The Corporate Library Blog

Cautious Optimism for TARP Boards' Effectiveness

If you were a director at a company that had to be bailed out by the US government, would you leave the board or would you continue to serve? This is a tough question and one that faced many directors last year. At many of the most high-profile companies, directors did leave the board – either by choice or in response to pressure from outside the company. I recently studied the governance changes made by the 25 most high-profile TARP recipients for a report published today, and found that 22 of those companies had changes in board composition since May of 2008. A few of these companies had dramatic turnover among directors (e.g., at AIG, only two of the 11 current directors have served on the board for more than two years). Other governance changes have been made by many of these companies, including changes in the board leadership structure and to the election standards used for director elections.

Changes made by some of the TARP companies give reason for cautious optimism that the boards now have more potential to be effective. However, let’s wait and see what decisions these boards make about CEO compensation, risk assessment, etc. I hope these companies will provide more information about these and other decisions as called for under the SEC’s new disclosure requirements. We will be watching as these companies file their proxies in the coming weeks.

Annalisa Barrett - Senior Research Associate

Bank pay: It’s not my fault, guv, it’s TARP

Doing some digging for some bank dirt for Nell Minow’s written evidence before the House Financial Services Committee, I resuscitated Wells Fargo’s infamous 522 percent “salary adjustment” which I had written about earlier, only to find that the flipping bank had set a trend. Not only that, but Christmas presents, and Epiphany gifts were being handed out right, left, and center by banks – thanks to our own Hoang Nguyen and Vineeta Anand of AFL-CIO for sending me the links.

First the trend, thanks to Fifth Third Bancorp slavishly following Wells Fargo’s example. And the bank even has the gall to try and attribute this to the government, as if somehow TARP FORCED them to increase their CEO’s salary by 250 percent. It even says it “amended the compensation of its senior executive officers in order to comply with the Interim Final Rule on TARP Standards for Compensation and Corporate Governance.” How’s that for barefaced cheek? Not only Kevin Kabat, the CEO, received a base salary increase of statuesque proportions on September 24, 2009, so did three other executives – Robert Sullivan, Daniel Poston, and Greg Carmichael, with increases ranging from 100 to 160 percent. Some were for additional job responsibilities, but others were merely “compensation adjustments related to compliance with the TARP standards for compensation.” Talk about unintended consequences. Then on December 15, 2009, an early Christmas present came for Mr. Poston and Mr. Carmichael in the form of further salary increases. Mr. Poston’s salary has now more than tripled from just over $300,000 to $950,000, and Mr. Carmichael’s has almost tripled from around $570,000 to over $1.6 million. And I don’t care that it’s paid partly in stock.

Other seasonal gifts came in the form of simple stock at other banks. For example, on December 23, 2009, executives at PNC Financial Services received the following amounts:  James E. Rohr ($4,874,000); Richard J. Johnson ($1,257,000); Joseph C. Guyaux ($2,084,000); William S. Demchak ($4,093,000); and Timothy G. Shack ($1,391,000) in restricted stock. Of course, on that date the stock was worth $53.55, compared to a high of $81.21 in September 2008. If it went back up there, CEO James Rohr’s award, for example, would be worth almost $7.4 million. A $2.5 million increase just for giving back to shareholders what he’d lost for them in the first place. Happy Christmas.

The next day, on Christmas Eve, Wells Fargo started making free with the stock grants again. At first sight these awards were “performance-restricted” so not so free as those at PNC, where two years service was all that was required for the grants to vest. But if you look a little closer at the conditions of vesting, half of CEO John Stumpf’s $10.3 million award will vest in three years even if the bank performs at the lower quartile position in the KBW Bank Sector as measured by return on realized common equity. And if the stock price returns to former levels that half would be worth over $7 million. For UNDERPERFORMING three-quarters of its peers? If shareholders are understandably reluctant to invest in companies which perform worse than their peers, why should executives be rewarded with incentives for running them?

Moving into Epiphany and beyond, what’s good enough for Wells Fargo is good enough for Morgan Stanley. For example, some of the 97,295 performance stock units awarded to CEO James Gorman on January 21, 2010 will vest even if the company ranks 8th out of its 10-strong peer group. So much for performance. The other performance target that must be met is average three-year return on equity (ROE) of 12 percent. Given that the company’s five-year average ROE to date is 14.2 percent, and that includes two of its worst years ever, probably, this doesn’t look too challenging either. In addition, at the same time as the performance stock units, Mr. Gorman received twice as many time-restricted stock units (194,950) that will vest if he just sticks around. So much for performance.

