The case for an executive compensation standards board: if private industry does not act quickly to self regulate executive pay and set high standards, the government will try to do so, and as history has shown, it will not do it well.

• Author: Delves, Donald P.

Contrary to popular perceptions, boards of American companies have made great strides in ensuring their independence from the CEO and management. Nominating, audit and compensation committees are composed solely of independent outside directors who are selected by other independent outside directors. A significant and growing number of public companies have lead directors or non-executive chairmen who are also independent from management. The age of boards as old friends of the CEO is clearly over. This is a fundamental transformation in the nature of corporate governance.

Independent boards, in turn, have made positive strides in creating and overseeing executive compensation plans that pay for performance and reward the achievement of strategic goals. Several studies have shown a reasonably strong and increasing correlation between total executive pay and both financial and stock performance. Companies have moved away from a heavy use of stock options to plans that are much more reflective of long-term financial performance. Perquisites, severance, and change-in-control benefits are gradually being pared down. These are marked improvements from past pay practices.

Despite these improvements, the public increasingly questions the independence of boards and the fairness of executive compensation. Regardless of the causes, there is a widely-held perception that CEOs and other executives of publicly traded corporations are overpaid, over-perked and over-protected: the general public is, at minimum, offended and suspicious. The result is an increasing distrust of public companies, cynicism about the American economy, and a rising call for regulation of executive pay.

Legitimate questions have been raised about the role executive incentives have played in creating the current economic crisis. Incentive plans that encouraged excessive risk taking and that provided tremendous upside rewards for success with limited downside penalties are likely culprits as are severance and parachute plans that protect executives from their own failure. Boards and their consultants did not effectively assess the risk they encouraged executives to take. In too many cases, compensation systems failed to align the interests of management with the long-term interests of investors, and--by extension--with the long term interests of the American economy. Some companies encouraged and rewarded excessive and inappropriate risk-taking and are now suffering the untoward consequences. An angry public is calling for punitive legislation to regulate executive pay.

The Treasury Department and Congress have already issued comprehensive rules governing executive compensation for the hundreds of banks accepting Federal assistance. Our new President has strongly criticized certain executive pay practices. This should serve as a wake up call for boards, executives and compensation professionals. If private industry does not act quickly to self regulate executive pay and set high standards, the government will try to do so, and as history has shown, it will not do it well.

Unintended Consequences

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