Well, it passed. The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama on July 21, 2010. It ran 2,319 pages in its final form, with innumerable provisions, not all of which will affect
executive compensation.
But many, of course, will do just that. Independent compensation consultancy Pearl Meyer & Partners summarized the most significant impacts of the act in a recent Client Alert (1):
- Say on pay, say on frequency, say on golden parachutes
- Mandatory clawback policies
- Additional compensation policy and governance disclosures
- Compensation committee member independence and oversight
- Compensation committee advisor independence
- Executive compensation rules at financial institutions
- Elimination of broker discretionary vote
- Proxy access
For companies that are rebuilding in the wake of the Great Recession, these provisions may not appear particularly threatening. Say on pay, for example, does not bind company management to shareholder input, and could be welcomed by boards and executives who value the direct feedback. Likewise, clawback policies are designed to punish improper behavior, not merely unsuccessful strategies.
The Wonder of It All
While there is some concern among consultants about the new independence strictures, nothing in the new legislation should significantly impede boards from making decisions. But one wonders. Compare the sheer weight of Dodd-Frank with related legislation over the years: its 2,319 pages far outnumber 2002’s Sarbanes-Oxley Act (66 pages), as well as 1933’s Glass-Steagall Act (37 pages).
Those with a libertarian bent will tell you that Sarbanes-Oxley has been a disaster, causing companies to shift their focus from encouraging investment to avoiding indictment. Other government interventions–or to use a milder term, regulations–over the years have had unintentional, if not onerous, consequences. The notorious IRS Section 162(m) is Exhibit A in such discussions.
So what does Dodd-Frank really mean? It’s too early to form anything approaching a final conclusion, as many of the act’s provisions won’t go into effect for some time. For example, say on pay doesn’t go into effect at meetings until January 21, 2011. Other provisions are awaiting the SEC’s issuance of rules as to how they will be implemented.
The spirited debate preceding Dodd-Frank’s creation, as well as the final legislation, have provided ample grist for the prediction mill. C-Suite Insight contacted a number of industry leaders to see what the general response to Dodd-Frank has been thus far.
Michael Melbinger: The Act is Ambiguous; You Can’t Be
Michael Melbinger, a partner at Winston & Strawn who serves as Chair of the firm’s Employee Benefits and Executive Compensation Practice, notes that “many of the rules added by Dodd-Frank–or to be added by required SEC or stock exchange regulations–have already become best practices in recent years.”
Melbinger feels that the new legislation is “riddled with ambiguity,” with provisions that will lead to unintended consequences. “Executive salaries will probably continue to increase (as they did for TARP institutions) at the expense of at-risk incentive pay, as a reaction to the clawback rules,” he notes. Overall, however, Melbinger believes that there will be a “gradual reduction of overall compensation to senior executives.”
Melbinger sees “incidentals and protections in employment agreements and compensation plans [being] reduced when the compensation committee has independent advisors,” and believes that “overall, this will be a very positive development for the executive compensation world.” In his opinion, it is likely that this development will also “raise the costs of the compensation committee function.”
He suggests that boards, and compensation committees in particular, “expect that most of the Dodd-Frank provisions will be effective for the 2011 proxy season.” Noting that many companies are already preparing for this possibility, Melbinger adds that “boards, and compensation committees need to act fast, although the actions they take may not need to be dramatic.”
Specifically, Melbinger and his firm recommend that clients take a series of steps in response to Dodd-Frank. “First, boards and compensation committees need to hear a detailed presentation on the technical provisions of Dodd-Frank. Other affected company parties should be present, including human resources, executive compensation, legal, and investor relations functions,” he urges, to ensure that the response is coordinated from the get-go.
Next, “boards and compensation committees should evaluate new policies and procedures and formulate a response to each of the provisions of Dodd-Frank that apply to executive compensation,” he says. “The SEC may not promulgate rules in time for a fully compliant reaction to Dodd-Frank before the 2011 proxy statement. However, we can developa good game plan based on provisions of the statute.”
“Of course, because the SEC rules may turn out differently from what we expect,” Melbinger adds, “the policies, procedures, and response of the boards and compensation committee should be flexible and principles-based, rather than written in stone.” Additionally, Melbinger says that “most compensation committees [now] need to add one more factor to their consideration of each compensation issue–how will we explain this decision, payment or policy in the proxy statement CD&A, and will it increase the risk that shareholders will vote ‘no’ on say on pay?”
Just “one questionable action, payment, or practice could cause shareholders to vote ‘no,’ regardless of the reasonableness of the overall packages,” he notes.
Doug Friske: Time For a Check-Up
Doug Friske, Towers Watson’s Managing Principal and Executive Compensation and Rewards Global Practice Leader, also mentions unintended consequences, noting that while the “thematic underpinnings” of the bill are clear, “the practical implications [of Dodd-Frank] are much less clear, as are the long-term effects of the new rules.”
“It will be years before we fully understand where this new law has taken us,” Friske comments. Friske recommends that boards “get a ‘check-up’ on executive pay plans, to ensure [they’ve] eliminated practices that don’t add value but [instead] might create issues with shareholders.” He notes that boards need to “make sure [they] have a good story to tell about pay for performance, alignment with business strategy, and shareholder value creation.”
Friske has two other prescriptions for boards:
- “Avoid the temptation to mechanically comply with so-called ‘best practices’ identified by various advisory groups,” and
- “expect it to be a while before the dust settles on how the legislation will affect your organization.”
For Friske, when it comes to best practices, “one size does not fit all and can lead to bad outcomes. If a plan design feature makes sense for your organization and supports your business needs, go with it.”
“The devil is in the details of these new rules,” he asserts, “and even when they are final, application will likely vary from company to company.”
Peter Chingos: Remember the Shareholders!
