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Spotlight on the Board Room
What are shareholders, regulators, and institutional investors across America—and here in Maryland—doing to make corporate executive pay practices more transparent and accountable?
Note: You can listen to the accompanying episode of "The Lines Between Us" here.
If you own any stock, even a few shares, this is the time of year you can make your voice heard in the corner offices of the world’s largest public corporations.
Most companies hold their annual shareholder meetings between March and June. And now, thanks to a U.S. Securities and Exchange Commission rule that emerged from the 2010 Dodd-Frank financial reform act, publicly-held companies are required to put their executive pay packages before shareholders for a non-binding vote.
If you look at average CEO pay among firms listed in the S&P 500, it nearly tripled between 1992 and 2007, the year the economy started to tank. If you look at the 500 largest companies in America, the average CEO pay went up nearly six times over. It’s dropped a bit since, but CEO pay is still growing much stronger than average wages, which the Social Security Administration says rose 75 percent in that time frame.
There is a number that people use to track whether CEO pay is outpacing the wages of other workers. It’s sometimes referred to as “internal pay equity”: the ratio of what a CEO gets paid to what that company’s average worker gets paid. Three or four decades ago that ratio was about 40. Measurements over the last few years capture it well over 300.
Bethesda-based Lockheed Martin is the biggest publicly-held company in Maryland, according to Forbes Magazine. Last year they made $47 billion in sales, mostly to the Pentagon.
Down in St. Mary’s County, over 100 members of the International Association of Machinists work for Lockheed Martin at the Naval Air Station Patuxent River, where the company tests fighter jets.
The union says machinists there make between $15 to $33 an hour. Last year at Lockheed Martin, then-CEO Robert J. Stevens brought home $1,800,000 in salary—26 times what the highest paid machinist makes working full-time. Of course, Stevens also gets bonuses, stocks, options, and other compensation. His total pull for 2012? $27,549,444. That’s over 400 times the highest-paid union machinists’ wages.
Some would say no one should make that much money, regardless of performance. Others would say the market determines fair pay based on CEOs’ performance—and that they’re being paid partly not to take their talent elsewhere, even if it means less money for everyone else. (We’ll call this the Joe Flacco argument.)
There have been efforts at the federal level and here in Maryland to rein in executive pay, or at least bring more transparency to the process by which companies determine how much they’re going to pay these guys. (They are mostly guys.)
The Dodd-Frank financial reform bill that passed in 2010 directed the U.S. Securities and Exchange Commission—the SEC—to write a rule requiring shareholders to vote up or down on executive pay packages at least once every three years at their annual meeting.
Nearly all say on pay votes in 2011 were yes votes—98 percent, according to Corporate Board magazine. They were strong yes votes, too: on average, getting the support of nine out of ten shareholders.
The vote is non-binding—boards of directors can ignore it. But it can send a message.
Patrick McGurn, special counsel with Maryland-based proxy advisory firm Institutional Shareholder Services, said, “Our clients tell us that the most important issue is pay for performance and the second most important issue is pay for performance as well.”
The line of influence between a shareholder say-on-pay vote and how companies pay their executives runs right through ISS’s offices in Rockville. When ISS makes recommendations on say-on-pay votes, shareholders listen. The Corporate Board says that when ISS gives a thumbs up to a pay package, an average of 94 percent of shareholders vote yes. That goes down to 73 percent when ISS gives a thumbs down.
Shareholders listen to ISS, but ISS listens to shareholders, too.
“We’ve seen shareholders giving more and more weight in the actual vote decisions that they make to the level of responsiveness that the board showed the year before,” said McGurn.
A Corporate Board analysis says that ISS will likely recommend that shareholders abstain or vote no if the previous year’s vote showed less than 70 percent support—unless the company makes adequate changes.
In 2011, 69 percent of Lockheed Martin shareholders approved of the CEO pay package. They voted that way despite Lockheed Martin making some last minute changes to the package—changes that actually convinced ISS to reverse an initial recommendation for shareholders to vote against it.
In 2012, ISS recommended a vote for Lockheed Martin’s CEO pay package. Yet a few weeks later…just 68 percent of Lockheed Martin shareholders approved of the pay package.
The company took notice. Two weeks ago, Lockheed Martin disclosed even more compensation reforms. They’ve set the compensation for their new CEO, Marillyn Hewson, at below the market rate, hoping she’ll earn her way up to market rate in two years.
On April 25, shareholders will convene and vote on Hewson’s pay package. ISS will release their recommendation for Lockheed Martin’s say-on-pay vote a few weeks before that meeting.
Another regulation from Dodd-Frank requires publicly-held companies to calculate the ratio between CEO compensation and the median total compensation for all other employees. That ratio has ballooned over the past couple decades.
The thing is…the SEC hasn’t written that rule yet.
I wrote to 15 of Baltimore and Maryland’s biggest publicly-held companies asking if they’d share that ratio with us. None did.
