In March , Swiss voters approved by a wide margin an initiative that broadened shareholders’ power to limit executive pay. Popular support for the measure was perhaps surprising in a generally conservative country that has one of the highest standards of living in the world and unemployment of just above 3 percent. While Switzerland is not a member of the European Union or the euro zone, it has close ties to both. Still, its economy has been resilient despite the crisis surrounding it.
Switzerland also has a long history of social equality, and many citizens were offended by cases like that of Daniel Vasella, the former chief executive of the pharmaceutical company Novartis, who this year demanded a $78 million severance package in return for a promise not to share his know-how with any competitors. In the face of a public outcry, Mr. Vasella withdrew the demand and has since retired. (Jack Ewing, Swiss Voters Decisively Reject a Measure to Put Limits on Executive Pay, New York Times, Nov. 24, 2013).
CEO-to-Worker Pay Ratios Are Material To Investors
By Brandon Rees, Acting Director, Office of Investment, AFL-CIO; Guest Blogging for The Conference Board Governance Center Blog
A long overdue executive pay provision of the Dodd-Frank Act will finally go into effect in the near future. As required by Section 953(b), the Securities and Exchange Commission has proposed rules to require public companies to disclose the median pay of all employees, and the ratio of pay between the median employee and the CEO.
The SEC has received over 100,000 comments that are overwhelmingly in support of this disclosure provision. Investors who have come out in favor of the rule include pension plans such as CalPERS and NY State Common, socially responsible investors including Walden and Trillium, and international investors like Railpen and Amundi.
Many of these investors’ letters express concern that existing CEO pay practices are flawed. At most companies, CEO pay levels are set based on a peer group analysis of what other CEOs are paid. While the CEO’s final payout may vary based on performance, the targeted amounts are based on these peer group studies.
The problem is that peer group benchmarking leads to CEO pay inflation. Not every CEO can be paid above average, yet no company wants its CEO to be “below average.” Some companies explicitly target their CEO’s pay above the median, while others cherry-pick their peer group with higher paid. Year after year, the average rises.
While peer group data is relevant for setting CEO pay levels, it shouldn’t be the only factor taken into consideration. Pay ratio disclosure will encourage board of directors to consider the relationship CEO pay levels relative to other employees. Investors will also use pay ratios as a metric to evaluate the appropriateness of CEO pay packages.
Why are these pay ratios material to investors? High levels of CEO pay relative to other employees can reduce company performance. Employees are well aware of how much their CEO is paid. Employee productivity, morale, and loyalty suffer when workers see that the CEO is taking more while those same workers do more for less.
In contrast, a reasonable pay ratio sends a positive message to the workforce that the contributions of all employees are valued. Accordingly, the Council of Institutional Investors recommends that compensation committees consider “the relationship of executive pay to the pay of other employees” as a factor when setting executive pay.
Pay ratio disclosure will help investors allocate capital to companies based on human capital considerations. There is no one-size-fits-all answer for the ideal ratio of CEO-to-employee compensation. Rather, disclosure will permit investors to compare the employee compensation structures of companies over time and to their competitors.
Lastly, pay ratio disclosure will help constrain further growth of CEO pay levels. Over the past two decades, average CEO pay at large U.S. corporations has increased at twice the rate of average worker pay. Had CEO pay grown at the same rate as worker pay, the average large company would have paid its CEO $5 million less in 2012.
Pay ratio disclosure gives investors an additional metric to consider when voting on “say-on-pay” votes and other executive compensation matters. This is important because the siren song of high pay can tempt CEOs to take on excessive risks. That’s why pay ratio disclosure is integral to the Dodd-Frank Act’s executive pay reforms.
About the Guest Blogger:
Brandon Rees, Acting Director, Office of Investment, AFL-CIO
Brandon Rees is the Acting Director of the Office of Investment for the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO). Brandon Rees joined the AFL-CIO Office of Investment in 1997. He received his B.A. in Economics and J.D. from U.C. Berkeley.
Norway's sovereign-wealth fund, a big shareholder in some U.S. companies, is pushing to make it easier to replace directors at firms, including Wells Fargo WFC +1.46% & Co., over concerns about financial performance and governance. . . .The NSWF has identified key corporate governance issues that it will focus its active shareholding: "Shareholder’s right to vote, Board of Directors, Anti-takeover measures, Capital structure and corporate transactions, Executive remuneration, Social and environmental issues, and General issues." (nicely summarized in the PowerPoints of a presentation by Director General Pål Haugerud, Corporate Governance: Norway's Pension Fund Global, presentation to the IFSWF Annual Meeting, Mexico City, Sept 2012). And it believes that its approach is arguably within the constraints of the soft law framework for the behavior constraints of Sovereign Wealth Funds, the Santiago Principles, though that is debatable. (on the IFSWF compliance with the Santiago Principles, see, e.g., Sarah Bagnall and Edwin M. Truman, IFSWF Report on Compliance with the Santiago Principles: Admirable but Flawed Transparency, Peterson Institute for International Economics, Policy Brief No. PB11-14, Aug. 2011).
Norges Bank Investment Management screened the fund's more than 2,000 holdings in the U.S. and selected six companies with unsatisfactory returns on capital or other factors.
For those six, it has filed proposals to give shareholders the right to list competing candidates for board seats on official company ballots, which currently only list management's choices. The fund hopes making it easier to replace directors via so-called proxy access will eventually improve returns by forcing boards to be more responsive to shareholders' concerns.
"We are an active investor, not an activist investor," Ms. Kvam said. Norges Bank Investment Management isn't demanding board changes or its own representation at the companies just yet, Ms. Kvam said. Nor is it demanding strategic or business changes. But if the boards aren't becoming more accountable to shareholders, "we will nominate directors. We are not planning that now; we would much rather have a good dialogue with the board." (Mattias Reiker, Norway Fund Targets Firms, Wall Street Journal, Dec. 6, 2011).
More importantly, the NSWF's active shareholding is meant ot both transpose a variety of international norms into Norwegian law, and then to transpose that law and policy into the approach of the Sovereign Wealth Fund as a "private" equity investor in companies through global markets. In its 2012 Report to the Norwegian Parliament, the NSWF reported:
Thee Bank has decided to focus active ownership on six strategic areas:These active ownership strategies reflect Norwegian understanding of the implications of the U.N. Global Compact, the OECD Guidelines fr Multinational Enterprises, and Principles of Corporate Governance and the UN Principles of Responsible Investment. (Ibid., Box 4.3 Basic Responsible Ownership Principles).
– equal treatment of shareholders;The strategic focus areas shall be financially justifiable, since Norges Bank is acting in its capacity of investor. Norges Bank also notes that it is committed to engage with individual companies, where its relationship with a company is based on long-term objectives and the process runs for many years. Such engagement seeks to communicate the expectations of the Bank and assist companies in evaluating and improving their own corporate governance processes. Confidentiality considerations and the need for ensuring good and effective processes mean that Norges Bank will not normally publish details of such contact with individual companies. (Norwegian Ministry of Finance, Meld. St. 27 (2012–2013) Report to the Storting (white paper), The Management of the Government Pension Fund in 2012 ¶4.4.2, p. 73).
– roles and responsibilities of the board;
– well-functioning financial markets;
– children’s rights;
– climate change; and
– water management