Just the other day someone asked me as I sat on a panel speaking about executive compensation whether I thought any good compensation practices had emerged as a result of the financial crisis.

I gave a very short answer.

“No.”

Paul Hodgson - Senior Research Associate

Goldman seeks No Action relief

No, that’s not a pun on the change/no change to compensation policies at our favorite investment bank. It’s a headline about its decision to bar a shareholder proposal from the Nathan Cummings Foundation, reported earlier today by Reuters. The Foundation wanted Goldman's compensation committee to produce a report by October that includes an analysis comparing the pay of top executives to median wages at the company and an evaluation of whether the pay is excessive and should be modified. Goldman has asked the SEC to allow it to omit the proposal from its proxy because of “technicalities” according to the Foundation.

Firstly, shareholders get another chance to vote on pay at the company as Goldman has adopted Say on Pay even though it is no longer subject to TARP regulations and doesn’t have to. So shareholders do get to have their say.

But we need to think a little about shareholders here. 

Goldman has either awarded or reserved for award more than half its outstanding shares for its stock incentive plan alone. Then there’s all that employee stock ownership (the directors and officers own nearly 4 percent on their own!) How many shares do public shareholders actually own? And therefore how many are likely to vote for any kind of “shareholder” proposal.

In other words, what are they worried about? Or is there something we don’t know….

Paul Hodgson - Senior Research Associate

I can’t survive on half a mill! How’m I gonna pay the second mortgage?

I know I’m going to be accused of being a communist just for saying it but, really, the news that some employees have threatened to leave special relief companies (AIG particularly) because they couldn’t make it on a salary capped at $500,000, with potentially more than twice that in stock, is particularly emetic at a time when real earnings for almost every other employee in the country are in decline and unemployment stands at a 26-year high.

The news that 12 exemptions were made to this salary cap by Kenneth Feinberg, the Pay Czar, in his latest pronouncements on pay doesn’t do much to keep the bile down either.

The letter to AIG is a good enough example of those Mr. Feinberg sent out to AIG, Citigroup, General Motors, and GMAC which set the pay rates and structure for employees numbered 26 to 100. The compensation design follows much the same path as that outlined for employees one to 25. I already blogged about this here and here. Cash salary, stock salary, incentive stock seems to make up the packages for all of these employees too, with the stock having a potentially huge upside potential. This could all have been avoided with the judicious use of premium-priced stock options, but it’s probably too late now.

Paul Hodgson - Senior Research Associate

Daniel Gross is Shocked to Find Gambling Going on in Casablanca, I Mean to Find Bankers Wanting More Money

Slate's Daniel Gross says that the "surprising reason" the banks are paying back the TARP moneyis that they want to free themselves from the restrictions on pay imposed by pay czar Kenneth Feinberg.  Um, duh.  The incentive aspect of Feinberg's incentive compensation was to get them out from under as fast as possible.  That's not bad thing -- for taxpayers.  But if the lessons of the past year don't lead boards to make some fundamental changes in the way pay is structured going forward then the least surprising outcome will be that we will be right back where we started, with perverse incentives to externalize risk and another cycle of economic upheaval. 

Nell Minow - Editor

Claudia Deutsch on Banks, Lending, and "Extraordinary Assistance"

Veteran reporter Claudia Deutsch is one of the toughest, smartest journalists I have ever known.  After an interview with her, I always feel like I have lived through a cross between an rigorous intellectual Swedish massage and a cross-examination by Clarence Darrow.  But I always end up having to think through my positions more thoroughly and I always enjoy it.

Now blogging on The Bottom Line at True/Slant, Deutsch has a typically insightful an incisive piece about the President's meeting with the bankers this week.  

I react with a mixture of sadness and outrage to the news that our President called all of the top bankers to the White House (some on conference call, as it turned out — inclement weather at airports, dontcha know. They never heard of Amtrak, or of flying in the day before?) to beseech them to take “extraordinary” steps to lend money to homeowners and businesses. And he asked them to shore up their capital reserves so they don’t again come hat in hand to the taxpayers.

Of course the bankers are balking. How can we ask them to loan more money if they have to keep more in reserve? Unreasonable, us taxpayer types.

Gee, I wonder why? Let’s reminisce. Last year the banks took the TARP money, shored up their own capital, paid their people oh-so-handsomely — and still refused to lend the money out. And now nearly all of them have paid the money back. Why? So they can give ludicrous compensation packages to their execs once again.

And the worst part, of course, is that with the money paid back, Washington no longer has much clout to force them to do the right thing. Thus it must beseech.

