Why Say on Pay Doesn't Matter

A series of posts on Race to the Bottom this week has made much about the likely prospect of “Say on Pay” becoming the law of the land if the Dodd bill addressing financial reform passes in the coming weeks, which it is likely to do. However, the practical effect of this provision of the Dodd bill on executive pay seems negligible.

For those unfamiliar with “Say on Pay,” this is a concept first put forth by shareholders that calls on companies to submit all executive pay decisions to a vote of the company’s shareholders prior to going into effect. Like the provision in the Dodd bill, this shareholder approval ritual is advisory. Thus, directors can ignore the wishes of shareholders if they so choose.

In the short-term, it is unlikely that this provision will have any impact on the vast majority of public companies. Race to the Bottom notes that only a few companies that have submitted pay plans to shareholder approval have experienced any blow back from their investors. Citing the situation at Occidental Petroleum, shareholders voted down a compensation plan for the company’s CEO Ray Irani, a perennially overpaid executive who has been a lightening rod for investors for many years. Undoubtedly, when Say on Pay becomes the law of the land, there will be a few more of these votes getting majority status.

While shareholder approval of executive compensation is a good thing for some obvious as well as less obvious reasons, as a practical matter, very little will change in the short-term. What remains unchanged is the fact that institutional investors largely give companies a pass when it comes to pay practices. Despite the railing of pitchfork capitalists that things must change, those major investors “pulling the lever” at proxy voting time have no incentives to change their voting practices. There are several reasons for this.

First, a substantial percentage of institutional investors – investment managers, corporate pension funds, insurance companies and some pension funds – have policies when it comes to executive pay that I would characterize as “but for the grace of God go I.” By tackling the executive pay head-on as large investors, these institutions risk impacting their very own pay practices. While most of these investors would not admit to this practice, as a practical matter, this is the consequence

Second, institutional investors defer to their professional proxy voting advisors – ISS/Risk Metrics, Glass Lewis, et al. – in order to untangle the complicated mess that is designed to obfuscate the executive pay setting process. A quick glance at any company proxy statement will confirm the fact that 60 to 80 percent of proxy statements are devoted to executive pay discussions.

The proxy advisors have responded in an equally complicated fashion both to analyze these complicated pay setting processes as well as justify their own existence to their paying clients by demonstrating their intellectual prowess on the subject. For instance, ISS/Risk Metrics employs multiple regression analysis and a two stage assessment of just one aspect of company executive pay setting. While this approach gets the job done, the entire process from both the issuer and investor perspectives only obscures the problem.

The good news in all of this is that the question of executive pay will now be addressed head on by shareholders. A procedural barrier preventing meaningful discussion about pay practices has been removed. What now must be done is to address excessive corporate pay practices and their underlying causes in a meaningful manner. This will require a better informed corporate electorate that can decipher the the arcane data that currently obscures greater understanding of the matter.

The 2011 proxy season should be an interesting test of shareholder mettle on this subject. While some executives may fear a firing squad of sorts from shareholders, as a practical matter, their investors will most likely miss their targets. However, in time, investors may become better shots.

CyberRisk: Lessons from the GhostNet Report

Recently, a number of web sites I have developed came under a severe hacker attack. Starting last October, several sites were “vandalized” with the site’s home pages replaced with new ones proclaiming that the site had been hacked. A little research into the servers and I thought the problems had been solved.

I was mistaken.

The attacks continued for some months, escalating into a full-blown battle for control of my sites. DDoS, SQL injetion viruses, brute force attacks and god knows what else was thrown at my sites. Eventually, Google forced the site offline by proclaiming that my sites had become predator sites and that anyone visiting the sites should go elsewhere. Several months later, things are returning to normal. Considerable expense and hundreds of man hours were spent fixing the problems and, quite frankly, I am not entirely certain that it won’t happen again.

Questions remain. How did my sites get hacked, who did it and why was it done?

After considerable research into the subject, I discovered that these are the great unknown questions. Answers to these questions can at best be inferred. An acquaintance in the cyber-policy community  heard my story and said “Iran and China. Look there for answers.” After further prodding, he referred me to a recent report issued by a Canadian organization, SecDev Group, which recently issued its report,”Tracking Ghostnet: Investigating a Cyber-espionage network.” This is a frightening exposé of a world around us that most of us, certainly myself, are totally unaware of but should pay close attention to. What I learned from this report was troubling given the risk that we all face from cyber-criminals, cyber-terrorists and nation states bent on asserting themselves on the world stage.

The report details hackers from China (PRC) who waged an attack on the Indian government and the offices of the Dalai Lama. These hackers were able to successfully intrude with impunity into the computers of these organizations, stealing secret information, identities and use those computers to wreck havoc elsewhere.

The pattern was a familiar one to me based on my experience. However, what happened next was even more striking.

As I was putting new security precautions in place on my servers, I found that I could track visitors to my sites. What I found was alarming to say the least. In the time I installed the intrusion tracking software (I am speaking about a couple of minutes), a single intruder had tried to enter the site 288 times.

I now know a new technology term: “IP address blocker.”

The Independent (NOT!) Chairman At Morgan Stanley

Among the many proposals up for consideration at this year’s annual meeting at Morgan Stanley is one that deserves your attention and your vote. Proposal #7 calls for the separation of the positions or chairman and CEO and also requires that the chairman be “independent.” For those of you that pay attention to these sorts of things, an independent chair proposal is not new. What makes this proposal unusual is the corporate chutzpah that suggests that this proposal is not in the interest of shareholders. Remember that “financial crisis” from a few weeks back? The boys at Morgan Stanley were some of the dealers at that crack house fiasco.

