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Former SEC and PCAOB Chairs Oppose Shareholder Vote on Executive Compensation

A group led by former SEC Chairman William Donaldson has come out against a shareholder advisory vote. The proper means for shareholders to express their opinions on executive compensation is through their votes for directors who represent them, according to the group. The group also recommended the elimination of quarterly earnings guidance. Other members of the group include former SEC Chairmen Harold Williams and Rod Hills and former PCAOB Chairman William McDonough. The group's report was sponsored by the Committee for Economic Development, an independent research and policy organization whose members include over 200 business leaders and educators.

With a pending House bill mandating a shareholder advisory vote on executive compensation, the former chairmen expressed concern that such an advisory vote would send mixed and confusing signals and work against 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.

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. For example, shareholders 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.

The goal of those supporting a vote is to create a dialogue about pay issues, so the former chairmen urged the company's compensation committees to initiate 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 practices and its link to value creation for the long term.

In their view, a good place to start would be for compensation committees to fully implement the new SEC requirement for Compensation Discussion and Analysis. The CD&A is a principles-based disclosure requirement, the purpose of which 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.

SEC Chairman Cox has publicly remarked that, relative to the SEC's goals, the submissions are unreadable, too long and overly burdened with lawyers' jargon. His assessment 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, in the group's view.

The former chairmen 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.

In addition, the group said that quarterly guidance on earnings per share should be terminated because it 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 the 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 are not measured at all. The group recommended that financial reports be supplemented with nonfinancial indicators of value.

James Hamilton