Speech by SEC Chairman:
Remarks Before the Council of Institutional Investors
Chairman Christopher Cox
U.S. Securities and Exchange Commission
March 30, 2006
Thank you, Coleman, for your kind introduction. It is a particular pleasure to join you for a free lunch at one of Washington’s better hotels.
As you may know, just a few days ago I announced that SEC investigators nationwide are commencing a multi-state crackdown on so-called investment seminars, typically organized around a free lunch, often at upscale hotels.
Coincidence? I think not.
Actually, you’re all quite safe — and you can rest assured, I’m not here as an investigator. This is one investment gathering that is certifiably devoted to the best interests of investors. If ever there were a group with interests and aims in perfect alignment with the SEC’s mission of investor protection, this is it.
In a brief two decades, the Council of Institutional Investors has had a profound impact on corporate accountability and shareholder rights. You’ve established that companies can and should be held accountable to oversight by shareholders. The result is that today, thanks to the combined economic influence and moral force of more than 140 of the largest pension funds in the United States, fairness, transparency, responsibility, and accountability are now more than ever the core values of corporate governance in America.
Most recently, under the leadership of your outstanding Executive Director, Ann Yerger, you’ve been a strong voice for reform in areas ranging from soft dollars, to commission levels, to directed brokerage. And you’ve tackled some of the most difficult and important issues in corporate governance, including the accountability of boards of directors to shareholders, the importance of independent directors, the need for auditor independence, and the need for effective and reasonable executive compensation arrangements that are clearly, comprehensively, and promptly disclosed in plain English.
As you know, the SEC is currently overseeing the implementation of the new Sarbanes-Oxley corporate governance requirements that boards include on their audit committees at least one member who is a financial expert; that companies make public their codes of ethics for senior management; and that the securities of any company that doesn’t comply with its audit committee’s standards be delisted.
Our recent executive compensation proposal is closely tied to these corporate governance norms, which are aimed at more closely aligning the interests of shareholders and management.
When it comes to compensation for men and women at the top, the question most often discussed is: is it too much?
Consider just a few examples from 2005: $290 million last year alone for one California executive; $185 million in 2005 for a well known Australian-born media baron; $87 million just last year for a talented but very young top dog from Orange County; and $60 million during 2005 alone for a top earner in the automotive industry.
You know who these people are. The California executive whose compensation last year was $290 million is George Lucas. The Australian-born media baron is Mel Gibson. The “talented but young” Orange Countian is Tiger Woods. And the top earner from the automotive industry is Michael Schumacher, the Formula 1 race car driver.
The truth is, we don’t begrudge athletes and the Hollywood glitterati their outrageously high salaries — even though we pay the ticket prices.
We don’t mind that Oscar de la Hoya got paid $38 million for two fights last year — or that Will Ferrell’s 2005 compensation was $40 million for such artistic triumphs as “Anchorman” and “Elf”.
We don’t even blanch at Michael Vick getting a guaranteed $130 million from the Atlanta Falcons.
Yet we are indeed concerned, and rightly so, that shareholders are disserved when executives of certain companies receive very similar amounts.
The reason we don’t complain about the first instance, and we do in the second, is that we’re implicitly more confident that the salaries of quarterbacks, movie stars, and race car drivers are determined by the market.
In a market economy, supply and demand should, and normally do, dictate what people are paid. If an athlete’s skills are exceptional even when measured in the context of global competition — and if the supply of similarly talented players is scarce — it stands to reason that individual will be highly compensated.
Consider, in contrast, the way executive pay is determined. In theory, the market for executive talent works just like the one for athletes and movie stars: the highest paid executives make what they do because that’s what the market will bear. But in practice, the corporate governance structures that determine executive compensation don’t work anything like the process for determining celebrities’ and athletes’ compensation.
As Michael Lewis so amply describes in his splendid book, Moneyball, an athlete’s pay is the result of elaborate market research on the part of the employer and a truly arm’s length negotiation between parties with opposing interests. No one has ever accused owners or players of trying to feather the other’s nest. (Nor, for that matter, has anyone ever accused a Hollywood studio of missing an opportunity to short-change an actor.)
Consider the negotiation for Michael Vick’s contract. The owner of the Atlanta Falcons, who pays the players, understandably wants to pay as little as possible. Mr. Vick and his agent understandably want Michael’s pay as high as possible.
