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Regulation and Pay for Performance

Steven A. Bank an George S. Georgiev, (Ucla School of Law) recently exposed their view that although regulation is intuitive and well-intentioned, it nevertheless often fails in addressing the problems it is supposed to attack. (1)

They argue that the last 25 years of regulation on pay and performance, led by legitimate concerns on corporate malfeasance and underperformance as connected with inflated executive pay, have not actually been successful in reigning in executive pay.

Complexities introduced by different pieces of regulation have left space for gaming the rules and manipulation and created links among them and with other regulatory goals. The authors recall the case of the 1993 regulation that settled a limit on the deductibility of Ceo`s fixed pay on 1 USD million; they argue the limit soon became a salary floor, and the regulation led to a huge increase in variable pay through stock options and other tools. And the also recall certain cases, (years after the Dodd-Frank regulations were introduced) where executives received large sums of money and rewards while investors saw their wealth squeezed.

They expose how the link between pay and performance continues to be elusive, even if it was the main objective pursued by the 2010 Dood-Frank act. Some tips arise:

Say on Pay.

Shareholders are supposed to have a strong incentive to monitor pay and performance. Dodd-Frank (and other regulations abroad) gave shareholders an option to reign in executive pay via a one (at least) in every three years vote on pay. Nevertheless, shareholders don`t use to reject pay packages (even if proxy advisors so recommend), when they do there is no binding effect, and neither do (US) courts entail from this rejection a breach of the business judgement rule on pay decisions. The effect may have been contrary to the legislator`s will, as companies have tried to disguise their inappropriate pay packages decreasing some components and increasing some others, with a positive net effect on total pay. (2)

“Say versus Performance” disclosure proposal.

Regulatory requirements have increased since the 1990`s, and complexity and extent of compensation proxy disclosures have both increased. Total pay to some executives and TSR evolution, plus the TSR comparison within a peer group must be disclosed by companies. Nevertheless, extraordinary events distorting the figures, the fact that the data are affected by decisions made on many different periods, and TSR being a backward-looking metric render the legislator`s aim elusive.

Pay ratio disclosure rule.

The pay ratio disclosure has been introduced in the Corporate Governance framework as a result of a mix of causes: on the one hand the income inequality concern, and in the other hand, the corporate governance concern where it could act as an indicator of a bad pay for performance connection. Calculation gaming, outsourcing the lower salary part of the labor force, and the low shareholder attention to say on pay will surely make this piece of legislation just another useless and costly tool.

Clawback on Incentive-based compensation proposal.

The rule orders companies to draft clawback policies for incorrectly awarded pay as a result of an accounting restatement, (no matter whether there was any fraud or not, and who was responsible for it). It covers a large number of executives, still employed by the firm or not, and refers to pay received for a three-year period. The eventual result of the rule could entail more accounting compliance efforts and costs, a restructuring of pay packages away from variable or performance based pay, or away from financial targets into more operational ones, many of them clearly disconnected from the “firm`s performance”.

Their conclusion is clearly a negative vision of regulatory measures, mainly in the case of those adopted without a thorough economic analysis and instead introduced as a result of a strong political or social short-term pressure. An argument that has already been expressed previously in a lengthier research made by Kevin J. Murphy (3).

 

  1. Bank, Steven A. and Georgiev, George S., Paying High for Low Performance (August 7, 2015). 100 Minnesota Law Review Headnotes __ (2016); UCLA School of Law, Law-Econ Research Paper No. 15-11. Available at SSRN: http://ssrn.com/abstract=2641152
  2. Kronlund, Mathias and Sandy, Shastri, Does Shareholder Scrutiny Affect Executive Compensation? Evidence from Say-on-Pay Voting (April 15, 2015). Available at SSRN: http://ssrn.com/abstract=2358696 or http://dx.doi.org/10.2139/ssrn.2358696
  3. Murphy, Kevin J., The Politics of Pay: A Legislative History of Executive Compensation (August 24, 2011). Marshall School of Business Working Paper No. FBE 01.11. Available at SSRN: http://ssrn.com/abstract=1916358 or http://dx.doi.org/10.2139/ssrn.1916358
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