She has a great idea to propose:

I still think the government should cut out the recalcitrant middleman, take some of that repaid TARP money. and lend it out directly to small businesses, probably through the Small Business Administration.

Sounds like good policy and even a good investment.

Nell Minow - Editor

US sees outbreak of ‘legislationitis’: could it be catching?

 This piece, by Senior Research Associate Paul Hodgson, appeared in the September 2009 issue of IDS Executive Compensation Review's Speaker's Corner.

‘When America sneezes Europe catches a cold’ is one of those maxims intended to show how developments on the other side of the Atlantic impact on the UK. One area where the influence has been especially evident is executive remuneration, with much UK practice closely following the US lead. But as over here, pressure has mounted to reform board pay and Paul Hodgson of The Corporate Library explains how the US is witnessing an outbreak of ‘legislationitis’.

It all started back on the campaign trail at the height of the economic crisis, when investment banks were falling like dominos, and both candidates for the presidency indicated they would support legislation to introduce a shareholder advisory vote on executive remuneration. That, and the worsening economic crisis, seemed to open up a flood of legislation. It started even before the new President took power, when the Democrats tried to insist that pay limits accompany government bailouts coming from the Troubled Assets Relief Program (TARP). Eventually, in February this year, remuneration regulations put forward in the American Recovery and Reinvestment Act (ARRA) – better known as the ‘Stimulus Bill’ – introduced a series of rules going further than anything proposed in the UK (see margin). One of these regulations became effective almost immediately following a decision by US stock market regulator, the Securities Exchange Commission (SEC), to mandate TARP companies to introduce a ‘Say on Pay’ vote for the 2009 proxy season.

But this has not been the end of it and since then the desire to legislate has spread like a rash. In May this year, for example, Senator Charles Schumer introduced the Shareholder Bill of Rights Act of 2009 to the US Congress. If the bill is passed, shareholders are going to have to come up with a whole new set of ideas for shareholder proposals as the bill requires companies to implement almost all of the most popular shareholder activist ideas of the past 10 years. These are: introduce a non-binding vote on executive remuneration (a Say-on-Pay vote); introduce a vote to approve golden parachutes; provide shareholder access to the proxy for the purpose of nominating directors; split the roles of chairman and CEO; make all director elections annual; and introduce majority voting for directors. And the bill would also require all of the above to be an exchange listing requirement.

Other pay bills abound

Following Schumer’s bill, Congressman Gary Peters introduced The Shareholder Empowerment Act, and all of a sudden it seemed like everyone, the Senate, the House of Representatives, the Treasury, the President, the SEC, was queuing up to support shareholders’ rights . Congressman Peters’ act attempts to codify into law some of the proposals made by the Secretary to the Treasury (see below). It also expanded on Senator Schumer’s bill while covering a lot of the same ground. Proposals include: majority voting for directors; independent chairman of the board of directors; shareholder approval of executive remuneration; independent remuneration advisers; clawbacks of unearned pay; no severance payments for poor performance and improved disclosure of performance targets.

There are several other remuneration-related bills up for consideration as well. Other key bills currently in committee in Congress include the Excessive Pay Shareholder Approval Act which seeks to cap the multiple of a company’s average salaried employee that can be used to determine CEO pay and the Corporate Governance Reform Act of 2009 introduced by Representative Keith Ellison that calls for, among other things, an SEC study to consider director certification.

Treasury proposes…

In July, the US Treasury added its voice and issued two sets of proposals. The first on ‘Say-on-Pay’ runs along the same lines as the other legislative initiatives and the second on greater independence for remuneration committee members mirrors the post-Enron audit committee reforms. New, tougher rules for board
remuneration committee members seek to give them the authority to hire independent consultants and legal advisers. While this looks like a necessary reform, it would seem unlikely to make a great deal of practical difference. While it is possible to legislate for independence, legislators cannot actually force directors to act independently.

Both measures take on more significance, however, if coupled with proposals the SEC issued a few days previously that aim to give shareholders easier access to corporate proxies. Given that any shareholder vote on pay is likely to be nonbinding, there remains a further opportunity for shareholders to effect changes or influence if they can get their own directors on the board.

…and the SEC gets in on the act

At the same time as issuing its proposals for shareholder access to the proxy statement, the SEC also issued another 137 pages of proposals on risk, remuneration, directors, boards, remuneration consultants, and proxy voting. In the area of executive remuneration and risk the SEC is looking for better disclosure about the relationship between a company’s overall remuneration policies and its risk profile. It also wants changes to
published summary compensation tables, wanting the grant date value of stock and stock option awards included rather than the ‘expensed value’. The fact that this continues to mix real and imaginary pay, apples and oranges, appears not to have occurred to the SEC. Under this change, the table contains apples and a different kind of orange, mandarin, rather than Seville, perhaps. A single table with actual realized pay would be the most effective way of communicating the wealth acquired by executives and the real associated costs.

