Executive Enrichment Sensibility Act - EESA

(Or maybe Here Come the Pay Police, the Compensation Cops, the Say-on-Pay Shareholders, take your choice, pick your poison)

What we are really speaking about is the Emergency Economic Stabilization Act (EESA) of 2008, signed by President Bush on October 3, but there is much speculation that the fallout of this historic legislation may be far broader than defined within the Act. Thus, executive compensation in all industries in the United States will start to feel the impact of more regulatory changes/controls, the net result of which will be to reshape both the amount of pay and the method of delivering such compensation. And with the Democrats clearly in control of both Congress and the White House going forward, there will be levels of hostility and public outrage that will no longer be buried and ignored. There are many in congress who will be prepared to initiate hearings, listen to their constituents, propose legislation and otherwise become advocates for pay sensibility, however defined. And we can expect that any new rules will be cumbersome, poorly drafted, and maybe not even understood by Congress, but they will be coming; we need to get in front of this movement by taking actions early in 2009.

By now, all of you have read summaries of the immediate regulations which are already in place. All of the major HR consulting firms and law firms have published the details and those in the financial services industry are in the process of working out implementation details. Our purpose here is to summarize what has already been written and then speculate about how these new rules may trickle, flow or cascade out from Washington to all corners of corporate America.

Summary of the Rules

As the rules stand today, they apply only to firms whose assets are directly acquired by Treasury and those whose assets are acquired at auction. So the scope is very narrow and is limited primarily to the financial sector. Working mostly through existing tax codes, new executive compensation standards have been established that:

Limit compensation to eliminate incentives that encourage executives to take unnecessary and excessive risks that might threaten the value of the business
Allow for “claw-backs” or recovery of bonus awards and other incentive payments to executives based on almost any criteria that is later found to be materially inaccurate
Limit or prevent the granting of golden parachute payments to senior executives.

Some of the terms have been defined (like senior executive officer) but many others are unclear at this time and will likely remain so for at least the next several weeks.

So What is the Problem?

The problem is that Congress is sticking its fingers directly into senior executive compensation practices because of perceived and actual abuse by senior executives from all sectors of American industry. I am not suggesting widespread fraud or misdeeds; rather, boards, senior executives, consultants, attorneys and others have not found how to turn off the greed switch, so Congress will do it for us. Or they will at least try, which as most of you know, generally leads to unintended consequences, a mass of regulations, and confusion rather than clarity.

What Should we do Now?

Here is a list of things to consider. Some of them are routine, others are pure speculation but at least provocative.

Review all of your terms and conditions of employment for senior executives and develop a written rationale for each one, demonstrating why the plan is in place, how it functions, how it relates to shareholder value and how it is impacted by performance
Make sure that you are listening to your key audience, such as board members, employees, shareholders, vendors, and the outside community. Understand the degree of discomfort created by your pay plans and how to address them.
Where possible, always promote from within for senior management positions. Pay practices are best understood by insiders who are also more likely to be comfortable with their terms and conditions when compared to an outsider. Paying a premium for an outside hire usually leads to pay equity issues, resulting in arbitrary pay inflation.
Establish targeted maximum compensation levels upfront (the embarrassment factor), from all sources, and communicate these to executives. If current executives are not satisfied with these levels, perhaps they should find other employment or move to another position. I am not suggesting forced turnover at the senior level; rather, forced understanding.
Identify who can operate the “greed switch” and is prepared to use it. For the CEO, this will likely be the COB or chair of the compensation committee; for other executives, this will be the CEO. This switch is simply the point of pay above which the company is not prepared to venture.
Above all, be reasonable and responsible. I am not suggesting the overused and hackneyed “Joe the whatever” as a reference point, but what seems to fit in the context of shareholder returns, employee terms and conditions, community involvement, the regulatory environment and similar current conditions. If it smells bad, don’t eat it.
Explain to executives upfront what they can expect to earn over their period of employment. Making them wealthy is OK; making them super rich at the expense of owners if not OK.
Use multiple consultants and multiple data sources when you evaluate your pay practices and levels. Consultants are a bargain when compared to the total compensation earned by the top 25 executives in any company, so take advantage of their expertise and experience.
Do not hesitate to ask for voluntary reductions in pay from current executives. Often, the CEO can set an example by giving up a significant portion of past compensation. Across-the-board pay cuts have been used extensively in the past and may be suitable for future conditions, especially where cost reductions are being pursued.
Measure the cost of all compensation and benefits for senior executives in absolute dollars first and then as percents of various metrics. One of the older rationales for high pay was it represented a very small percent of sales, profits, shareholder return, etc. The public reacts to gross dollars, plain and simple.
And finally, do something and do it early in 2009.

Are these naïve and simple-minded suggestions? In many instances, yes, but they will also set you off on the right path to recast your executive compensation practices in the new light of a proactive Congress and a dubious public.

Robert D. Buford, November 2008