Some companies share it. Whole Foods sets a cap on their CEO’s salary: 19 times the company’s annual average wage. Whole Foods vice president Mark Ehrnstein told the Wall Street Journal, “It doesn't take months and months and millions of dollars to calculate this. It's a relatively straightforward process that takes a few days.”
In a January webinar hosted by Equilar, an executive compensation and corporate governance data firm, Wendy Davis, a partner at law firm Cooley LLP, said companies are already talking about so-called “internal pay equity” in public SEC filings. Not just CEOs compared to everyone else, but also compared to the next couple executives at the top of the ladder, their potential successors.
“I think if you don’t expect management and the employees are looking at that proxy when it comes out to see what that table says,” Davis said during the webinar, “you’re kidding yourself. Don’t underestimate the morale impact.”
But as far as calculating the ratio that Dodd-Frank mandates?
“Dodd-Frank required about 400 sets of regulations,” Davis said. “And if I’m a bettin’ woman, I’m gonna say they’re hoping this is the last one that they tackle so that it will go away before they have to tackle it. And to junior budding engineers out there, the person who figures out the software on how to calculate total compensation for every single employee in every country will all the various different kinds of foreign legal compensation that’s required…god bless you: you’re going to be a bazillionaire. And I still don’t understand how it’s going to be useful. At the end of the day, this feels like—forgive me—compensation porn.”
In her March 6, 2012 testimony before the U.S. House Subcommittee on Financial Services, then-SEC Chair Mary Schapiro said the ratio requires a complex calculation. “It's not just that we could take the W-2 forms and -- and come up with an average and then compare it to the CEO's compensation,” she told the committee. “It's much more complex than that.”
When will the SEC actually write the pay ratio rule? The news site HousingWire.com reported last year that Schapiro said the rule would be probably done by June…2012.
We reached out to the SEC. Spokesperson John Nester replied with this comment: "Although Congress did not set a timeframe for Commission action, the Commission and staff are working hard to adopt an effective rule as soon as possible."
Here in Maryland, officials, legislators, and institutional investors have made their own moves to affect executive compensation.
In Maryland, executive compensation is a legitimate deductible expense for corporate tax filers. Paul Pinsky, a Democratic State Senator from Prince George’s County, introduced a bill during last year’s special session that would render executive compensation illegitimate for deductions…unless the CEO’s pay is no more than 25 times the lowest paid worker’s pay.
He’s introduced this bill several times.
“I have to tell you,” said Sen. Pinsky, “it didn’t get a very long look in the budget and tax committee. They say, ‘Well, you’re going to scare away companies, they’re not going to be able to pay their CEOs.’ And I always remind them, a company can pay their CEO as much as they want.
“The question is,” Pinsky continued, “how much does the state of Maryland say as a policy is a legitimate business expense.”
Pensions and mutual funds have some sway on pay, too.
The Maryland State Retirement and Pension System holds $40 billion in assets. Maryland State Retirement Agency executive director Dean Kenderdine said that in 2003, their board established an adhoc committee to work on proxy voting policies.
“This was post-Enron/WorldCom,” said Kenderdine,” “and we had proxy voting guidelines up to that point. But it was at that point the Board of trustees made the determination that it wanted to be much more activist in its orientation toward proxy voting.”*
Did the 2008 financial crisis lead the board to become “more more” activist? Not really, says Kenderdine. But with the guidelines they have in place, plus consulting from ISS, the pension fund looks at executive pay packages on a case-by case basis.
They’ll vote agains a pay package, Kenderdine said, “if there’s a misalignment in our view between the CEO pay and the company performance, or if a company maintains any sort of problematic pay practices, or if the board exhibited poor communication and responsiveness to the shareholders.”
T. Rowe Price, a Baltimore-based firm handling over $500 billion in assets, has a screening tool with 80 different metrics to identify companies that need a closer look. Corporate governance specialist Donna Anderson says T. Rowe Price voted no on 12 percent of last year’s CEO pay votes for U.S. companies.
“You know before Dodd-Frank,” Anderson said, “shareholders didn’t get a vote on pay, so our only option was to vote against members of the compensation committee. And you would think that would be effective.”
Not so much.
“But now that there is a line item on the proxy that says ‘say on pay,’” said Anderson, “it’s personal. I’ve been really surprised at the level of responsiveness and attention that not only compensation committee members but CEOs pay when they are at risk of being embarrassed in a public setting about their pay.”
Will more embarrassment in the form of a CEO-to-average-worker pay ratio make CEOs and boards even more responsive? We’ll see when the SEC finally writes the rule that the law says they must write.
* - CORRECTION: We had a typo in the original version. Maryland State Retirement Agency executive director Dean Kenderdine said "But it was at that point the Board of trustees made the determination that it wanted to be much more activist in its orientation toward proxy voting," not "much more activist in its orientation toward activist voting."