Cory Howard (’14) publishes paper in The Student Appeal on executive compensation

America’s most recent “Great Recession” brought with it public outcry over the pay of executives who were leading companies that were receiving public assistance, mainly in the form of cash infusions via the Troubled Asset Relief Program (TARP). 

Although high executive compensation had been justified by the belief that it is designed to reflect corporate performance, that it simply rewards leaders of successful companies with high pay, the past two decades have seen executive compensation increase dramatically without any relationship to a company’s performance.  Given this stagnation in proportionality, policy makers, shareholders and academics began to increase their calls for reforms to executive compensation packages.  However, regulation, especially direct control by the federal government, has gotten mixed support at best.  While criticism over executive pay and failed reforms demonstrates that faith in the current system is a minority belief, there is little consensus as to which reforms would most effectively rein in extravagant executive pay packages or even who should be implementing these reforms.

Although Congress used provisions in TARP and the Emergency Economic Stabilization Act to impose a de facto “federalization” of executive compensation, it was merely a temporary measure.  As a result, during the post-recovery period states have begun to target executive pay, albeit as it pertains to executives in the non-profit sector, and it is only a matter of time before political pressure forces governors and state legislators to tackle the issue of pay in the for-profit sector.  Therefore, federal lawmakers ought to enact a comprehensive and long-lasting legislative scheme to prevent states from “racing to the bottom” in their attempt to (de) regulate pay.

Some academics, such as Wake Forest Law Professor Omari Simmons, have underplayed the importance of serious resource allocation to executive compensation reform.  By arguing that overemphasis on it has served as a “blue pill” for lawmakers, that is, that it serves as a diversion that pulls attention away from more important economic, social and corporate governance issues, these scholars downplay the significant impact that executive compensation reform could have on these serious societal problems, such as reducing socio-economic inequality.

Corporate governance is focused on processes, most notably “the process by which business decisions are made and the process by which the persons who will make those decisions are chosen”, or in this case, compensated.  This includes internal corporate rules and norms, shareholder rules, and federal regulations (including securities regulation).  Most important to the discussion about corporate governance is the relation between shareholders and directors and any discussion about executive compensation will certainly highlight the notion that excessive pay furthers the divide between these two parties.  Additionally, corporate governance is increasingly seen as way to ensure ethical corporate behavior and commitment to fixing other social and economic issues, which the amount and structure of executive compensation can help achieve.

Excessive executive compensation poses a grave threat to corporate governance as it furthers agency costs by incentivizing executives and directors to diverge from shareholder interests, one of the fundamental problems that corporate governance is intended to address.  Reforming executive compensation is essential to corporate governance if, for no other reason, it forces corporate boards to listen to shareholders complaints.  There is a wealth of anecdotal and statistical evidence that compensation reforms, especially say-on-pay votes, are widely successful in forcing corporate boards to listen to shareholders, even if they were originally skeptical. Although these votes on compensation are not (yet) binding, losing a vote would be embarrassing for a company and often times signal, or hasten, the departure of C-Sweep executives.  Clearly executive compensation votes have gone beyond merely passive expressions of board actions that can be easily ignored by corporate executives.  Instead, even non-binding votes have become powerful tools of the shareholders to annually show their displeasure with the direction that the corporation is headed and even put pressure on boards to make changes in the composition of the executive slate.

Read the full story here.