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House Financial Services Committee Holds Hearing on Advisory Votes on Executive Pay

Rep. Barney Frank (D-MA) recently held a hearing of the Financial Services Committee to solicit views on H.R. 1257, the "Shareholder Vote on Executive Compensation Act." Frank said the legislation would enhance the ability of shareholders to vote on the compensation of the executives they employ. It does not provide one avenue to the exclusion of others and does not add or subtract from existing rules, according to Frank. It simply adds another channel through which shareholders would be allowed to vote on an advisory basis on executive compensation.

Ranking member Spencer Bachus (R-AL) said he has an abundance of concern about the government's ability to fix the widening gap between rich and poor. The SEC's recently adopted disclosure rules may address the executive compensation issue to a large degree, he said, and there may not be a government solution that makes it any better. 

Rep. David Scott (D-GA), a cosponsor of the legislation, believes that executive pay has become dangerously outsized, especially when compared to the pay of rank and file employees. He believes the escalating executive compensation is threatening the very fabric of the economic system. The advisory vote would be nonbinding, but Scott believes it would be very powerful.

Rep. Scott Garrett (R-NJ) noted that Frank had urged patience during the implementation of the Sarbanes-Oxley Act and suggested the same for the SEC's executive compensation disclosure rules. Give the rules time to work, he said.

Harvard Law School professor Lucian Bebchuk said the SEC's rules cannot improve pay arrangements. Investors must be able to use the information that is provided to them. He believes an advisory vote will help and noted that shareholders in the U.S. have much weaker rights than in the U.K.

Richard Ferlauto, the director of pension and benefit policy at AFSCME, said the union does not have the option to sell shares if it is unhappy with executive pay. Most of its investments are indexed and are held for the long term. AFSCME has been highly concerned about executive pay and its distortion on the marketplace for many years. Institutions have tried to effect change for years, he said, but without success. Ferlauto added that the exchanges have the power to require an advisory vote, but he has little hope that they will use it to shareholders' advantage.

Ferlauto said that when an advisory vote is in effect, the company's consultation with shareholders increases and company performance is better aligned with long-term shareholder value. It provides an incentive for the company to execute its strategic plan. He is concerned that the increased disclosure under the SEC's rules could spiral up executive pay as CEOs seek to compete with the top echelon. Shareholders also must have the right to replace directors, according to Ferlauto. He said the U.S. is falling behind the European markets in corporate governance matters.

John Castellani, president of the Business Roundtable, said the best mechanism for setting executive pay is independent directors. The Roundtable supports the SEC's new disclosure rules and believes the increased transparency will benefit the marketplace. The introduction of an advisory vote could erode critical board responsibilities, in the Roundtable's view. It is not a process that enhances shareholder wealth, according to Castellani.

Stephen Davis, a fellow at the Millstein Center for Corporate Governance and Performance, gave a preview of a white paper the Center is producing on advisory votes on compensation policy. The overall conclusion of the analysis is that advisory votes on executive pay policies are rational, timely and practical for use in the U.S., he said. The Center reviewed the U.K. experience with advisory votes and found that they sparked a dramatic increase in the dialogue between companies and their shareholders. Advisory votes transformed the way executive pay is determined, David said.

Davis reported that the U.K. now sees advisory votes as critical to its competitive position in the world marketplace. The Center believes that advisory votes are best adopted on a legislative basis.

Steven Kaplan, a professor at the University of Chicago Graduate School of Business, argued that the critics are largely wrong and that the pay process is not broken. The legislation will generate few benefits while imposing additional costs, in his view. He does not believe that CEOs are overpaid today and warned that many are leaving public companies for private equity funds and higher pay. The problem with the legislation, Kaplan said, is that even companies with no problems will be subject to advisory votes.

Bebchuk suggested that underpaid CEOs may see their pay increase with an advisory vote. Critics assume the vote would be negative, he said. The only reason one would be concerned about pressures on executive pay is if they believe they have a problem, Bebchuk said.

Jacquelyn Lumb