Compensation Advisory Partners’ Senior Partner Peter Chingos and Partner Eric Hosken also note that “much of the Dodd-Frank Act reflects where the market was [already] moving.” Nonetheless, they assert that the act “will accelerate certain reforms of executive compensation and governance practices,” including say on pay, pay for performance, CIC severance, clawbacks, and anti-hedging policies, among others.
Chingos and Hosken echo Melbinger in noting that “aspects of the legislation are confusing and require greater clarity for implementation,” but still feel that its “main impact will be to further heighten the emphasis on responsible behavior and the relationship between pay and performance.”
Their prescription for boards is simple: “Begin byvalidating [your] company’s overall compensation strategy and program to ensure that the design represents the interests of shareholders, reflects responsible compensation practices, and provides for appropriate alignment of pay and performance.” When it comes to say on pay, the two recommend that boards and management “engage with major shareholders on a regular, ongoing basis to communicate the business rationale for the compensation program and gather input from shareholders on their support for the program.”
Irv Becker: Don’t Just Follow the Leader
Irv Becker, National Practice Leader, Executive Compensation at Hay Group, urges company management to understand that things “are getting tougher.”
He says Hay Group “expects the impact [of Dodd-Frank] to be substantial.” He also believes that “despite the fact that most companies to date have passed their advisory votes with room to spare, say on pay will shake things up.”
In a new environment in which “all public companies are being subjected to this [say on pay provision], many of the more hot button pay practices will become less and less prevalent,” Becker notes. This in turn, “will impact a company’s ability to tell shareholders that everybody in the industry is doing it.”
He expects “shareholders will have to get tougher on these votes [because] there’s now a provision that requires the votes of investment managers to be made public.” The net result will be that companies will have to take these “votes much more seriously.”
Becker also cautions companies from simply “replicating what others are doing,” Claiming that “every company seeking out a new middle ground isn’t the right outcome.” Therefore, he says, “we are telling all of our compensation committees that there is no security in what others are doing. The only safety in this process is in maintaining–and communicating–an ironclad linkage to business strategy.”
“Even when your program looks different than your peers’, if your shareholders understand how the program supports what you’re trying to do with your business, then the program can be justified,” Becker says. But “companies need to help their shareholders become savvier about evaluating their executive pay programs, and the best way to do that is to take pains to ensure that the program directly links to helping the company make money and create value,” he concludes.
Robert McCormick: How to Avoid Backlash
In response to C-Suite’s questions regarding Dodd-Frank, Robert McCormick, Chief Policy Officer at Glass Lewis & Co. commented that not only will Dodd-Frank “further encourage companies to examine their compensation programs to ensure the programs enjoy widespread support among shareholders,” but the Act will also “further the oft-stated goal of say on pay proponents to encourage companies to engage with shareholders about compensation.”
McCormick predicts that “companies may simplify their compensation programs in order to enable clearer explanation of how these programs work,” but cautions that they should “provide clear disclosure of how and why the performance metrics they have selected foster the performance they seek to encourage.” This is particularly true, he notes, “since Dodd-Frank bans the use of broker votes for [say on pay] proposals.”
Looking at the big picture, McCormick says that “shareholders are less concerned with actual compensation amounts than knowing that a company’s compensation programs result from thoughtful deliberations by the compensation committee, and are clearly linked to sustainable performance criteria.”
He also stresses the commonsensical tactic of “thoroughly explain[ing] any aspects of their compensation programs that could be interpreted as outside the norm to avoid shareholder backlash.”
Michael Powers: Say on Pay Looms
Michael Powers, Managing Partner with Meridian Compensation Partners, is inclined to think that “the absolute and primary forms of executive pay are not likely to be immediately impacted by the Dodd-Frank Act. However, over time, the compensation landscape may be significantly affected by say on pay voting patterns, proxy access, and the rising influence of shareholder advisory firms.”
“Boards are not under significant pressure to take immediate action prior to the SEC issuing rules on the Dodd-Frank Act’s executive pay and corporate governance provisions,” Powers adds. “There is one pressing item, though: the thousands of say on pay votes that will occur during the 2011 proxy season.”
“In advance of these votes,” Powers advises, “boards should take the time to critically evaluate executive pay programs to identify possible areas for improvement and exposure, surface any issues regarding executive pay programs among institutional investors, and make a compelling case on the merits of their executive pay programs.”
David Swinford: “Selling” the CD&A
Pearl Meyer’s President and CEO, David Swinford, believes that “companies are going to have to think more about how to define and communicate, in the CD&A, the link between pay and performance.”
Swinford advises board members to approach their proxy “as a campaign tool [used] to ‘sell’ their compensation programs to investors.” The proxy should explain exactly how an organization measures performance under its incentive programs, avoiding “obvious lightning rods, like huge or unusual perquisites that people don’t understand, or gross-ups.”
“With say on pay votes and pending changes in proxy access rules, some directors may feel pressured to opt for non-controversial performance measures and plan designs that won’t attract outside criticism,” Swinford notes. “It’s unclear what value is provided by certain of the newly required disclosures,” he adds, citing the ratio of CEO pay to median pay as an example.
Swinford is concerned that the new requirements “will generate a great deal of new data, but no useful information” and suggests that companies should focus on the question of “what compensation approaches enable [them] to attract, retain and appropriately reward the executive talent necessary to create superior returns for shareholders.” Without this focus, Swinford worries that “the pay discussion becomes almost a Tower of Babel.”
(1) “Dodd-Frank Wall Street Reform and Consumer Protection Act Signed Into Law: New Requirements for Say on Pay, Executive Pay Disclosure, and Director Independence Will Affect All Public Companies.” Pearl Meyer & Partners. http://www.pearlmeyer.com/newexecpayrules/PMP-CA-DoddFrankBill-7-21-10.pdf