOs agree with me and Greenberg about this. It might be dicey for them to speak out, but I think some behind-the-scenes corporate lobbying of Congress and the SEC might be called for. This rule does not deserve to see the light of day.