Treasury Secretary Outlines the Direction of Executive Compensation Reform

On June 10, 2009, Treasury Secretary Geithner issued a public statement outlining five broad-based principles for executive compensation reform. Notably, he made it clear that there is no intention to cap pay levels or set forth precise prescriptions for how companies should set compensation. The Treasury Secretary further indicated that President Obama's Working Group on Financial Markets will provide an annual review of compensation practices to monitor whether they are creating excessive risks.

The Five Principles:

Compensation Plans Should Properly Measure and Reward Performance

Compensation should be tied to performance and align with long-term value creation. Performance bars should not be set too low and benchmarks should not trigger bonuses when a firm is underperforming relative to its peers. Performance-based pay should be conditioned not just on stock price, but also on other internal and external metrics. These include the firm's performance relative to its peers, an individual executive's performance, the performance of a particular business unit and the firm's overall performance.

Compensation Should Be Structured to Account for the Time Horizon of Risks

Executives should not be rewarded for decision making that encourages short-term gain at the expense of the company's long-term value. Companies should seek to pay top executives in ways that are tightly aligned with the long-term value and soundness of the firm. In addition, firms should carefully consider how proper incentives can extend beyond top executives to those involved at various levels in designing, selling and packaging financial products.

Compensation Practices Should Be Aligned with Sound Risk Management

Compensation committees should conduct and publish risk assessments of pay packages to ensure they do not encourage imprudent risk taking. Because risk managers in the past lacked the authority necessary to safeguard against risky activities, firms should explore how they can provide risk managers with the tools and authority to manage the relationship between incentives and risk taking.

Reexamination of Whether Golden Parachutes and Supplemental Retirement Packages Align the Interests of Executives and Shareholders

Companies should reexamine how well golden parachutes and supplemental retirement packages are aligned with shareholders' interests, whether they truly provide incentives for performance, and whether they reward top executives even if their shareholders lose value.

Transparency and Accountability Should be Promoted in Setting Compensation

Treasury intends to work with Congress to pass legislation in two specific areas. First, Treasury will support efforts to pass "say on pay" legislation, i.e., giving the SEC authority to require companies to give shareholders a non-binding advisory vote on executive compensation packages. Second, Treasury will propose legislation giving the SEC the power to ensure that compensation committees are more independent, providing standards similar to those for audit committees under the Sarbanes-Oxley Act. Compensation committees would also be given the responsibility and resources to hire their own independent compensation consultants and outside counsel.

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Claudia Elmore
Elmore Consulting Group
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