By James Hamilton, J.D., LL.M.
A group chaired by former SEC Chair William Donaldson has come out against a shareholder advisory vote. The proper means for shareholders to express their opinions on executive compensation, said the group, is through their votes for directors who represent them. The group also recommended the elimination of quarterly earnings guidance. The group is also composed of former SEC chairs Harold Williams and Rod Hills, as well as former PCAOB Chair William McDonough.
Against the backdrop of a pending House bill mandating a shareholder advisory vote on executive compensation, the former chairs expressed concern that such an advisory vote would send mixed and confusing signals, working against rather than for responsible engagement. The group described the shareholder vote as a crude instrument for communicating about a complex topic. For example, the group wondered how a no vote, or even a yes vote, should be interpreted. In addition, some shareholders might focus on the overall compensation policy, while others might vote on the basis of specific details and outcomes.
More broadly, the group sees no reason for shareholders to vote only on a company’s executive compensation plan rather than any of the other major decisions taken by a board of directors. Shareholders, for example, do not vote on a company’s investment policies, which may be more significant to the long-term, or even short-term, performance of the company.
Because the goal of those supporting a vote is to create a dialogue about pay issues, the former SEC chairs urged the company’s compensation committees to initiate such a dialogue up front. The group also encouraged U.S. companies to take steps within the current system to engage long-term investors on compensation practice and its link to value creation for the long term.
In their view, a good place to start would be for compensation committees to implement fully the new SEC requirement for a Compensation Discussion and Analysis” (CD&A). The CD&A is a principles-based disclosure requirement whose purpose is to provide material information and perspective about the company’s executive compensation objectives. The current year is the first in which CD&A reports are to be filed. The group knows of few, if any, companies that have met investor expectations of customized and tailored disclosure.
Indeed, SEC Chairman Cox has publicly complained that, relative to the SEC’s goals, submissions are unreadable, too long, and overly burdened with lawyers’ jargon. That assessment, reasoned the former SEC chairs, indicates that companies have missed an opportunity to explain to shareholders, equity analysts, and the market in general how the design of compensation practices is integrated with performance goals.
For their part, the former SEC officials urged companies to structure incentive compensation plans so that a significant portion of the income of senior corporate officers is tied to the achievement of well articulated long-term performance objectives in line with the corporate strategy.
Eliminate Quarterly Guidance
Quarterly guidance on earnings per share should be terminated, said the group, because such guidance encourages a focus on, and sometimes a distortion of, short-term financial results and attracts short-term, speculative trading rather than long-term investing. At present, about half of listed, public companies issue quarterly guidance on expected earnings.
The group also said that the current financial accounting system fails to provide investors with as much useful information as it could. One significant problem is that intangibles, such as the value of the company’s brand or its relationships with employees, suppliers and customers, which often drive company performance, are not well measured, or not
measured at all. The group recommended that financial reports be supplemented with non-financial indicators of value.