Companies Deserve Pay Transparency, Too

Robin Ferracone

Executive Pay Watch

Dan Walter

Companies Deserve Pay Transparency, Too

For today’s Executive Pay Watch blog, I have asked

Dan Walter

, President and CEO of

Performensation

and founder of

Equity Compensation Experts

to weigh in on pay transparency.

Executive compensation
is justifiably complex. In fact, the total compensation for nearly
everyone in this country is difficult to communicate. Those at the
highest corporate levels generally have pay structures that reflect the
complexity of their company. Regardless of the intricacy of executive pay programs, it is still a very reasonable request to ask for pay transparency from these publicly traded firms.

New disclosure rules
have taken another step or two up the ladder towards transparency. In
fact, the HR Policy Association reports that the average Executive
Compensation Disclosure for the 50 largest U.S. public companies has
increased 23 percent to 32 pages since 2008. This represents about
one-third of their total proxy statement.

Pay transparency is a reasonable concern, but it should be a two way
street. Shareholders, employees and politicians want to understand how
and why executives are compensated. The new Dodd-Frank provisions have
once again increased transparency, but some of the loudest advocates for
this are the proxy advisory firms whose rating processes and databases
are deemed proprietary.

Not surprisingly, executives and compensation committees
want to understand how these third-party evaluators are measuring
compensation. Compensation professionals are tasked with making
“best-guess” estimates regarding the acceptability of potential
compensation proposals. While a trained professional can often get close
to the right answer, they never know how well they have done until
advisory firms have released their opinions. This process is both
inefficient for the company and board of directors and does not truly
serve the shareholders.

Measuring executive compensation should be similar to a sport like
diving where the voting is a subjective interpretation of a well
documented scoring system. In a sport like this, the coaches and
athletes (boards and executives) understand the scoring system. They
know the potential reward for every move and understand the impact of
every risk. Each series of dives is based on an athlete’s ability to
maximize return while minimizing risk. Such a system requires execution
on the part of the athlete, with the confidence that the only surprise
in the individual’s performance is against their peers. The rules are
well documented and the judges apply them to the best of their
abilities.

Imagine if executive compensation
worked this way. The execution is already increasingly more public.
Executives at public companies are not diving in a windowless room and
then reporting how well they did. It is time for the scoring system to
become equally transparent. Everyone should know the rules and how
exactly they should be applied. The final analysis will be subject to
interpretation and allow for companies to be both creative and
individual within a framework these both sides understand.

In writing this post, I found an April 19 article
from Stanford Professors, David Larcker and Brian Tayan discussing
whether the voting recommendations from Institutional Shareholder
Services (ISS) and other proxy advisory firms actually create
shareholder value. They found that examining the impact of the
recommendations was difficult because “the algorithms and data are
considered proprietary.” This inability to measure effectiveness is the
same common complaint against the lack of transparency in executive
compensation.

There are tens of thousands of proxies to be reviewed every year.
Firms like ISS and Glass-Lewis serve an important service in reviewing
the data for all of these firms by providing insight into corporate
governance and best practices. In theory, they allow the smaller
institutional investors to invest in a broader array of companies with
more confidence. It is unlikely that many of these investors would be
able to operate, as cost-effectively if they had to staff their own full
team of analysts like the very large investors do. The proxy advisory
firms help create some consistency in voting, but it is at the price of
guesswork on the part of companies.

Firms such as Glass-Lewis and ISS have generally been a positive
force on executive compensation over the past decade. As the world of
executive compensation evolves, it may be time for them to follow their
own guidance and raise the shades on their windows. If transparency
works well for executive compensation, it should also be great for those
who provide definitive guidance on it.

Guest contributor Dan Walter is based in San Francisco, CA and is the President and CEO of Performensation,
an independent compensation consulting firm focused mainly on the needs
of companies not in the Fortune 1000. In addition, Mr. Walter is the
founder of Equity Compensation Experts, a free networking group.