Geithner: 'Say on Pay,' No Caps

The White House proposal for overhauling executive-pay practices, announced on June 10, was as notable for what the Administration isn't advocating as for what it is.

Treasury Secretary Timothy Geithner said the Administration would support legislation known as say on pay, which would give shareholders a nonbinding vote on executive pay packages. Geithner also threw his support behind separate legislation aimed at making compensation committees more independent from management. It was the first time the Administration has said openly it would support so-called "say on pay" legislation, though it has earlier signaled its interest in seeing it passed. But Geithner added that the Administration won't mandate compensation limits.

"We are not capping pay," Geithner said after a meeting with Securities & Exchange Commission Chairwoman Mary Schapiro, Federal Reserve Governor Dan Tarullo, and top compensation experts. "We are not setting forth precise prescriptions for how companies should set compensation, which can often be counterproductive. Instead, we will continue to work to develop standards that reward innovation and prudent risk-taking, without creating misaligned incentives."

The combined moves sent a sigh of relief across the corporate sector, where many had feared the Administration was planning more stringent controls on compensation. "What they have proposed is fairly modest; we were expecting something much more heavy-handed," says Michael S. Melbinger, the head of the executive compensation practice at Winston & Strawn in Chicago. "They're basically ideas that have been kicking around awhile; they're not that far from what already constitutes best practices."

Shareholder Interests

In his remarks, Geithner said the Administration is putting its support behind pending say-on-pay legislation, which would give the SEC the ability to mandate nonbinding shareholder votes on executive compensation packages. The rules would apply to all public companies, according to a fact sheet distributed by the Treasury Dept.

"Say on pay—which has already become the norm for several of our major trading partners, and which President Obama supported while in the Senate—would encourage boards to ensure that compensation packages are closely aligned with the interest of shareholders," Geithner said.

The Administration had been widely expected to push for an expanded say on pay measure for months. Obama is a co-sponsor of the say on pay bill now before the Senate, and he frequently cited the need for it on the campaign trail. And when the White House announced its initial pay restrictions on the financial sector in February, it had already made say on pay the de facto standard for the ailing financial services firms that had turned to Uncle Sam for help. The only way any of the firms which had been bailed out by the Treasury's Troubled Asset Relief Program (TARP) could get around the stiff pay limits imposed by the Obama Administration and Congress was by submitting their compensation plans to a shareholder vote. "There is no one in the country who didn't expect this to be the law of the land by year's end," says Melbinger.

Still, the President's overt backing will likely speed things up. "There's already a broad consensus on Capitol Hill behind say on pay; this virtually guarantees swift passage," says Patrick McGurn, special counsel to proxy advisor ISS Governance Services. While he had expected a bill to move by late in the year, McGurn now thinks it could be signed into law before the August recess. That means say on pay could be in effect by the time 2010 proxy season rolls around next spring.

What impact might that have? Governance activists say it won't bring pay levels down instantly—indeed, it may not bring them down at all. But over time, it should help make boards more responsive to shareholder concerns, which could lead to pay packages in which pay is more closely tied to company performance. That's what's happened in the UK since say on pay was adopted. "Boards are embarrassed to be told by the shareholders they are supposed to be serving that the package they've agreed to isn't adequate," says Jesse M. Fried, a law professor at the University of California at Berkeley and co-author of Pay Without Performance: The Unfulfilled Promise of Executive Compensation. "The vote may be non-binding, but the prospect of having pay arrangements voted down will cause boards to consult with large institutional investors before the finalizing a deal." He also argues that the adoption of say on pay in the UK has opened the door to more communication between boards and shareholders in general, leading to improved corporate governance overall.

In addition, Geithner said the Administration will introduce legislation that would give the SEC power to make sure that corporate compensation committees adhere to independence standards "similar to those in place for audit committees as part of the Sarbanes-Oxley Act."

The committees would also have more direct authority over independent compensation consultants and outside counsel. The rules would apply to all companies listed on national securities exchanges, according to Gene Sperling, a top Geithner aide. Treasury's goal: "To ensure that compensation committees are not just independent in name, but in fact," Sperling said in a media conference call, adding that it was critical for compensation committees to have "the rules and the tools they need to be independent."

Governance experts say those changes will help, but mostly on the margin. "There's definitely a need for tightening of standards, but it's not a glaring problem," says McGurn. On their own, the improved board standards would not likely bring much of a change if say on pay were somehow to stall in Congress. "Unless the balance of power is shifted between shareholders and the board, we won't see any lasting impact on pay practices," warns Fried. "You might see some minor improvements for a while, but when the heat dies down, boards would eventually lapse back into bad habits."

Fully Understanding Pay Packages

While backing away from some of the more stringent controls on pay that some in Congress and elsewhere have advocated, pay experts say the Administration's proposed changes may be more likely to have an effect. Efforts to impose strict controls on pay in the past have been largely ineffective and often led to unintended consequences, argues James F. Reda, head of independent pay consultant James F. Reda & Associates. "You can't legislate this kind of thing; it just creates more work for clever lawyers," he says. Instead, he argues, the only effective way to bring pay under control is to do what the Administration appears to be doing: "You've got to make the compensation committee as independent as possible," says Reda. "And make sure there is disclosure; you've got to make sure the compensation committee truly understands" what a contract entails. That may sound obvious, but until the SEC imposed heightened pay disclosure requirements in 2005, many directors didn't understand how the various elements of a CEO's pay package added up—one reason why they were as surprised as shareholders when departing CEOs often left with stunningly high packages.

Meanwhile, the Administration is preparing to announce pay practices for top executives at financial firms that received money from the $700 billion Troubled Asset Relief Program. A provision of the $787 billion stimulus package passed earlier this year put limits on the pay and bonuses of the 20 top-earning executives at companies receiving federal bailout money.

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