The SEC’s proposals on director nominations and qualifications go well beyond those put out by the Treasury on increased independence for remuneration committee members. Under the SEC guidelines, a company will have to provide a great deal of evidence to persuade a shareholder to vote for the director, including risk assessment skills, past experience and what use it might be, the nominee’s area of expertise, and what benefit he or she would bring to the board. With all the discussion about splitting the chairman and CEO positions, the commission is also asking companies to explain why they combine or do not combine the roles, or why they have a lead independent director and what benefits this decision might bring for shareholders. As part of this, a much more comprehensive description of the board’s role in the risk management process is likely to be required.

In response to much shareholder activism, a raft of additional disclosures surrounding the hire of remuneration consultants by the board are also being proposed, including the disclosure of other work they do for the company, what each of these services cost, the involvement of management in the hiring decision and the board’s involvement in approving other work.

House passes legislation

Finally, on July 31, 2009, the House of Representatives passed legislation mandating public companies to hold annual non-binding shareholder votes on executive remuneration. The legislation, known as the Corporate and Financial Institution Compensation Fairness Act, was introduced by Representative Barney Frank, chair of the House Financial Services Committee, to obtain ‘Say on-Pay’ rights for shareholders. A summary of the main provisions can be seen in the margin.

Some form of ‘Say-on-Pay’ vote would now seem to be almost an inevitability, and likely for the 2010 proxy season. It is to be hoped that the fact this has come through legislation rather than affirmative action from corporations – who were given ample opportunity to adopt this voluntarily – will not impair the effectiveness of the legislation.

Will anything change?

As all this legislation and reform pressure builds shareholders continue to wait for additional rights and additional power, but in the meantime they must also endure the spectacle of Wall Street returning to its former habits. Many investment houses are now registering the same level of remuneration expense in the first half of 2009 as was seen in the first half of 2007 – one of the US economy’s supposed boom periods. This hardly indicates that a major change in corporate behavior is underway, despite some recognition from the banks
themselves that former remuneration policies were in part to blame for the economic crisis.

But not only do banks appear to be gearing up for another boom year for bonuses, it would appear from disclosures forced by New York City’s Attorney General that they never stopped. Even during 2008, as the U.S.
economy collapsed around them, banks were paying out billions of dollars in bonuses. Not only that, but as soon as remuneration rules came into play, those covered immediately began to design ways around the rules. The ban on termination payments was evaded by re-classifying golden goodbyes to anything from consultancy payments to non-compete arrangements. Guaranteed bonuses proliferated, underwater stock options were replaced with new mega-grants, a ban on bonuses was trumped by increasing salaries, or even quintupling salaries and ‘paying’ the excess in stock. In the face of this kind of behaviour, it would seem difficult for any kind of legislation, or even yet more increased shareholder scrutiny, to begin to tie remuneration closer to performance.

So now that America has sneezed on executive remuneration will the UK catch a cold? In one sense, all the legislative proposals show just how far ahead of the US Britain and much of Europe has been in terms of corporate governance, where much of what is proposed is already common practice. But in another sense, some of the latest proposals leap ahead of previous UK codes and US bodies seem far more willing to legislate to rein back executive excess than their British counterparts. Such would be the revolution in US governance were all
the proposed bills to become law that the only thing left for shareholders to do would be, well, vote.

Still confused about the Pay Czar's rulings

Now while it sounds like Timothy Geithner is happy with Kenneth Feinberg, at least according to this press release, there were other rumors coming out of the Treasury that they were less than happy. I’m not sure about that, those are just rumors. I’ll tell you what, though, if they admitted to being confused that I would just take on faith.

I’ve read the rulings and there are some things that are pretty obvious

• all incentive pay is going to be paid in stock predicated on three years’ service, TARP repayment, and the achievement of performance goals agreed with the Special Master
• no increases to existing golden parachutes
• perks capped at $25,000
• SERPs frozen and no more company contributions to NQDC accounts.

OK, all of that is pretty plain. But before it gets into that easy bit there’s a whole section on salary that I can’t make head nor tails of. First there’s this:

Approved cash salary generally limited to $500,000: Consistent with the Administration's February 4 guidance on executive compensation at TARP recipients, the Special Master approved base salaries of $500,000 or less for more than 90 percent of the employees in this group. Base salaries greater than $1 million were approved in just three cases: for the new CEO of AIG, as previously announced, and for two employees of Chrysler Financial, which will wind down its operations in the near term and cannot grant employees long-term incentives.

