Speech by SEC Commissioner:
Open Meeting Statement: Proposed Revisions to the Executive Compensation and Related Party Disclosure Rules
Commissioner Paul S. Atkins
U.S. Securities and Exchange Commission
January 17, 2006
Thank you, Mr. Chairman. You will have to forgive me today for thinking that I might be in another time and place 14 years ago I was also at the SEC in our old auditorium when the SEC adopted the current rules regarding proxy disclosure of executive compensation. Today's meeting reminds me of the movie Groundhog Day, in which Bill Murray lived the same day over and over again. Back in 1992, the Commission took a comprehensive look at this issue and went out with a proposal and then a reproposal. Many compromises were built into the final rules to respond to the many comments. In the ensuing years, some critical holes in compensation disclosure have developed and become apparent. Now here we are looking at the issue again. I am optimistic that we can work towards a proper balance and achieve the disclosure that shareholders are requesting.
I cannot help but also compare today's atmosphere with that in 1992. Back then, the newspapers were full of stories about how supposedly bleak the American economic condition was, why America was losing its competitive position, and how soon it would be before Japan and Europe would surpass us. In March of 1992, the SEC in fact held a two-day conference on Corporate Governance and American Economic Competitiveness, where many invited guests discussed executive compensation and the role of shareholders. The concern was that bad incentives built into our marketplace would weaken the economy. These fears, of course, never panned out. Our country's economy is truly the envy of the rest of the world. Ironically, the OECD currently projects that America's real GDP growth will be 75% greater than the real GDP growth rate in either Japan or Europe during each of the next 3 years.
As former Chairman Richard Breeden made an important observation when proposing the SEC's executive compensation disclosure rules: "[I]t is important to recognize that the appropriate amount and structure of compensation for corporate employees whether on the shop floor or in the executive suite is a question that should be resolved in the private marketplace. Market forces, not government regulation, should be used to address instances of abusive conduct."
Today's meeting is all about giving shareholders information about executive compensation that is easier to understand and to compare as between companies. This proposed disclosure, if adopted, should assist companies in providing investors with the information that they need to make informed investment decisions in this complex area. Well-crafted disclosure can allow the debate about executive pay to be decided on a case-by-case basis by investors rather than through knee-jerk condemnations of all executive pay packages.
It has also become apparent in reading various critiques of executive compensation both on an individual-company basis and generally that methodologies of calculating pay differ very much. Some people count, for example, in one year exercise of previously granted options together with the estimated value of currently granted options. To others, this seems like double-counting. Our proposed rules attempt to provide a common base for discussion and to avoid double counting. I am sure that we will get much commentary on this aspect.
We also must be careful about unintended consequences. Some suggest that the very disclosure of executive compensation has contributed to some of the instances of large pay packages, as all packages are now public and any company can see what its competitors pay. There may be a ratcheting effect as each tries to outdo its competitors. Although it is certainly true that these compensation packages are now in the open, I suspect that compensation consultants would have found a way to build databases of comparison even if no information were publicly available.
Perhaps the action that had the most effect as far as unintended consequences was the so-called Million Dollar Rule of section 162(m) of the Internal Revenue Code. This 1993 law limits the deductibility of non-performance-related executive compensation to $1 million, and economic studies have shown that companies as a result changed their pay packages away from salary and toward "performance-based pay." Thus, in effect, it costs companies 35% more to pay their top executives more than $1 million per year because of the corporate tax rate.
That led to the increase in the grant of stock options, which had been seen as too risky in the past as compared to cash. With a stock market increasing in value, options, while still risky, became more attractive.
The amount and form of executive and director compensation can also affect how a company is managed. A company that gets the incentive balance wrong can become a victim of, for example, a short term vision. For a host of reasons, "short-termism" is already a disturbing trend among corporations in this country, and the pay packages of some corporations may exacerbate this because corporate management may focus more on a company's stock price as a sole measure of success, without considering long-term prospects. Tom Donahue, President of the U.S. Chamber of Commerce, expressed it this way last November:
We've created an environment where a company's long-term value and health are all too easily sacrificed at the altar of meaningless short-term performance. We focus on a company's numbers and ignore its business-and that philosophy poses a significant threat to our future competitiveness. 1
Executive compensation, of course, is just one factor that can contribute to short-termism, but I am hopeful that the changes that we are proposing today will assist investors in determining whether a company is making decisions with an eye towards long-term profitability.
I look forward to hearing commentary on this proposal from investors, companies, and executives. With your help, we can ensure that investors get the information that they need in a manner that is clear and easy to understand at a reasonable cost to companies. Your insights are particularly useful in helping us to set the appropriate level of detail about compensation. The staff has worked very hard to craft this proposal and the accompanying questions in a way that would encourage public comment. I would especially like to recognize Paula Dubberly and Anne Krauskopf, who were here working on the first round in 1992. Finally, I'd like to thank Alan Beller for his years of leadership and service here in Washington. I share the Chairman's sentiments and look forward to an appropriate valedictory.
1 Speech by Thomas J. Donahue, President and CEO, U.S. Chamber of Commerce, before the Wall Street Analyst Forum, Nov. 30, 2005 (available at: http://www.uschamber.com/press/speeches/2005/051130tjd_wallstreet.htm).