Capping compensation won't solve bank crisis

Boards must step up and set sensible salaries

By KAREN KANE

http://www.chron.com/disp/story.mpl/editorial/outlook/6274228.html

Feb. 21, 2009, 10:08AM

With the
stroke of a pen at the eleventh hour, Democratic Sen. Christopher Dodd
of Connecticut added a provision to the stimulus bill to strictly limit
the pay of bankers whose firms receive federal cash. It seems that
everyone in Washington wants a say on pay — if only to gain bragging
rights that they will not tolerate the excesses that brought about the
financial crisis. Yet, even the Obama administration that had earlier
imposed restrictions on executive compensation has begun to worry that
such moves may have unintended consequences. Legislating compensation
programs from on high, unilaterally, does little to solve the crisis.
What Dodd and the House Financial Services Committee revealed was the
hubris that they could fix the economy by managing compensation. Not
only is it more complicated, but the compensation discussion is already
occurring inside boardrooms of companies untouched by the bailout.
Directors have been hearing loud and clear that pay for performance is
acceptable but pay for failure is not.

In the midst of
the terrible downturn that has gripped the world economy, it’s more
than a little satisfying for a politician to call out the bad behavior
of the Wall Street bankers who rewarded themselves with $18 billion in
bonuses as the economy was imploding. It would be wrong to tar all
executives and their boards with the same brush. The current situation
demands that boards do a better job explaining how they provide
oversight and how they evaluate and reward company leadership, two key
elements of corporate governance.

Studies suggest
that high pay on Wall Street is episodic and highest in bull markets.
While the compensation cap is historic, it pertains only to those firms
getting exceptional help; that is, excessive amounts of taxpayer money.
The Obama administration is not signaling that it will try to manage
executive compensation but it has changed the context. It is now up to
boards of directors, charged with company oversight to use common
sense.

As Chronicle
columnist Loren Steffy pointed out in his column, “Let Boards of
Directors Police Pay,” Obama could change corporate governance by
revising company bylaws to require directors to stand for annual
election and to let shareholders vote against directors rather than
simply withhold their vote. That would give teeth to the concept that
directors serve to protect the interest of shareholders.

There was a time
when boards were little more than rubber stamps, the friends of
management, golf buddies who served on multiple boards. But since
Sarbanes Oxley and shareholder activism, boards have evolved to operate
at a higher level. Strong boards have no more than two directors who
are current or former company executives. The audit, compensation and
nominating committees now are made up solely of independent directors.
More companies require directors to have an equity stake in the
company, investing alongside shareholders. The quality of board
membership has improved with at least one independent director
experienced in the company’s core business. Companies set standards
about board attendance as well as director evaluation.

That doesn’t
mean they always get it right. In the economic meltdown, boards have
received their share of the blame. Some boards have found it easier to
reward executives and leave the explanation to compensation formulas
and legalese. Today, directors recognize that data is just a tool and
they are required to bring their best judgment to the task. Boards
understand that shareholders expect to pay for outstanding performance
but they are loathe to pay for failure.

It’s been
popular for companies to adopt the mantra of creating long-term
shareholder value as a mission. However, the purpose of the company is
not shareholder return, according to Paul Volcker. “The purpose of the
company is really to provide goods and services at the best possible
price, at the highest level of productivity, and in a way that serves
society and communities.” It is management’s job to ensure that the
company is ethical and successful. Corporate boards provide oversight.

Examples of poor
oversight are an affront to investors. Certainly, in the aftermath of
the dotcom meltdown and the disgraces of Enron, WorldCom and Tyco, most
boards chose discretion as the better part of valor, continuing to
operate quietly behind closed doors. Unfortunately, the boards that
have saved companies from crisis and scandal have gone unrecognized and
unheralded. In the best circumstances, CEOs turn to boards for
strategic advice and guidance.

In the current
climate, boards are learning that they must tell the story of the work
they do in carrying out their fiduciary responsibilities to
shareholders or detractors will. A board with a strategic communication
plan can use transparency and communication as effective risk
management tools. Conversely, a board with its head in the sand
pretending that no one is looking is courting disaster or shareholder
mistrust.

Boards need to
convey to shareholders that their contributions are significant in
providing the necessary oversight and direction to management. Further,
they need to convey that they are taking their responsibility very
seriously. The truth is that boards are spending more high-impact time
on the company’s complex issues. At the same time, boards need to use
every communication vehicle at their disposal — their Web sites, annual
meetings, the proxy’s compensation discussion and analysis to convey
the thought and time they are putting into these issues.

Boards should
continue to manage compensation as part of their oversight
responsibilities. If they are not effective, the shareholders should
vote them out. It’s time for effective boards to communicate their
understanding of shareholder concerns and how seriously they take their
responsibility.

Kane, formerly senior vice
president of corporate affairs and board secretary for the Federal
Reserve Bank of Chicago, served as communication officer for the Bank
and the Federal Reserve System. She provides independent communication
counsel to corporate boards. She can be reached at karen@karenkaneconsulting.com.