While regulators need more authority and resources, and gaps in the regulatory framework must be closed, stronger financial regulation alone is not enough to address abuses that contributed to the meltdown. The debacle represents a massive failure of oversight by boards as well as regulation. Investors need better ways to hold directors’ feet to the fire so they will be motivated to monitor and, if necessary, rein in management. Shareowner-driven market discipline must go hand-in-hand with vigorous regulatory oversight.
Majority Voting for Directors: Directors in uncontested elections should be elected by a majority of the votes cast. In contested elections, plurality voting should apply. Directors should be required to resign in the event they fail to win majority support in contested elections.
Why it matters: At most US public companies, directors are elected by a plurality of votes cast, rather than by a majority. Under plurality voting, a director is elected to the board by virtue of having received the most votes. In an uncontested election, a single vote “for” a candidate theoretically would be sufficient for him or her to win a board seat. Plurality voting is fundamentally flawed: It results in “rubber stamp” elections and directors who are less accountable to shareowners because the shareowners lack a meaningful vote. Majority voting ensures that shareowners’ votes count and makes directors more accountable to the company’s owners.
Shareowner Access to the Proxy: A long-term investor or group of long term investors owning in aggregate at least 3 percent of a company’s voting stock for at least two years should have access to management proxy materials to nominate less than a majority of directors. Company proxy materials and related mailings should provide equal space and equal treatment of nominations by qualifying investors.
Why it matters: Proxy access allows shareowners to place their nominees for directors on the company’s proxy card. In the United States, unlike most of Europe, public companies are not required to provide shareowners with access to the proxy to nominate directors. The only way that shareowners can present alternative director candidates at a US public company is by waging a full-blown election contest. For most investors, that is onerous and prohibitively expensive. A measured right of access would invigorate board elections and would make boards more responsive to shareowners, more thoughtful about whom they nominate to serve as directors, and more vigilant in their oversight of companies.
Independent Board Chair: The board should be chaired by an independent director.
Why it matters: Strong CEOs can exert a dominant influence on the board and the board’s agenda and thus weaken the board’s oversight of management. Separating the chair/CEO positions appropriately reflects the differences in the roles of each position. Most importantly, an independent board chair provides a better balance of power between the CEO and the board, and facilitates strong, independent board leadership and functioning.
Independent Compensation Advisers: Compensation advisers and their firms should be independent of the client company, its executives and directors, and should report solely to the compensation committee.
Why it matters: Compensation consultants play a key role in the pay-setting process. The advice provided by these consultants may be biased as a result of conflicts of interest. Most firms that provide compensation consulting services also provide other kinds of services, such as benefits administration, human resources consulting and actuarial services. Conflicts of interest contribute to a ratcheting up effect for executive pay and should thus be minimized and disclosed.
Advisory Shareowner Vote on Executive Pay: All companies should provide annually for advisory shareowner votes on the compensation of senior executives.
Why it matters: Perverse executive pay incentives encouraged excessively risky behavior and helped lead to the current financial crisis. While investors have grown more concerned about perceived excesses and abuses of executive pay, they have limited ability to signal their disapproval to boards or to shape pay policies. Though non-binding votes on executive pay practices are required in Australia, Sweden and the United Kingdom, shareowners of U.S. companies have no way to directly vote on all compensation matters. An annual, advisory shareowner vote on executive compensation would give boards fast feedback about how shareowners view the company’s compensation practices. Compensation committees looking to rein in executive compensation could use the results of advisory shareowner votes to stand up to overly demanding officers or compensation consultants. Nonbinding shareowner votes on pay would induce compensation committees to be more careful about doling out rich rewards, to avoid the embarrassment of shareowner rejection at the ballot box.
Strong Clawback Provisions: At a minimum, senior executives should be required to return unearned bonus and incentive payments that were awarded due to fraudulent activity, incorrectly stated financial results, or some other cause.
Why it matters: Existing federal clawback provisions must be strengthened. The clawback clause in the 2002 Sarbanes-Oxley corporate reform law is too narrow; it only applies in cases of proven misconduct and covers just the CEO and CFO. Proof of misconduct is too high a threshold. It is in the best economic interest of shareowners for boards to recoup incentive awards erroneously paid to executives. Strong clawback policies discourage executives from taking questionable actions that temporarily lift share prices but result ultimately in financial restatements.
Limits on Severance Pay: Executives should not be entitled to severance payments in the event of termination for poor performance, resignation under pressure or failure to renew an employment contract. Company payments awarded upon death or disability should be limited to compensation already earned or vested. Any provisions providing for compensation following a change-in-control should be “double-triggered,” meaning that compensation is payable only after a control change actually takes place and if a covered executive’s job is terminated because of the control change.
Why it matters: Boards continue to pay executives generous severance packages despite poor performance. Large “golden parachutes” awarded to executives terminated for poor performance are fundamentally inconsistent with a pay-for-performance philosophy. So-called “golden coffins,” posthumous payments to executives, who have died while in office, are also at odds with performance-based principles. Such severance packages amount to nothing more than “pay for failure.”