Two key reforms getting big pushback from Big Business

How do we address the mind-boggling sums paid to corporate executives? Pat Garofalo of the The Wonk Room investigates say-on-pay and proxy access, two reforms that are getting big pushback from Big Business.

Say-on-pay and proxy access seem like sensible enough concepts. Giving shareholders (who are the owners of the company, after all) the ability to determine their company’s executive compensation practices and board composition logically align with free-market principles. But judging by the business community’s reaction to both reforms — which congressional Democrats and the SEC, respectively, want to implement — one would think capitalism itself was under assault.

Gross management incompetence, and, at times, malfeasance played serious roles in America’s last two business booms (and subsequent busts). During both the dot-com and mortgage bubbles, corporate management failed to rein in excessive risk-taking and irrational speculation, or resorted to accounting gimmicks to hide massive losses, leaving corporate implosions and economic wreckage in their wake. Enron, WorldCom, Citigroup, and AIG come to mind as some of the largest culprits, but the problem by no means ends with them.

The current structure of corporate governance in America discourages transparency and accountability and encourages static boards that don’t have to answer to their shareholders. The upshot: Shareholders find it exceedingly difficult to exert any pressure on management to curtail the perverse risks that they encourage to boost short-term corporate profits and hefty annual bonuses.

Take proxy access. Currently, during an election for a corporate board of directors, a company sends out a “proxy” (ballot) with its preferred slate of candidates, with the cost billed to the company. In contrast, “dissenting shareholders [must] pay up for mailing and publicity costs, sometimes in the millions of dollars,” to send out their own, separate ballot.  As the New York Times’ Gretchen Morgensen put it, “only those shareholders with millions to spend on hard-fought proxy wars could hope to influence a board’s makeup.”

The SEC wants to mandate that shareholders who hold 1 to 5 percent of a company’s shares (depending on the company’s size) for more than one year be allowed to put their candidates for a limited number of board seats on the main ballot.  But the business lobby, spearheaded by the Chamber of Commerce, is intensely lobbying against the change.  The Chamber, in fact, has promised an “all-out lobbying effort with lawmakers that it plans to ramp up after Labor Day.” 

Never mind that studies have shown that boards with members elected by activist shareholders perform better in both the long- and short-term. The non-profit Investor Responsibility Research Center Institute and the proxy advisory firm Proxy Governance found that companies’ total returns were 19.1 percent, “or 16.6 percentage points better than peers’” during the run-up to and first year following a successful activist board campaign.  And total share price performance for the first three years under hybrid boards averaged 21.5 percent, almost 18 percentage points higher than their peers. 

The Chamber claims that proxy access would prevent companies from focusing on long-term growth. But this is a false argument because, as we’ve seen, management is not looking at the long-term, but is trying to maximize short-term gains, even if it means taking on absurd amounts of risk.

“The objections to the SEC proposal are weak,” agrees Harvard Law Professor Lucian Bebchuk. “The case for comprehensive reform of corporate elections is supported by a significant body of empirical evidence. Arrangements that insulate directors from removal are associated with lower firm value and worse performance.” 

Big Business’ objections to say-on-pay are no better than those it uses to discourage proxy access, and again, it is the Chamber leading the opposition by claiming that the measure is simply a way for unions to wedge their way into corporate pay discussions. But say-on-pay would mandate the most minimal of intrusions into business activity, simply requiring that companies allow a non-binding shareholder vote on a companies’ executive pay packages.

As Treasury Secretary Tim Geithner points out, “[say on pay] has already become the norm for several of our major trading partners.”  In two of those countries - Great Britain and Australia - CEO pay “grew 2.4 percent and 25.3 percent, respectively, from 2002 through 2006, while pay in the United States soared 59.9 percent in the same period,” according to data compiled by Compliance Week.  In fact, some criticize the say-on-pay measure for not going far enough, as it counts on managers being shamed into holding down pay, and the shareholders’ recommendations can ultimately be ignored.

Would more shareholder input have prevented the subprime crash or the tech bubble? At first glance, the answer would seem to be ‘probably not.’ Most shareholders were just as captivated by surging profits as the managers themselves, and probably would have been loath to pull back the curtain and examine what was happening. But if better corporate governance had been in place and more shareholder say over pay packages allowed, then the widespread shenanigans might have been mitigated, the pay that incentivized bankers to take wild risks could have been pared back, and the managers that failed to adequately police risk could have had at least some small reason to fear for their jobs.

Going forward, both say-on-pay and proxy access would be useful checks on corporate power to have as we try to rebuild the economy. Let’s hope that Congress and the SEC finally take a stand against a big business community that it staunchly defending the status quo.

Pat Garofalo is an Economics Researcher/Blogger for The Wonk Room and The Progress Report at the Center for American Progress Action Fund.