The difference with executive compensation, as Lucian Bebchuk of Harvard and Jesse Fried of Boalt Hall have pointed out, is that boards of directors of public companies don’t always negotiate at arms’ length with their executives. And as a result, the executives are often able to influence the level of their own compensation.
Of course, the shareholders are the owners of the corporation, and management works for them. But for a number of very good reasons — including specifically the dispersed ownership of publicly traded companies — shareholders do not direct management. Instead, they must act through the intermediation of the board.
But broadly dispersed shareholders also face problems in trying to control the boards in setting executive compensation. That’s true for a number of reasons. For example, executives frequently sit on the boards. The CEO is often the chairman of the board.
And even when the compensation committee is comprised exclusively of outside directors, the CEO may be responsible for recommending the pay packages for the directors’ approval, or for hiring a compensation consultant.
And of course, a director who’s been invited to serve on the board by the CEO herself might well equate his opportunity to continue enjoying the advantages of board membership with his continued cordial relations with the CEO.
It’s because of these potential, and often real, conflicts of interest that a good deal of sunlight needs to be focused on the entire process by which executive compensation is determined. It’s already hard enough for shareholders to exert themselves, without inadequate information compounding the problem.
We aim to fix that.
Executive compensation matters — not only because if moral hazards inherent in these conflicts of interest are unchecked, executives will be paid too much, but also because it can play a valuable role in disciplining management across the board, and in protecting the entire range of shareholder interests.
By restraining executives from self-indulgent behavior — and using salary, bonuses, options, long term benefits, and other financial incentives in very purposeful ways — compensation committees acting on behalf of the shareholders can increase management’s incentives to improve corporate performance.
So our purpose in advancing a very aggressive executive compensation rule is very straightforward: It’s to protect and advance the interests of shareholders.
This is the first time in 14 years that the Commission has undertaken significant revisions of its rules for executive compensation. Simply put, our rules are out of date, and it’s high time we updated them.
And while we’re at the task of overhauling our rules on executive pay, we’re also proposing changes in disclosure of related party transactions, director independence, and corporate governance. All of these are key to our effort to provide investors and markets with comprehensive — and comprehensible — information about a company’s financial dealings with management, directors, and significant shareholders.
Over the last decade and a half, the compensation packages awarded to directors and top executives have changed substantially. Our disclosure rules haven’t kept pace with changes in the marketplace.
And in some cases, today’s disclosure regime fuzzes up rather than illuminates the true picture of compensation.
We want investors to have better information, including one number — a single bottom line figure — for total annual compensation.
That single figure will include a more accurate representation of perquisites. Currently, companies are required to report a lump sum if an executive’s perks are more than $50,000, or 10 % of his or her salary and bonus.
And under current rules, an individual perk has to be reported only if it represents more than 25% of all the perks that an executive receives.
That sets the bar too high. $50,000 is what many of a company’s shareholders make all year, and it’s far above the median household income of $44,400. So under our proposal, perquisites must be itemized if they total $10,000 or more.
The proposed new rules would also improve the disclosure of retirement benefits. New tables would outline the defined-benefit and defined-contribution retirement plans of top officers. There would also be detailed descriptions of payments that could be made if an executive is terminated. Those disclosures aren’t required under our current rules.
This should ensure that retirement benefits, which under the current disclosure regime can be nearly impossible to understand, will finally become intelligible. We don’t want any more “Aha! moments” when shareholders learn the details of a “Golden Goodbye” only when an executive leaves the company — and it’s too late.
An important part of our job at the SEC is to ensure that investors have available to them all of the compensation information they need, presented in a clear and understandable form that they can use.
And that means that while it is up to boards of directors to decide how much to pay the CEO, companies will now have to provide a clear explanation of how they arrived at both the amount and the measurement. That’s because investors deserve more than just a figure. They need also to understand how the compensation committee and board of directors arrived at it.
So our proposed rule changes would require a new Compensation Discussion and Analysis section, designed to provide both an obligation and an opportunity for a company to clearly explain its compensation policies.
The rule changes would also amend Form 8-K to focus the real time disclosure of changes in executive compensation on unquestionably or presumptively material events.
The new rules would bring together, in one place, all of the disclosures concerning related parties, director independence, and other corporate governance matters.
And they would, for the first time, require that all compensation to board members be fully disclosed.
Finally, the entire compensation of the top executives and best paid people in the company, including deferred payments and complicated derivatives, will be distilled to one bottom-line number.
Perhaps the most shareholder friendly thing of all is that all of this new disclosure in proxy statements, information statements, and annual reports will be in plain English, the new official language of the SEC.
