Over the weekend, voters in Switzerland rejected by a roughly two-to-one margin a referendum that would have restricted executive salaries at Swiss companies to twelve times that of the company’s lowest paid employee. The vote outcome is interesting because it follows so closely on the heels of a ballot initiative earlier this year in which Swiss voters approved a long list of items (collectively referred to as the Minder Initiative, in reference to the politician who proposed the reforms) addressing and regulating executive compensation for Swiss companies.
Though Swiss voters rejected the 1:12 Initiative for Fair Pay, the executive compensation debate is likely to continue, there and elsewhere. Among other things, here in the U.S. the SEC’s proposed new pay ratio disclosure rules, due to be implemented in the months ahead, are likely to spur further controversy and discussion of pay equity issues.
As discussed in a November 25, 2013 Wall Street Journal article (here), the Swiss 1:12 pay ratio initiative arose out of a popular perception of a growing wealth gap between executives and everyday workers. An interesting feature of the 1:12 Swiss initiative is that it sought to create a relationship not just between the compensation of the CEO and of employees in general; the initiative sought to establish a relationship between the compensation of the CEO and the compensation of the company’s lowest paid employee. The proponents of the initiative basically argued that nobody should be able to make in a month more than another employees would make in an entire year.
The vote on the 1:12 initiative followed Swiss voters’ March 2013 vote in favor of a package of measures (named for Swiss politician Thomas Minder) addressing executive compensation. As discussed here, more than two thirds of voters cast ballots in favor of a 24-item package of measures that, among other things, will require a binding shareholder vote on executive compensation at all publicly traded Swiss companies. The measures also ban signing bonuses, golden parachutes and other forms of executive compensation.
Despite the earlier vote on the so-called Minder Initiative, the 1:12 initiative was unsuccessful. Swiss business interests and government officials had come out strongly against the 1:12 initiative on the grounds that defeating the initiative was important to help the country maintain its attraction as a business location and thus to continue to attract secure jobs. Individual companies argued that the proposed initiative would restrict the companies’ ability to attract experienced employees capable of leading complex international operations.
The ratio of executive compensation to employee compensation has also been on the radar screen here in the United States, as well as in Switzerland. As discussed at length here, pursuant to the requirements of the Dodd-Frank Act, the SEC has promulgated regulations requiring reporting companies to disclose the ratio between the CEO’s compensation and median employee compensation. The proposed rules remain in the comment stage and likely will not take effect for most companies until 2015 or 2016. Nevertheless, the pay ratio disclosure requirements are likely to ensure that the topic of the appropriate relationship between executive compensation and employee compensation will remain on the docket.
The SEC’s pay ratio disclosure requirements differ from the requirements of the Swiss 1:12 initiative in several key respects. First, the Dodd-Frank pay ratio provisions did not mandate a proscribed pay ratio, opting instead for a disclosure approach rather than an absolute compensation requirement. Second, the Dodd-Frank pay ration disclosure requirements seek to illuminate the relationship between CEO compensation and median employee compensation – that is, the focus is on overall employee compensation and overall fairness. The Swiss initiative, by contrast, was based on the relationship between the CEO (presumably the highest paid employee) and the lowest paid employee. The Swiss initiative incorporated an implicit (and arguably more radical) assumption about the need for social leveling.
The defeat of the Swiss measure hardly marks the end of the debate over executive compensation, even in Switzerland. Perceptions involving income disparities and pay equity, as well as social equality and economic fairness, will continue to drive debate on these issues. The sentiments behind the Occupy movement and the discussion about the 1 percent ensure that the questions will continue to be debated.
I have long thought that much of the discussion of these issues suffers from a reflexive bur relatively unexamined view that the “fat cat” executives are just getting paid “too much.” Many of the same people who rail against CEO compensation wouldn’t think twice about the massive amounts that star athletes and media stars can command. Most people understand that LeBron James can command an astronomical pay check because he has unusual talents and abilities that are easily appreciated; as a result, there are no populist movements to try to drive down professional athletes’ compensation. It is much harder to appreciate how difficult it is to run a modern, complex, global company, and so there is a much greater willingness to conclude that corporate executives are paid “too much,” even if the individuals in question also have a highly unusual set of talents and experiences.
