Know Your Finances: “Special Master of Compensation”

Posted by Ellen Le on June 12, 2009

My beef with the latest and greatest government attack on excessive executive compensation is not your typical right-wing fear about the slippery slope towards “comrade” economics.

As can be expected, many conservatives on Capitol Hill and in business will freak out over any government intrusion into any decision-making within corporations. After all, this is a democratic and free market country. Where will government intrusion end?

My problem with the Obama administration’s latest plan is that it is an inefficient, bureaucratic, and ineffective solution.

The plan involves three components: two legislative proposals and one executive authorization of power. The legislative proposals are (1) to order that all company shareholders be allowed to vote on pay levels on an advisory basis and (2) to require companies to strengthen the independence of committees that set executive pay. The executive component is the naming of a “Pay Czar” or “Special Master of Compensation” to physically review and approve the compensation for the top 100 most highly paid employees of seven companies (AIG, Citigroup, Bank of America, GM, GMAC, Chrysler, Chrysler Financial); these firms have received the most government money.

On the surface it all sounds fair. And I assure you, I get just as outraged as anyone about the absurd millions of dollars in compensation paid to mere corporate mortals; many of whom have failed miserably.

Legislative proposal #1: Mandating that shareholders vote on pay isn’t a solution. The vote isn’t binding, it’s just advisory. There are companies that have already been putting compensation out for vote and the result has been that shareholders have been voting with management anyway. Most investors, including many professional investment managers, do not have enough information or time to make an educated vote on compensation. I expect this proposal will become a superficial compliance checklist item that companies will gladly check off to appease government.

I believe a better way to get the public to have an affect on executive pay is to treat them as educated investors instead of trying to treat them as pseudo-managers. The SEC should direct that every company release a succinct and easy to understand summary of the company’s compensation programs and how they compare to peer companies. It should include comparative profitability ratios of similar companies so that differences in compensation can be understood vis-à-vis company performance. This information should be included with company proxy and 10K materials. Let the investor show approval or disapproval by buying or selling shares in the company. Give investors more and better information to do their analysis before investing. Many senior executives lost many millions of dollars in just this way as their stocks plummeted as a result of poor performance.

Legislative proposal #2: Instructing that company compensation committees be more independent from management is a good idea in theory because those committees are often in bed with management (management often hires and fires the committee members); but how in the world will the SEC enforce that? The SEC staff is stretched as is; how will they monitor said independence? It is a solution that is impractical. I suspect that ordering committee independence will become a bureaucratic charade full of wasteful paperwork.

Special Master of Compensation: Czar Kenneth Feinberg is probably a super bright and nice man, but what parallel universe are we now living in when we authorize a new government agency to review and determine pay levels for top employees? The argument in defense of this plan is that these seven companies are largely owned by the government (and taxpayers) and therefore government should play a role in management to protect taxpayer interests. When the government decided to bail these companies out instead of letting them fail they never said, nor should they have said, that managerial decisions would become part and parcel of keeping companies afloat. Czar Feinberg’s job will be unwieldy, political, wasteful, distracting, and ineffective.

The only way that real and lasting changes in compensation will occur is through investor outrage about the fundamental aberrant relationship between corporate performance and executive compensation. The outrage has already begun. The public and investors are mad and they aren’t going to take it anymore. Let them vote with their pocketbooks. Government has better things to do with their time!

I look forward to receiving your questions about investments, retirement planning, or the economy. Send them to: ellen@ascendcapmgt.com and write “Chadds Ford Live” in the subject line.

About Ellen Le

Ellen is the Founder and President of Ascend Investment Management. She was born in Philadelphia and has lived in the Delaware Valley for most of her life. When she is not researching investments and managing portfolios, she pursues her interests in tennis, bridge, hiking and art. Beginning her investment career in 1981 as a stockbroker at E.F. Hutton and Co., Ellen now has over 20 years of investment management experience. Prior to founding Ascend in 2006, she managed high net worth assets for many years at Bank of America, Mellon Bank, and most recently at Davidson Capital Management. At Davidson Capital Management, Ellen served as a Senior Vice President and Senior Portfolio Manager of the firm. She managed assets for more than 50 family relationships and was a core member of the firm’s Investment Committee.Ellen earned a BA in History from Brown University and a MBA in Finance & Investments from The George Washington University. She is a member in good standing of the Chartered Financial Analyst (CFA) Institute, which is a global organization dedicated to setting a high ethical standard for the investment profession. Her professional memberships include the Delaware County Estate Planning Council, Women Enhancing Business (WEB), and the Chadds Ford Business Association. She is a docent with the Delaware Art Museum and an active volunteer with the Brown University Alumni Association.