During a House Oversight Committee hearing in October, a rare bipartisan consensus appeared to be building around a strategy to rein in executive compensation.
“We need to empower the stockholders of public companies to better manage the package of pay and the incentive packages of their key executives,” said Representative Darrell Issa of California, the panel’s ranking Republican.
“Some constraints on these companies are necessary to protect the safety and soundness of the entire financial system,” said committee chair Edolphus Towns, a Democrat from New York. “We need to give the shareholders a way to get this under control.”
But while reinforcing shareholder rights may solve other corporate governance problems plaguing the US economy, like sloppy board oversight and managerial incompetence, shareholders are not going to end the bloated pay practices that have sparked outrage over the past year.
Compensation schemes that rewarded risky activity helped usher in the economic crisis. If you can book a huge short-term accounting profit by selling subprime loans, and your own paychecks are tied to those short-term accounting profits, then you don’t have to worry about pesky details like whether that subprime loan will ever be paid off–or whether thousands of defaulting subprime loans will bankrupt your company in a few years. If those short-term profits ever turn into long-term pain, your short-sighted bonus metrics will have already made you rich.
It’s easy to see why empowering shareholders to deal with bloated CEO pay might be attractive. We’ve just watched several regulators, from the SEC to the Office of Thrift Suspension to the Federal Reserve, fall down on the job–maybe shareholders who want to see a good return on their investment will exercise more prudence. For many companies, especially at small- and midsize banks, a stronger set of shareholder rights really will help curb corporate abuses. The savings and loan crisis was largely a story of small-bank executives looting their own companies at shareholder expense. The SEC has been far too complicit in allowing management teams to stack the deck against shareholders for far too long, steadily transferring power from those who own companies to those who run them–and blessing whatever lobbying interests the managers might find attractive in the process. In 2007 the SEC issued a rule that made it almost impossible for shareholders to challenge corporate directors in elections, allowing management teams to seal themselves off from shareholder criticism. This past May the SEC proposed amending the rule to allow shareholders to directly nominate directors, but this has not yet been enacted. Congress really does need to restore a set of meaningful shareholder rights.
But at major US banks, the public good and the interests of shareholders are in a fundamental state of conflict. “Too big to fail” financial behemoths have been the source of all the recent bonus outrages; and at “too big” firms, shareholders actually want their executives to be rewarded for taking on excessive risk. It’s the smart bet. If the risk pays off, the bank’s stock price soars. If the risk backfires, the government will spare shareholders from losses. You can’t solve a problem by punting the issue to the very parties who benefit from the imbalance.