Flaherty: No Place to Hide in Dodd-Frank's New Glass House
If you thought Sarbanes-Oxleyshook up the corporate world, wait until you get a load of Dodd-Frank. When Corporate America comes back from summer vacation, it will find that the extensive disclosure and transparency requirements it has been grappling with for the last eight years just got a tough big brother.
The Dodd-Frank Wall Street Reform and Consumer Protection Actchanges the balance of power between shareholders and corporations. It changes the roles and responsibilities of corporate executives, changes the way corporations find and appoint directors, and will have to change the way everyone communicates about all those things.
Be Careful What You Wish For
The opening of the 21st century is certain to be remembered as the decade we woke up to risk. Terrible things happened, and we want to stop them from happening again. The 9/11 attacks opened our eyes to a new kind of geo-political risk. The devastating collapse of Enron and Arthur Andersen exposed a new magnitude of corporate risk.
Washington responded with Sarbanes-Oxley, giving rise to the chief financial officer as a new power broker, and giving accountants, if not exactly greater cachet then at least a leg up on the corporate ladder. Optimists hoped SOX-level scrutiny wasn’t the new normal; that the pendulum would swing back to a simpler time. But SOX didn’t prevent an even greater financial crisis that nearly brought down entire economic systems.
For the first time, America has regulators focused on the danger that large institutional risks pose to the nation’s economic health and market stability.
If the regulator sees trouble ahead, it will move in to mute the systemic risk.
Dodd-Frank certainly addresses some systemic risk but, like Sarbanes-Oxley, it will create unintended consequences.
One perhaps unexpected consequence is that companies will need to endlessly explain and, in some cases, “campaign” aspects of their governance and compensation policies or risk a giant gap in expectations and understanding among the public and their own employees.
The Quicksand of Executive Compensation
There probably has been no single corporate issue that is as inflammatory to the person on the street – or the Senator in the hearing room – than executive compensation. Dodd-Frank pushes even further than previous legislation on executive compensation. It liberalizes compensation clawback rules, calls for shareholder votes on golden parachutes, and requires compensation committees to be made up of independent directors. It also requires companies to disclose how CEO compensation relates to corporate performance and compares it to median employee compensation. For years, activist investors have compared CEO pay to the pay of an entry-level employee and produced ratios like 350 to one. Dodd-Frank uses the new benchmark of “median” employee compensation. This statistic will be confusing for everyone. If a CEO’s pay is 20 times the median employee’s salary, is that good or bad?
"There probably has been no single corporate issue that is as inflammatory to the person on the street – or the Senator in the hearing room – than executive compensation."
The new law also gives shareholders a “say on pay” through a non-binding vote on executive compensation – a vote that must be held every one, two or three years, as determined by a separate shareholder vote. Does it look defensive if a company chooses to hold the vote every three years? Explaining the intricacies of executive compensation in relation to these new rules will feel like standing on quicksand.
A Full-Time Education Campaign
Dodd-Frank also promotes board independence and diversity by enabling shareholders meeting certain ownership requirements to place their own director nominees in the company’s proxy. Some people think that’s great. Activist investors of all stripes are gearing up to take advantage of these changes mandated by Dodd-Frank. But consider the impact on management facing a powerful and effective campaign by a union, environmental group, powerful pension fund or other interest group promoting its own slate of directors. Any company faced with the possibility of such an interest group campaign will have a serious educational challenge to get its views heard and may choose to launch its own a pre-emptive campaign, likely at great expense in both dollars and management time and attention.
All of this adds up to a new series of tests for corporate leaders and communicators. In time we’ll know whether Dodd-Frank succeeds in mitigating the risk of future economic crises. But we already know that it will create major reputational issues. It’s not an overstatement to say that the year-round communications and education obligations created by Dodd-Frank will require full-time staff attention and tight coordination across functions, particularly the office of the CFO, investor relations, legal affairs, communications and human resources.
For more check out:
- Slideshow - High Profile CEO Exit Packages
- How Wall Street Will Beat the New Financial Regulations
- Watch - Flaherty on Corporate Governance
- Valliere: Scaring the Voters
- CNBC Guest Blog - The State of Business Today
Rob Flaherty is senior partner and president at Ketchum, a global public relations firm, and serves as managing director of Ketchum’s Global Corporate Practice.