Morgan Stanley, along with a number of other financial services companies on Wall Street were engaged in a range of financial transactions that contributed to the global financial meltdown. The company, along with its compadres on the Street, traded on a range of securities that bet on the failure of the mortgage market. This gamble based on a failed bet that the unsustainable mortgage market would last (i.e. millions of bad mortgages would not somehow fail all at once) blew up, leaving ordinary people in financial disarray, economies around the world in crisis and the financial companies at risk of collapse. So far so good?

In 2008 and 2009 the company was in crisis. The Company’s then CEO John Mack (now the Chairman) was under pressure from the Fed and the Treasury to merge the company with JP Morgan Chase. Eventually, the Company was forced to take TARP funds, which it has since paid back. While all of this was going on, shareholders were taking quite the hit. MS share price went from a high of $67 and change in 2007 to less than half of that amount in 2010. Of course then CEO and now Chairman Mack saw a $41 million payday in 2007, which has since diminished to a paltry $1.5 million and change in 2009.

Yeah, pay for performance is working here.

Anyway, late in 2009 the Company announced the change in duties of Mr. Mack and the co-President James Gorman but from a shareholder perspective has anything changed on the board?

Well, no.

While a number of new faces have appeared on the MS board over the last couple of years, much remains the same. Several directors are seriously overboarded, holding 4 or more board positions (James Hance (5), Donald Nicolaisen (4), Charles Noski (4), Laura Tyson (4)), several directors have held their posts for excessive terms (Robert Kidder (17 yrs), Laura Tyson (13 yrs)) and of course, the chairmanship is held by an insider, Mr. Mack. Perhaps these problems could be ignored if the company hadn’t, well, screwed the pooch. Unfortunately for the rest of the world, that was not the case.

For MS shareholders interested in sorting out the pros and cons of this shareholder proposal, the Company proxy statement is of little help. Regrettably, the proponent talks in platitudes about the merits of independent chairmen. (Yawn). But somehow, corporate hubris seemed to get the best of executives at the Company who offer that “[t]he Board should not be constrained by an inflexible, formal requirement that the Chairman be an independent director who has not previously served as an executive officer.” The proxy statement goes on for several more interminable paragraphs suggesting that its independent board and committees all somehow validated its decision to let Mr. Mack continue on as CEO-Emeritus/Chairman.

Okay, so let’s recap: Stock price in the toilet, entrenched Chairman, entrenched board, executive pay rewarding short term performance, shareholders left holding the bag. This is a no brainer folks.

Vote for requiring that the chairman be I N D E P E N D E N T!

Waddell and Reed: Hyperbole as a Measure of Performance

In the never-ending grab for higher levels of excessive pay at shareholder expense, CEOs have shown a remarkable set of qualities: hubris, greed and brazenness. This list runs on but today, I am reminded by CorpGov.net that another talent has been overlooked, at least at the financial services company Waddell and Reed. That quality is hyperbole. It seems that the company’s CEO, Henry J. Herrmann has quite a talent in that department.

In a March 5, 2010 letter to shareholders, Mr. Herrmann suggests that a shareholder proposal coming to a vote on April 7th “could put Waddell & Reed Financial, Inc. at a serious competitive disadvantage and could erode the value of your investment.”

Really?

This apocalyptic event Mr. Hermann refers to is a shareholder proposal calling for an advisory vote on executive compensation. As Mr. Herrmann notes in a quieter moment in his letter, the proposal “recommends that the Board of Directors adopt a policy requiring an advisory vote of our stockholders to approve the Compensation Committee Report and the executive compensation policies and practices set forth in the company’s Compensation Discussion & Analysis in our proxy statement.” Somehow, this doesn’t strike me as a doomsday event so it prompted me to see what’s going here at WDR. (See ProxyAnalyst’s recommendation on this vote here)

A quick glance at the company’s proxy statement clarified things. Indeed, somebody would be at a disadvantage should shareholders be allowed some say on executive pay. However, it wouldn’t be the company’s investors.

Mr. Herrmann received approximately $4.9 million in total compensation in 2009, up roughly 20% from 2008. The market was up, company performance as measured by stock price for 2009 was up. One could argue that pay linked to performance was as it should be. Unfortunately for shareholders, the process could use a bit of tweaking considering how pay was set at the company.

As noted in the company’s proxy statement, four factors were used in determining Mr. Herrmann’s pay:

• The Company’s financial and operational performance for the year;

• Market survey information for comparable public and private asset managers prepared by the Committee’s independent compensation consultant;

• Recommendations of the Company’s Chief Executive Officer, based on individual responsibilities and performance;

• The previous year’s compensation levels for each named executive officer; and

• Overall effectiveness of the executive compensation program.

Yes, it seems that at Waddell and Reed, the CEO calls the shots when it comes to setting his own pay package. This arrangement is threatened should investors have some sort of input into this process. Undoubtedly, Mr. Herrmann is disturbed at the prospect that shareholders might take exception to his pay package, which includes the free personal use of the corporate jet, tickets to sporting and cultural events as well as this nifty pay package. Mr. Herrmann has undoubtedly worked hard to cultivate a solid relationship with his board of directors and doesn’t need that apple cart upended by the company’s owners.

However, it seems unlikely that this hullabaloo will come to much should shareholders approve this proposal. After all, the same proposal submitted by the same shareholder received majority support from shareholders last year. What did the company do in response?

Nothing.