Spencer Stuart Governance Lexicon 2007
Hot topics in corporate governance — United States
Executive compensation
With audit committees getting stronger and more effective by the day and lead independent directors now ubiquitous, shareholders, politicians, media and regulators are focusing their attention on executive compensation, which has become the single most visible and emotive governance issue affecting US listed companies.
Investors are starting to express their anger at shareholder meetings, and some activists are dismayed by the growing disparity between top executive pay and the average wage. All this disaffection has mobilized public opinion, bringing much adverse publicity in its wake. There are three distinct but related issues. The first concerns the relationship between pay and performance, which is often tenuous, lacking in transparency and obscured by complexity. In some instances, rises in executive compensation have not been aligned with improvements in performance and share price. This raises fundamental questions about the basis for large pay awards, since in some large companies delivering shareholder value no longer appears to be the principal measure of executive success.
The second issue relates to the components of individual compensation packages, such as equity awards and pensions. Equity awards are usually a combination of restricted stock and stock options. The repricing of options, which can occur after a market setback, is controversial; the backdating of options is a potentially fraudulent practice that has sparked lawsuits from investors and close interest from the SEC. Oversized pension and severance payments have sometimes provoked a similar outcry, especially when the beneficiaries have presided over disappointing financial performance. Today, the compensation of the five most highly paid executives has to be spelt out in the proxy in precise detail, which is a significant change. The third issue concerns the role of compensation committees in the perceived excesses of executive compensation. Shareholders are asking serious questions of committees that authorize pay increases for executives without the justification of improved performance.
They argue that the independent directors who make up compensation committees should be more robust in curbing excesses in pay, by introducing transparency, setting specific performance goals, and making compensation contingent on meeting those goals. Where this is not seen to be happening, investors are taking an aggressive stance on compensation committee nominations, withholding votes on the re-election of individual committee members, and generally putting committees under pressure to propose appropriate levels of compensation.
Shareholder activism and majority voting
Executive compensation is just one of several battlegrounds opening up between institutional shareholders and US listed companies. Activists are also pressing for changes in the way directors are elected on to boards. In place of the traditional system of “plurality voting” (which guarantees that directors will be elected unless there is an opposition candidate who receives a greater number of votes), there is growing support for “majority voting” (which, in its purist form, only allows directors to be elected when they win a majority of the vote) 3. Proponents of majority voting argue that it promotes democracy and proper accountability in the board room. A number of companies, anticipating shareholder proposals for the introduction of majority voting, have voluntarily opted for a modified form of plurality voting in which the lack of a majority vote does not carry legal weight, but gives the board an opportunity to exercise its own judgement (and sanction) in the case of a director who does not secure a majority, taking into account the reasons for the low vote.
Director recruitment
With boards becoming more independent of management, there have been significant and far-reaching changes in the way boards approach recruiting. Active CEOs are taking on fewer directorships, and this is forcing boards to make more varied choices when adding new independent directors. Boards increasingly see recruiting as an opportunity to add someone with a defined set of skills and experience that will improve a board’s ability to support the strategy. So, for example, technology and marketing expertise are in demand, as are directors with an international background. However, the representation of women and minority directors still falls short of the levels desired by boards. It is a simple case of supply and demand: the universe of qualified and available candidates in the most highly coveted groups (CEOs, women and minorities) remains very small.
Splitting the roles of chairman and CEO
Debate has continued over the relative merits of splitting versus combining the roles of CEO and chairman. Advocates of splitting the roles argue that a non-executive chairman can reduce the concentration of power in the hands of a single individual, act as an intermediary between independent directors and the CEO, and free the CEO to focus on running the business. Advocates of combining the roles argue that this is the best way to avoid ambiguity about authority and responsibilities — pointing out that there is little evidence that companies that split the roles outperform those that combine them. They also argue that the institutionalization of the lead/presiding director role offsets any potential imbalance in the leadership of boards. The Spencer Stuart Board Index 2006 records that the number of S&P 500 company boards with a combined chairman and CEO role has come down to 67 per cent from 74 per cent in 2001, although in the majority of situations where the roles are split the chairman was formerly the CEO.
Focus on strategy and succession
Now that companies have adjusted to the myriad governance requirements, financial controls and disclosure rules imposed on them by Sarbanes-Oxley, the Securities and Exchange Commission and the New York Stock Exchange, boards are refocusing their attention again to broader and more pressing issues that represent the real work of the board. In recent years, the main focus of a board’s work has been governance and compliance, with strategy squeezed into the agenda, time permitting, but there is clear evidence that boards are treating the review and fine-tuning of strategy as a top priority and a regular agenda item. Companies are also taking a more strategic approach to board composition, giving careful consideration to succession planning — for the CEO, the senior executive team, and the board itself. In the more progressive companies, there is a shift from the short-term, tactical recruiting of directors to fill slots towards a longer term strategic approach to building boards in response to the direction and needs of the business.
1 : Among the influential shareholder groups in the US supporting majority voting are the proxy advisory firm Institutional Shareholder Services (ISS), CalPERS and the Council of Institutional Investors.
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