A coalition of investors and advocates has called on Congress to regulate corporate pay practices – especially at banks. In a July 31 letter, ShareOwners.org, Americans for Financial Reform (AFR) and the Social Investment Forum (SIF) expressed support for a House bill to give shareowners "a 'say on pay' for top executives," and also compel financial firms to "disclose any compensation structures that include incentive-based elements."
The groups' focus on incentives comes from a bit of conventional wisdom on the causes of the financial crisis: Pay practices at financial firms encouraged executives to look out for themselves, rather than shareholders. ShareOwners.org conducted a poll which found that "the No. 1" threat to investors' faith in the markets is "overpaid CEOs and/or unresponsive management and boards."
But what if "overpaid" executives believed they were looking out for shareholders? New research suggests that CEOs' interests have been all too well aligned with the short-term interests of investors, rather than the long-term health of their companies.
On the Harvard Law School Corporate Governance blog, René Stulz of Ohio State University writes:
"Our [research] shows that there is no evidence that banks with a better alignment of CEOs' interests with those of their shareholders had higher stock returns during the crisis and some evidence that banks led by CEOs whose interests were better aligned with those of their shareholders had worse stock returns and a worse return on equity."
Mr. Stulz is referring to "Bank CEO Incentives and the Credit Crisis," a new paper he co-wrote with Rudiger Fahlenbrach. They studied "whether the alignment of interests between CEOs and shareholders can explain the performance of banks…during the credit crisis, and how CEOs fared during the crisis." In particular, they looked for correlation between a CEO's share price-based incentive pay, such as stock options, and the stock's performance:
"Though options have been blamed for leading to excessive risk-taking, there is no evidence in our sample that greater sensitivity of CEO pay to stock volatility led to worse stock returns during the credit crisis. "A plausible explanation for these findings is that CEOs focused on the interests of their shareholders in the build-up to the crisis and took actions that they believed the market would welcome."
In describing their research, Stulz and Fahlenbrach assert that a CEO who focuses on share price is "aligned" with investors' interests. Perhaps this short-term "alignment" distracts managers from creating value for other stakeholders, including workers, communities, and committed "shareowners."
In a June 25 statement, ShareOwners.org, SIF, and AFR called on corporate America to manage for its "long-term sustainability," not high share prices.
Reforming corporate pay practices is only one part of this process. ShareOwners.org's summary of their reform agenda is reproduced below; it is a blueprint for a truer alignment of managers and investors.
"…Shareholders in America's corporations – who more accurately should be thought of as 'shareowners' -- have limited options when it comes to protecting themselves and the long term sustainability of the companies they own. … "The four-part ShareOwners.org agenda is spelled out in detail on the Web and may be summarized as follows: * Stronger regulation of the markets through a beefing up the Securities and Exchange Commission (SEC), ensuring that it has the resources and authority to increase supervision and enforcement of financial professionals, hedge funds, and mutual funds, and also forfeiture of compensation and bonuses earned by management in a deceptive fashion, strengthening state-level shareowner rights, and protecting whistleblowers and confidential sources who expose financial fraud and other corporate misconduct. * Increased accountability of boards and corporate executives by allowing shareowners to vote on the pay of CEOs and other top executives, empowering shareowners to more easily nominate directors for election on corporate boards, requiring majority election of all members of corporate boards at American companies, splitting the roles of chairman of the board and CEO at major companies, stopping the practice of brokers casting votes for shareowners in board elections, and allowing shareowners to call special meetings. * Improved financial transparency, including a crackdown on corporate disclosure abuses used to manipulate stock prices, strengthening corporate disclosures so that shareowners can better understand long-term risks, and protecting U.S. shareowners by promoting new international accounting standards. * Enhanced protection of the legal rights of defrauded shareowners, which means preserving the right of investors to go to court to get justice, ensuring that those who play a role in committing frauds bear their share of the cost for cleaning up the mess, and allowing state courts to help protect investor rights."