The executive compensation debate is at its least meaningful when it is simply about “how muc”h the executives make, as if the mere fact that compensation is above some vague (and subjective) level alone establishes that the compensation is unwarranted.
Where the executive compensation debate is much more meaningful is when it is focused on the fact that in some cases, the highly compensated executives are their own paymasters. To use the analogy to compensation in the sports world again, one of the reasons that there is less concern about salaries in the sports world than in the corporate world is that the athletes get paid what the market will bear as a result of an arm’s length negotiation – LeBron doesn’t set his pay, the marketplace does.
When corporate executives have too much control over their own pay, the objections to executive compensation are far more compelling, Cynical observers may even question whether some board members are capable of exerting control, as they are often the beneficiaries of similar compensation arrangements in their own primary employment position.
I happen to think that it takes an enormous amount of skill and experience to run a complex global company in this day and age. I also think that there are far fewer individuals who are capable of running a company well than is commonly perceived. I think that the small number of people who have the right skills to run a complex global company well are entitled to be compensated very well, subject to certain specific concerns.
First, pay must be based on performance. The sorriest spectacle in the corporate arena is the occasional instance where outsized executive pay follows corporate underperformance.
Second, because of the problems that arise when there is a perception that corporate executives are acting as their own paymasters, the compensation setting process for top executives needs to involve significant controls to ensure that an independent and objective authority is in fact controlling executive compensation.
Third, transparency around these issues is indispensable for maintaining confidence in the process. I don’t know that the impending pay ratio disclosure requirements are going to add much in that regard. Just the same, the pay ratio disclosure requirements proceed from a legitimate assumption, which is that better disclosure around compensation issues will help foster investor confidence – and, as many of the executive compensation critics hope, will also act as a check on outsized executive compensation issues.
One thing that should not be lost in the discussion is the fact that executive compensation is now very much of a political issue. Even though the recent Swiss pay ratio initiative was voted down, the earlier Swiss initiative passed. By the same token, the executive compensation related provisions of the Dodd-Frank Act were incorporated in the legislation for political reasons.
The public debate about executive compensation will certainly continue. Indeed, the implementation of the new SEC pay ratio disclosure requirements could raise the temperature on these issues. It seems likely that controversy could follow some pay ratio disclosures. The possibility that we might wind up with pay ratio mandates of the kind that the Swiss voters recently rejected seems remote. But if populist discontent on executive compensation issues reaches a sufficient level, there could be political initiatives in this country that include even the possibility of compensation mandates and constraints. Look at it this way -- if executive compensation can become a ballot box issue in a business-oriented country like Switzerland, it could become a populist issuer for voters here as well.
The political sensitivity of these issues, particularly at a time where there is a growing perception of pay inequity and economic inequality, militates strongly in favor of voluntary measures calculated to try to reduce controversy and increase investor confidence in executive compensation issues. While I have no comprehensive solution to propose here, I believe that well–advised companies will be focused in developing and implementing measures calculated to develop confidence in the companies’ compensation-setting processes and to provide transparency around those processes, as well as around the compensation itself.
The ABA Journal Blawg 100 for 2013: I am delighted to report that The D&O Diary has been selected once again for the ABA Journal’s Blawg 100, the publication’s annual list of the top 100 legal blogs. The Journal’s list of the 2013 Blawg 100 can be found here. The D&O Diary is listed in the “Niche” category.
It is an honor in and of itself to be recognized, but it is even more of an honor to have my blog associated with those of so many excellent bloggers whose work I follow and respect.
The ABA Journal is asking readers to weigh in and vote on their favorites in each of the Blawg 100's thirteen categories. Readers can cast their ballot by visiting the Blawg 100 page on the Journal’s website, here. I would be honored if there are readers out there that would be willing to take the time to register to vote and to cast a ballot for The D&O Diary as their favorite blog in the “Niche” category. Voting ends at close of business on Dec. 20, 2013.
My very special thanks to the loyal readers who nominated me for be a part of the Blawg 100. I couldn't do this blog without the tremendous reader support that I enjoy so much.