A Window Opens on Pay for Bosses

Is it possible that shareholders will finally get a reliable view of what the bosses are getting paid? And that it will come this spring?


There is no doubt that pay consultants are now looking for ways to keep that from being the case, and it would be a risky wager to say they will not succeed. But it appears that new disclosure rules that take effect with this year’s proxies will provide the most accurate view ever.

Mary Shapiro
Getty Images
Mary Shapiro

Anger over executive pay, particularly at banks, is high. That may have been one reason the Securities and Exchange Commission moved to improve the rules this year, but it was something that would have needed doing even if business leaders were widely deemed to be geniuses. Shareholders need good information, and the disclosures required by the S.E.C. before made the figures unnecessarily confusing.

There is still one area where companies could play games to make their bosses look less well paid than they really are. That is in the area of performance-based awards, where the payout will depend on how well the executive or the company performs relative to undisclosed goals. A company that wants to do so may be able to obscure just how likely a rich reward is for an executive.

Still, the information will be better than ever before. A particularly important change will make it more likely for shareholders to learn when one executive is given a huge options award. In the past, it was sometimes possible for a company to leave that out of disclosures, since the impact of the grant was spread over several years. Companies could make someone the highest-paid executive in a company for a year but not disclose that to shareholders.

Perhaps the most impressive fact is that the new information will be available this year. Mary L. Schapiro, the S.E.C. chairwoman, decided to fight her way through bureaucratic delays to get the new rule out just in time for this year’s proxy season. Under normal S.E.C. procedures, there is little doubt the changes would have been effective a year from now, not this year.

In less than a year, Ms. Schapiro has established a reputation for careful but determined reform, of the commission itself and of the markets it regulates.

She took over a commission whose final Bush-era chairman, Christopher Cox, remains an enigma. Evidently brought in with a mandate to keep things quiet, he did that by doing little unless everyone agreed. By giving a veto to Paul Atkins, a member of the S.E.C. who was basically against regulating Wall Street, he ensured that nothing good would happen.

Enforcement slowed and the morale of the S.E.C.’s staff plunged. The collapses of Bear Stearns and Lehman Brothers showed that S.E.C. inspections had been close to useless. In the final blow, the exposure of Bernard Madoff’s Ponzi scheme made the commission’s enforcement staff appear inept at best. There was talk that the S.E.C. might not survive a regulatory restructuring.

Now it looks safe and even effective. It is moving forward with giving shareholders a bigger role in choosing directors, despite howls of pain from corporate chief executives. That idea had been around for years and was almost adopted before Mr. Cox arrived, but there are other areas where the new S.E.C. is pioneering.

One of Ms. Schapiro’s most important moves was to establish a division of risk, strategy and financial innovation headed by Henry Hu, a Texas law professor who had written extensively on regulatory issues produced by financial innovation. This week the commission moved to at least reduce the advantages some hedge funds give themselves through rapid access to markets, and it put out a thoughtful request for comments on how such things as high-frequency trading should be regulated.

Writing rules will not be easy, or free of controversy, but the commission appears to have staff now to do the job. It may also help that the enforcement division is getting specialists who will concentrate on certain types of violations.

In contrast to some of the issues involving derivatives and superspeed trading, the disclosure of executive pay had been well debated long before Ms. Schapiro arrived. But the speed of action is still impressive. The S.E.C. proposed the rules in July, and it appears to have carefully weighed comments in changing its proposals without abandoning the goal. The rules were adopted on Dec. 16, a date that seems to have been chosen because it meant the rules could take effect Feb. 28, one day before the first 2010 proxies are due from large companies.

The principal change investors will see is in the summary table for each of the top executives — the chief executive, the chief financial officer and the three other highest-earning executives.

Under a system adopted by the Cox-led commission, the table has done a good job except when it came to equity grants — the most important part of the package for many executives.

That is because it used the amount of pay that was taken as an expense for each executive each year. There were two problems with that. First, it spread options awards over several years based on when the options vested. That meant that an executive could be given a huge options grant, perhaps on hiring, without the company having to disclose it, even if that was the largest pay package the company gave out that year.

The second problem was that accounting for options can produce some strange results. Under some circumstances, the expense can turn negative if the share price plunges. That meant some executives were reported as having worked without pay — even if their salaries were in the millions. In some cases, identical grants to two executives could produce wildly different results if one of the executives was old enough to retire.

The new summary table will count the grants as they are made. If someone gets a mega-grant, he or she is likely to show up in that year’s proxy disclosure. If a company chooses not to give options to an executive — perhaps because of poor performance — that will show up with a clarity that was not present before.

The new rules also will require companies to disclose if compensation policies are increasing the risk of the company having to take large losses, as seems to have happened in financial institutions before the crisis. There are unlikely to be many such disclosures, but being forced to think about it could produce needed changes in policies.

The game that is left open for companies to play concerns the valuation of performance-based incentives — ones that will pay off if the company hits certain goals. The value shown in the summary table will be the amount the company thinks is the most probable to be paid. It could even be zero. A footnote will show the maximum value for the executive if everything goes right, but it is the value in the table that is most likely to be noticed.

Auditors will have to sign off on that probable value, but since it relies on forecasts of the future, they are unlikely to challenge even halfway reasonable estimates. Since the exact performance targets are often not disclosed, it will be hard to tell if a company is being excessively conservative in estimating the value.

The summary table, even if it is as good as anyone can design, cannot tell the full story. Much of the value in pay packages comes from restricted stock and stock options, whose ultimate value will be clear only years later. New “claw-back” provisions may mean that this year’s grant could vanish next year. Other parts of the proxy will still show the profits executives realize when they cash in those grants, and deserve attention from investors.

Executive compensation is getting more attention this year than it may deserve, stirred by anger over the bonuses paid by banks that would be dead but for government bailouts. At least now we will be in a better position to intelligently discuss how much the pay really was.