Directors and Investors at Odds on Performance-Based Pay

Two camps disagree on whether the current executive compensation model is changing for the better

Directors and institutional shareholders disagree on whether the current U.S. executive pay model is changing for the better. But while the two groups are split on the pay process, both agree that the status quo is giving Corporate America a bad rap. A recent study by consulting firm Watson Wyatt reveals that two-thirds of directors think the current system is improving, while only 36 percent of institutional investors feel the same way. Both groups also disagree over whether the pay model has helped improve company performance.

No Pay Revolution

"Corporate America didn't get into this situation overnight," says James Pitts, a director of Wainwright Bank & Trust. He says boards will be careful not to overreact to the backlash against CEO pay. "Boards are not about to arbitrarily ratchet back their current CEO's pay. No revolution is about to happen here, notwithstanding how revolting some of the total compensation numbers may look."

It's not exactly the answer some large investors were hoping to hear. Amy Borrus, deputy director for the Council of Institutional Investors (CII), says that the current model overlooks performance- based pay for many CEOs. "Many pay plans continue to reward mediocrity—bigtime bonuses that pay out at so-so performance targets," she says. "The parade of CEOs that have exited troubled financial-services companies with golden parachutes is dismaying and suggests there is plenty of room for improvement. The crisis in the credit markets has destroyed shareowner value across a wide swath of the financial-services industry. Yet at many of these companies, CEOs continue to be lavishly rewarded."

Directors and institutional investors agree that the Securities and Exchange Commission's new disclosure requirements have been a help, but improvements are still needed. More than 80 percent of institutional investors and close to 75 percent of directors say the new Compensation Disclosure and Analysis (CD&A) sections in companies' proxy statements help facilitate clearer pay disclosures and transparency.

"Directors, and very rightly so, see the many changes to the process approving, quantifying, disclosing, and understanding executive pay as positive changes," Pitts says. "So, directors are focusing now on process, and both process and transparency are getting better. In many cases, directors have had their eyes opened. The new transparency will surely change the game over time. It will evolve. You already see it when CEO turnover occurs and directors get to start with a clean slate, comp-wise."

The CII's Borrus, on the other hand, says only modest improvements are the result of the SEC's new pay-disclosure rules. "Additional sunlight is chasing some perks away at some companies," she says. "That's a good thing— perks are the polar opposite of pay-for-performance. But overall, investors still see too many compensation plans where incentive pay is tied to a single performance metric, such as EPS (earnings per share), which can too easily be manipulated."

Show Me, Not Trust Me

While the two sides of the battle may not see eye to eye on the issue, Pearl Meyer, senior managing director at comp-consulting firm Steven Hall & Partners, says directors are beginning to give more attention to CEO pay. "You have directors out there who are far more diligent and far more committed on this issue," Meyer says. "It's a very thoughtful process now, compared to what I have witnessed in the past. The older view was 'trust me,' and now, it's 'show me.'"

Meyer also believes the disconnect with investors might be more of a communications problem: "I think there is a real failure of communication by the companies as well as boards of directors."

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