Dodd-Frank on Pay: Neutrality, Signaling, and Exposé
Neutrality, signaling and exposé are the tonics served up on executive compensation in the new law nominally aimed against Wall Street and for consumers. The 848-page statute also named for its sponsors, Senator Dodd and Representative Frank, makes public companies put neutral committees at the pay-setting helm, lets shareholders cast precatory votes on the results, and shines a potentially embarrassing spotlight on prevailing pay realities and ratios. It puts a heavy hand on big bank pay setting.
Those incrementally averse to regulation will be appalled while those fearing serious flaws in pay practices enthralled. But neither group seems right, as these efforts reflect real problems, yet they are not likely to achieve their objectives. Even so, here’s a run-down of our new federal executive compensation laws, and predicted effects.
Neutrality. Courtesy of mandates on our stock exchanges the SEC will impose, companies won’t be able to list securities unless their boards use pay committees staffed by independent directors. This new neutrality on pay committees looks different from other uses of the independence concept, riveting heavily on how those members are paid. The neutral group gets exclusive power to hire and pay consultants, whose neutrality in turn is to be mandated by regulation. This move mirrors the one in 2002’s Sarbanes-Oxley Act, dictating the power of audit committees who preside over financial reporting. Predicted effect: limited, as have been nearly all other investments in director independence since that reform impulse became fashionable two generations ago.
Exposé. Following the standard approach in securities law generally and executive compensation in place for decades, you’ll see more charts and images displaying pay. Disclosure will include what the neutral directors and their consultants did along with images relating pay packages to enterprise financial performance. Stunningly, companies will show in a crisp ratio what the median worker makes compared to what the CEO makes. Impressively, you’ll find out whether managers owning stock can hedge against declines in the stock price. That’s important because even stock pay designed to induce optimal incentives can be circumvented with hedges. Predicted effect: intensification of existing polarity in the populace dividing those outraged by great income disparities between workers and managers from those who assume big pay rewards hard work.
Signaling. At least every three years, companies must ask shareholders what they think of company pay in this newly neutralized and exposed world—and ask them every six years whether to make those votes more or less frequent. Shareholders also have to be told of any special pay managers get when voting on organic business changes like mergers and asset sales. These are all merely precatory votes, though, the statute making it clear they’re not binding and have no legal effects whatsoever, including on director duties and power. That makes this properly classified as a signal on pay (not, as the popular but misleading slogan has it, say on pay). Predicted effect: a new way to stick it to managers unwanted for other reasons.
Big Banks. Federal regulators must adopt rules to prohibit big banks—those commanding assets exceeding $1 billion—from using any contingent pay packages that yield either “excessive compensation” or risks of “material financial loss” to the bank. By fall, regulators must find out from banks whether any existing pay arrangements pose those problems. None of that must be disclosed to the public, though, and individual deals don’t have to be shared with the regulators either. Predicted effect: Byzantine regulations delineating the meaning of excessive and material plus incremental retrenchment against pay explosion.
Upshot: I still like my proposal to let the common law of contracts police particularly obnoxious pay contracts on a case by case basis under its doctrine of unconscionability. Contract law has a majesty and beauty unmatched by federal regulation or state corporation law. (My proposal is now in a paper I’ll submit to the law reviews in mid-August. The Dodd-Frank Act strengthens its appeal.)