Monday, December 18, 2006

Corporate Governance and Executive Pay Across the Pond

Fred Whittlesey
Compensation Venture Group, Inc.

My monthly interview session for Keeping Up!, the podcast series sponsored by the Global Equity Organization, focused this time on the differences between corporate governance-based approaches to dealing with the executive and equity pay issues of the day. The Association of British Insurers (ABI) gave me a little Christmas present by releasing "Executive Remuneration - ABI Guidelines on Policies and Practices" on 14 December. We would have done the podcast interview the next day, but the windstorms and power outages in the Seattle area delayed us and gave me time to read and digest the document.

Why should we in the US care about what a bunch of British insurance companies think about executive pay? Because ideas about executive pay are flowing freely, like all information, across national boundaries. If you know the history of FAS123R, the relatively new accounting rule for share-based payments, you know that the term "share-based payments" comes from the UK. In the US we called it "stock-based compensation" and the Financial Accounting Standards Board proposed "equity-based compensation" until the IASB - a UK-based organization - used the new term in IFRS2, their version of our FAS123R (they of course consider FAS123R to be our version of IFRS2, which is actually more accurate). Much of FAS123R is taken from IFRS2 and if you think reading accounting rules is difficult, try reading them when originally drafted in a more formal English that we typically use in America.

But beyond the terminology issue there are important differences between the two nations' compensation cultures, and the gap is widening even as it appears that governance trends are on similar trajectories. I won't go into all of the details in this posting, but it is interesting to note some significant positions prevalent in the UK that are not (yet) found here in the US as represented by the ABI’s positions. For example:

*"Where a company seeks to pay salaries at median or above, justification is required." In the US there has been some attack on companies targeting the 75th percentile and the potential ratchet effect of everyone wanting to be "above average" - but note this says "at median." Companies that strive to pay at the middle point of the market must now "justify" that.

* "Annual bonuses should not be pensionable." That would be very disruptive to those companies in the US that still have pension plans, and supplemental executive retirement plans (SERPs) and is contrary to the notion that some of executives’ annual cash compensation should be at risk. Perhaps we should pay all salary and no bonus to executives? Or just eliminate executive pensions?

* "Contracts should not provide additional protection in the form of compensation for severance as a result of change of control." In other words, no golden parachutes. "Contracts should commit companies not to pay for failure." Here, here.

* "...inappropriate for chairmen and independent directors to receive incentive awards geared to the share price or corporate performance that would impair their ability to provide impartial oversight and advice." Cleary, stock-based compensation - excuse me, share-based payments - may not be an appropriate form of pay for boards of directors.

* "...future performance should govern the vesting of options or share awards. Performancing at point of grant is generally not considered a future alternative." (Performancing? I checked that word on Merriam-Webster's online dictionary and was told "The word you've entered isn't in the dictionary." Is that "the" dictionary or "our" dictionary? Microsoft Spell-Check didn’t like it either.) Shareholders in the UK have made it clear than any form of share-based pay to executives should be performance-contingent and not subject only to time-based vesting. Goodbye, plain vanilla stock options. Good riddance, restricted stock.

I could blog on about this and address all of the important points from the ABI's 20-page paper, but here's the point: Not only do we have ISS, Glass Lewis, CalPERS, CalSTRS, Fidelity, Dimensional, et al opining on and influencing executive pay policy, and driving shareholder voting accordingly, but we must keep our eyes and ears tuned to their counterparts in other countries as executive pay has become a global issue. We have been unable to converge on a set of policies here in the US that we can all agree are "good" and "bad" and we may find that those standards are influenced by organizations that many executives and board members have never heard of.