4 simple ways to rein in CEO pay

  • Article by: TED ADAMS
  • Updated: May 7, 2014 - 6:18 PM

Bye-bye, buddy system on corporate boards. Hello, stronger say for shareholders.

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The extreme gap between hourly workers’ pay and that of executives has gotten a lot of attention lately. There have been public demonstrations, shareholder resistance and even an attempt to rein in high CEO salaries on the part of the government by requiring a shareholder vote (advisory but nonbinding) on executive compensation.

Despite all, including the recent TCF shareholder dissent (“TCF loses vote on executive pay,” April 25), executive pay has continued to skyrocket as boards simply ignore shareholders, unions and citizenry. Some are advocating linking executive salaries to that of the average worker. There is a better way.

The reasons why boards continue to dole out shareholders’ money despite opposition stem from the way board members are nominated and elected. Under current practice, a nominating committee made up of current board members selects nominees to be presented to the shareholders for approval. Since there are rarely any more nominees than open positions, being nominated virtually assures election. These elections are the same as what you would expect in a communist country where voters vote yes or no on a single candidate.

The nominating committee is usually selected by the board chairman and the CEO (in too many cases, the same person). The CEO and the chairman are almost always on the nominating committee. It is in the CEO’s interest to select board members whose loyalty can be trusted. In many cases, a nominee’s primary qualification is loyalty to the CEO and the board chairman, with little knowledge of or experience in the business. Often there is a prior business or personal relationship to the nominee and very often the CEO and/or the chairman serves on the board of a nominee, a cozy mutual back-scratching arrangement.

Serving on the board is prestigious and lucrative and abounds in perks. Besides cash and/or stock options or grants, perks such as company-paid travel to foreign trade shows, board meetings in posh resorts (with spouses, of course) and other company benefits make continuing on the board the first priority of most board members, with shareholder interests a distant second priority. This is akin to a politician whose first priority is to get re-elected and whose constituents’ interests come next.

To maintain continuation of this bonanza of benefits, the board member must be assured of being renominated by the nominating committee. Since the CEO and the chairman are on the nominating committee, which they selected, they have great influence over the ultimate choices for nominees. Now, if you are a board member and want to be assured of being renominated, it pays (literally) to be looked upon favorably by the CEO and the chairman.

What better way to accomplish that than to enthusiastically endorse giving the CEO and the chairman hefty pay packages and golden parachutes? The fact that it also provides cover for increased board pay doesn’t hurt, either. Unless there is a monumental failure on the part of the CEO where the board is forced to act responsibly, this system goes on indefinitely. Can you imagine the likelihood of a board member being nominated for another term after he has protested higher pay for the CEO?

There is a rather simple solution that would assure that board members’ loyalties are to the shareholders and that their renomination isn’t dependent on their relationship with any executive. The key is to remove the nominating committee from board control and put it into the hands of the shareholders. This can be done by having the state modify the articles of incorporation and company bylaws in the following ways.

1) The board will select a nominating committee from among non-board-member shareholders who are among the top 100 largest shareholders.

2) There will be no compensation for the nominating committee.

3) The nominating committee shall not nominate any of its own members.

4) The nominating committee will nominate at least one more person than the number of open board positions.

With these simple rule changes, the shareholders could finally take over control of the company they own. It should also be obvious that new board members would represent the interests of the shareholders, since the nominating committee members would be among the largest shareholders themselves. There would be no benefit to the board members in approving the outrageous salaries they are now giving to executives. In fact, the shareholder nominating committee would probably penalize board members by not renominating them if they did so and/or were not spending the company’s (i.e., shareholders’) money wisely. Every unnecessary dollar of executive compensation and every unnecessary stock grant comes at shareholder expense.

Beyond the salary issue, a nominating committee made up of large shareholders would be far more likely to select the best and most qualified board members possible, rather than those who are most loyal to the CEO and the chairman. It is in the shareholders’ interest to have the best in the business represent them, rather than the buddy system we have now. A board immune from any management-inflicted repercussions from their actions could be far more demanding and effective.

A prudent board nominated and elected by shareholders from among a plurality of candidates would go a long way toward honest and quality governance. We cannot expect companies to enact such changes on their own. Those in power have too much to lose. It will be up to our governor and Legislature to force these changes. If every state followed suit, the corporate world would benefit hugely.

 

Ted Adams, of Edina, is the retired chairman and CEO of Envoy Medical. He was formerly an executive at CPI/Guidant (now Boston Scientific) and St. Jude Medical.

 

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