How To Fix Runaway Executive Pay Before It Fuels The Next Crisis

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"How To Fix Runaway Executive Pay Before It Fuels The Next Crisis"

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CREDIT: AP

The Wall Street reform package President Obama signed into law three years ago has failed to bring about meaningful change in how top financial executives are paid, according to a chapter of a new report from the Roosevelt Institute on the unfinished work of financial reform by University of Denver law professor Jay Brown.

The most recent crisis was caused in part by contracts that hitched executive pay to short-term outcomes, creating incentives to commit fraud rather than tend to the long-term sustainability of a bank’s balance sheet. Those same pay incentives could bring about the next crisis, too, unless the problem gets a second look from Congress and the regulators it charged with crafting detailed rules to enforce Dodd-Frank’s big ideas.

Brown recommends a few different changes, most of which rely upon regulators rather than lawmakers. The reform package was supposed to curb “excessive compensation,” but neither Congress nor the Securities Exchange Commission (SEC) has provided a useful definition of what constitutes excessive pay, and there is no clear process for the committees that determine executive compensation to follow in order to avoid excessive payouts. The SEC should clarify the definition of “excessive” and re-draft its rules to include “substantive requirements for implementing” the ban, Brown writes.

The law helped push compensation decisions from companies’ boards of directors to separate and independent compensation committees, but it didn’t provide a useful definition of what constitutes independence. Brown recommends that the SEC lay out exactly what sorts of personal, financial, or other connections to a CEO would disqualify a nominee from being on those committee. Similarly, the commission should set up a process for shareholders to nominate compensation committee members — something the SEC tried to do only to have its first proposal blocked by a federal appeals court. Stronger, more independent compensation committees would make it easier for shareholders to prevent executives from rigging their compensation incentives in ways that essentially guarantee that performance bonuses will be paid. A third of the highest-paid CEOs of the past 20 years have ended up bailed out, busted for fraud, or fired by their boards for being ineffective, which underscores the disconnect between performance and pay.

Brown’s other recommendations require congressional action. First, compensation boards should bear legal responsibility for ensuring that executive pay packages and incentives are fair to shareholders, something that went out of fashion in the 1990s and which regulators would need specific legal authority to reinstate. Second, and perhaps most simply, Congress should institute binding shareholder approval votes on executive pay. Dodd-Frank included a “say on pay” rule that allowed shareholders to vote on executive compensation, but the rule is a flop. Shareholders barely exercise their rights because corporate boards are free to ignore the votes. The rule has failed to make any changes to executive compensation as a result.

Binding shareholder votes on executive pay seem to be gaining steam internationally, as Brown notes. The British and Australian governments are giving shareholders extensive rights in this regard. Switzerland instated such a system by popular demand earlier this year, and it may act later this month to cap the ratio between the highest- and lowest-paid employees’ compensation at 12-to-1. Brown doesn’t recommend anything so drastic, but like the 10 other policy articles contained in “An Unfinished Mission,” his chapter plots a course to realizing the original goals of financial reformers whose ambitions have largely been thwarted over the past three-and-a-half years.

The rest of the report argues that while the Dodd-Frank Act that was supposed to bring Wall Street to heel, it hasn’t yet achieved many of its most critical goals, labeling financial reform “An Unfinished Mission.”

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