When all is said and done, all of you will have far more useful tools to exercise your rights and responsibilities as shareholders.
It’s essential, however, that this proposal be understood for what it is — an effort to improve disclosure by including all elements of compensation. By improving the total mix of information available to the marketplace, we can help shareholders and compensation committees of boards to assess information themselves, and reach their own conclusions.
It then becomes their job — your job — to determine how best to align executive compensation with corporate performance, to determine the appropriate levels of executive pay, and to decide on the metrics for attaining it.
The answer to the often-asked question of just what the impact will be on prevailing levels of executive compensation awaits us.
But I have a feeling that when people are forced to undress in public, they’ll pay more attention to their figures.
This executive compensation proposal is part of a larger effort underway at the SEC to give investors better tools to look after their interests. I am absolutely convinced that putting the investor in charge will lead to better governance, better performance, stronger portfolios, and a more robust economy. Those are the results that all of us in this room want to see.
In all that we’re doing at the SEC, our goal is to put investors in the driver’s seat, and give consumers more control over their money. That’s just as true of our initiatives with interactive data, which may someday give investors qualitatively better information than they’ve ever had before.
Bringing this kind of added flexibility and better usability of information to investors is sheer, unmitigated good. Then again, just last week, a newspaper article about our interactive data initiative, after praising its potential to demystify mountains of financial information for ordinary investors, questioned whether it could ever pass muster with companies because of fears that “it would give investors too much power.”
From my point of view, it’s all but impossible to give investors too much power. Empowering investors is what the SEC is all about. We are, after all, the investor’s advocate.
Our theme here this afternoon — very aptly, given that it’s springtime in Washington, and the cherry blossoms are in full bloom — is “New Environment, New Faces.” And it’s true, I’ve been leading the SEC now for just seven months. But perhaps in my case, given the 20 years I’ve spent in government service, we might say “Old Face, New Job”. (Or maybe I had better say “Familiar Face, New Job”.)
Either way, this is a great opportunity to get to know one another on a personal level. As your new Chairman at the SEC, I’d like to share with you a personal story about why our mission of investor protection is so important to me.
I never met my grandfather, a man of the 19th century and early 20th, but I’ve always admired him because of the obstacles he overcame and his example of hard work. One of the only possessions of his that’s come down to me is a book of his, High School Self Taught, inscribed with his name, which is a dog-eared reminder of his determination.
He was born in Kentucky and raised in Tennessee, and worked hard for what he earned before his untimely death at age 52 — younger than I am today. Sadly, much of what he was able to save was lost in the market crash that gave birth to the SEC.
I didn’t even realize this until last summer, when my mother died.
For any of you who have lost a parent, or worse yet both of them, you know that you never feel so alone in the world as when you stand by your parent’s grave.
As hard as it was to accept my mother’s death, it was harder still to see my father so vulnerable. So it was nice that it seemed to help both of us to spend some time going through old pictures and mementos in Mom and Dad’s apartment. And in that enjoyable scavenger hunt, I came across a small framed check, made out to my grandfather.
It was for $3.36 — representing 56/1,000 of 1% of the hard-earned savings he’d earnestly entrusted, in 1929, to the debentures of Insull Utility Investments, Inc. That was the eventually notorious holding company of Samuel Insull, the Ken Lay of his day — who combined scores of power utilities to create a corporate pyramid.
It came crashing down in 1932, and 100s of thousands of investors, including my grandfather, lost their savings as a result. The Insull abuses, which FDR railed against in the 1932 campaign, helped give birth to the Securities and Exchange in 1934.
I’ve hung that small frame on my office wall. It serves as a reminder that being the investor’s advocate means standing up for the little guy.
Since last summer, when my mother died, and I became Chairman of the SEC, I’ve had the opportunity to devote myself to the cause of the ordinary investor. The same investor who has entrusted many of you with her pension funds. The teacher whose retirement funds represent virtually his entire life savings. The union member whose future health care depends on the success of the very corporate governance reforms that you’re fighting for.
The proposals I’ve outlined here this afternoon, and the broader agenda of investor empowerment that we’re pursuing at the SEC, aren’t merely theory, or just dry accounting concepts. Ultimately, this is all about people’s lives.
I couldn’t be more proud of the dedicated men and women of the SEC with whom it’s my privilege to work.
And I couldn’t be happier to have allies such as the Council of Institutional Investors in the struggles that lie ahead.
Thanks for all that you do — I look forward to working with you.