The Board Blog: Crystal Ball Needed on Executive Compensation

I’m doing my best to understand what is evolving in front of our very eyes with respect to controlling compensation or, in some cases, controlling the risk of excessive executive or incentive compensation. The Federal Reserve has just put a new proposal out for comment that would mandate guidelines for all banks on what is “sound” incentive compensation policies. We’re also recently seen the Obama administration through its Pay Czar Kenneth Feinberg cut base salaries of executives from seven companies’ that have benefited from our tax dollars’ rescue program. And while I’m sure the general public is applauding this hard stance, I sit here very worried about what the long-term ramifications will be by either of those actions.

Immediate questions are: 

• Will this mean the very companies that need the best minds will now lose their top talent, particularly talent that has been cultivated for many of the corporation’s key top jobs?
• Are we putting any of these companies at a disadvantage versus their competitors at just the wrong time and, in essence, sending them into a dreaded death spiral?
• What about a company, or worse, a foreign company that was giving consideration to listing or going public on one of our esteemed U.S. exchanges? Does Sarbanes-Oxley and the new compensation rules drive valuable listings away from the U.S. business environment?

I honestly don’t know the answers to the above questions but they are real concerns. A crystal ball would certainly be helpful so that we could eliminate all us “Chicken Littles” who are warning that the sky is falling. Or maybe the best we can hope for is that when we see signs this might have been a long-term mistake, that we are confident enough to man-up and make the appropriate changes to make things right. The true growth of the U.S. economy may depend on it!

Now, as promised in an earlier blog, here are the responses to the questions asked during the Mike Halloran/Harvey Pitt session at Corporate Board Member’s Annual Boardroom Summit earlier this month. We only have Mike’s answers so far due to Harvey’s busy schedule but we want to get those to you as quickly as possible. Enjoy!

Q: When do compensation programs cause "material risks" to a company?

Mike Halloran: When they are structured to produce short-term performance(e.g., immediate revenues, fees, bookings) in a business whose performance is properly measured in terms of longer term performance(bookings of loans to go bad over five years, fees on deals that result in liabilities in connection with the deals over a few years,etc.). American business should ask itself over what period of time its performance should be properly measured and should structure its compensation, particularly the incentive component, to match that.

Q: NYSE said that biggest challenge today is to rebuild trust in our capitalistic system. They (NYSE CEO Neiderauer) also said that trust takes a lifetime to build up but it can be destroyed in a day. In the wake of Madoff... how can the SEC build up trust again?

Halloran: This is of course, a personal issue for me, because I was at the SEC during 2006-2008 and never even heard the name Madoff even though the entire Division of Enforcement reported up to me for the chairman. The SEC in my opinion is already building back up its reputation under Mary Schapiro; the Enforcement Division is ever so aggressive. However, to be credible, the SEC needs to figure out a way to bring in more experienced hands at various levels in various offices—even by bringing in retired people from the Street. If you read the Inspector General Report on Madoff, you will see one of the major problems is that the Enforcement Staff in the New York office under Mark Schoenfeld simply did not understand the type of index and derivatives trading in which Madoff was engaged, did not understand the markets in which he traded, and did not know what leads to pursue.

Q: The London Stock Exchange mandates "nominated advisers" (NOMADS) for certain list companies. Does this make sense for U.S. companies?

Halloran: I could be wrong, but I thought it was only the AIM part of the London Stock Exchange that required NOMADS. These are companies that elect to do an IPO on the AIM rather than the LSE—they are usually smaller companies with a limited following. The purpose of the NOMAD is similar to the purpose of having an underwriter in the U.S. to underwrite your IPO—that underwriter is responsible for due diligence obligations on the company under Section 11 of the Securities Act of 1933. My understanding is that the NOMAD system is designed to be, in effect, a substitute for that. But so far, I am just talking about IPOs. If the asker of this question is saying that AIM or even the LSE requires NOMads on an ongoing basis for listed companies, even after the IPO, I was unaware of that and really would like to learn more about it. I would think that if it were required on an ongoing basis, that it could be similar to a market maker for U.S. over-the-counter companies, but I am not sure.