OK. So, lucky Robert. Though why he’s different I don’t know, and $3 million in cash salary exceeds $500,000 by quite a lot.

Then it goes doolally.

Requires Salaries to be Paid in Company Stock Held Over the Long Term: The Special Master's rulings fundamentally change the structure of compensation at these firms. Rather than cash, today's rulings require that the majority of salaries be paid in stock that must be held for the long term-giving executives incentives to pursue long-term value creation and financial stability.

Stock is Immediately Vested, Requiring Executives to Put Their Own Funds at Stake: Rather than just cash, executives will earn base salaries in the form of vested stock in their companies. In effect, the Special Master is requiring each executive to invest their base salary in the long-term future of the firm, alongside taxpayers. These structures ensure that executives do not have incentives to take the excessive risks that contributed to the financial crisis.

Stock May Only Be Sold in One-Third Installments, Beginning in Two Years: Unlike the pay practices of the past, which allowed executives to sell stock in their companies immediately, the Special Master's rulings require stock to be held for the long term. Stock received as salary may only be sold in one-third installments that will not begin until 2011, unless the taxpayer is repaid earlier.

Now, I think, just think, mind you, that this is different from the $500,000. This is Stock Salary, not Cash Salary. Like Mr. Benmosche gets Cash Salary of $3 million and Stock Salary of $4 million. But it doesn’t actually say it is anywhere, except it implies it when it says: “Rather than just cash….”

Then the news that the Wall Street Journal has calculated the change in base salaries for the employees under Feinberg’s review and most of them have got an increase in cash salary just caps it all for confusion.

I’m quoted as being flabbergasted. I used the word flabbergasted because gobsmacked, which immediately came to mind, is too English. But it’s stronger and it’s what I meant. Because I heard that NPR interview and I put the Journal on to it. Now that it’s out, the ostensible justification for increasing base salaries needs to be examined. Everyone seems to agree that the ban on cash bonuses is leaving employees cash-strapped and the stock is tied up for too long. Isn’t that the point?

Cash-strapped?

What if they didn’t earn the bonus one year because of poor performance – except of course that never seems to happen – but in theory it might. Wouldn’t it be responsible of these employees to keep their household budgets within their fixed income? That’s what everyone else has to do.

I mean this just takes the biscuit. That’s tantamount to saying: “I always get a bonus so It’s in my budget.” And that’s the whole problem right there. How is it an incentive if you always get it? These have ceased to be at risk and are now expected. And if that’s what the market dictates, the market’s gone mad.

Webcast: Executive Compensation and TARP

Check out this webcast of a conversation with Kenneth Feinberg that took place October 27 at Georgetown Law.  The conversation is followed by a panel discussion of TARP and corporate governance, which features The Corporate Library's Editor and Co-Founder, Nell Minow.

Say on Pay? No one cares

At least that seems to be the message from a new research report from Pearl Meyer. Despite the possibility that Say on Pay will be mandated for all companies, only 7 percent of the 231 companies surveyed said their company is “very concerned” about Say on Pay, with another 35 percent describing themselves as “somewhat concerned.”

Not only do most companies not give a monkeys, most companies either haven’t done anything  or aren’t going to. About two-thirds of the sample said that had done nothing to prepare themselves for Say on Pay, and about the same proportion are not going to do anything in the next six months. And the sample includes 15 companies that are subject to TARP and have already had a Say on Pay vote.

In fact, removing the TARP companies out the mix, and the proportion of companies that have done nothing rises to four-fifths.

Things are a little different for TARP companies, however. Around 10 of the TARP companies have already take some action in regards to Say on Pay, while all 15 of them are going to be taking some action in the next six months.

So when Say on Pay comes, and it is looking increasingly likely that that will be 2011, the number of companies taking action is likely to be a little higher, if those TARP company statistics are anything to go on.

The survey also asked the non-TARP companies how they felt their shareholders would vote on their pay structures. Only 3 percent felt that shareholders would vote against them, which is not a surprise. What is a surprise however is that just over a fifth said they “weren’t sure” how shareholders would vote.

A fifth?

That’s 100 companies in the S&P 500. Six hundred in the Russell 3000.

That’s a lot of companies.

I mean, I’m not renowned for being too complimentary about executive compensation, but I didn’t think it was that bad.

But, I’ve got a solution. If you want to be sure, buy a copy of my forthcoming Pay for Success III. Do everything they’re doing. And you’re away.

Paul Hodgson — Senior Research Associate