This article originally appeared on Robin A. Ferracone’s “Executive Pay Watch” blog on Forbes.com.
“For today’s Executive Pay Watch blog, I have asked Dan Walter, President and CEO of Performensation and founder of Equity Compensation Experts to weigh in on pay transparency.”
Executive compensation is justifiably complex. In fact, the total compensation for nearly everyone in this country is difficult to communicate. Those at the highest corporate levels generally have pay structures that reflect the complexity of their company. Regardless of the intricacy of executive pay programs, it is still a very reasonable request to ask for pay transparency from these publicly traded firms.
New disclosure rules have taken another step or two up the ladder towards transparency. In fact, the HR Policy Association reports that the average Executive Compensation Disclosure for the 50 largest U.S. public companies has increased 23 percent to 32 pages since 2008. This represents about one-third of their total proxy statement.
Pay transparency is a reasonable concern, but it should be a two way street. Shareholders, employees and politicians want to understand how and why executives are compensated. The new Dodd-Frank provisions have once again increased transparency, but some of the loudest advocates for this are the proxy advisory firms whose rating processes and databases are deemed proprietary.
Not surprisingly, executives and compensation committees want to understand how these third-party evaluators are measuring compensation. Compensation professionals are tasked with making “best-guess” estimates regarding the acceptability of potential compensation proposals. While a trained professional can often get close to the right answer, they never know how well they have done until advisory firms have released their opinions. This process is both inefficient for the company and board of directors and does not truly serve the shareholders.
Measuring executive compensation should be similar to a sport like diving where the voting is a subjective interpretation of a well documented scoring system. In a sport like this, the coaches and athletes (boards and executives) understand the scoring system. They know the potential reward for every move and understand the impact of every risk. Each series of dives is based on an athlete’s ability to maximize return while minimizing risk. Such a system requires execution on the part of the athlete, with the confidence that the only surprise in the individual’s performance is against their peers. The rules are well documented and the judges apply them to the best of their abilities.
Imagine if executive compensation worked this way. The execution is already increasingly more public. Executives at public companies are not diving in a windowless room and then reporting how well they did. It is time for the scoring system to become equally transparent. Everyone should know the rules and how exactly they should be applied. The final analysis will be subject to interpretation and allow for companies to be both creative and individual within a framework these both sides understand.
In writing this post, I found an April 19 article from Stanford Professors, David Larcker and Brian Tayan discussing whether the voting recommendations from Institutional Shareholder Services (ISS) and other proxy advisory firms actually create shareholder value. They found that examining the impact of the recommendations was difficult because “the algorithms and data are considered proprietary.” This inability to measure effectiveness is the same common complaint against the lack of transparency in executive compensation.
There are tens of thousands of proxies to be reviewed every year. Firms like ISS and Glass-Lewis serve an important service in reviewing the data for all of these firms by providing insight into corporate governance and best practices. In theory, they allow the smaller institutional investors to invest in a broader array of companies with more confidence. It is unlikely that many of these investors would be able to operate, as cost-effectively if they had to staff their own full team of analysts like the very large investors do. The proxy advisory firms help create some consistency in voting, but it is at the price of guesswork on the part of companies.
Firms such as Glass-Lewis and ISS have generally been a positive force on executive compensation over the past decade. As the world of executive compensation evolves, it may be time for them to follow their own guidance and raise the shades on their windows. If transparency works well for executive compensation, it should also be great for those who provide definitive guidance on it.
Guest contributor Dan Walter is based in San Francisco, CA and is the President and CEO of Performensation, an independent compensation consulting firm focused mainly on the needs of companies not in the Fortune 1000. In addition, Mr. Walter is the founder of Equity Compensation Experts, a free networking group.