TCS Daily


When Less Really Is More

By Stephen Bainbridge - January 17, 2006 12:00 AM

On January 6th, the Securities and Exchange Commission announced a new regulatory initiative to "consider whether to propose amendments to the disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters, and securities ownership of officers and directors." The seemingly innocuous wording of the notice conceals a plan said to be of sweeping proportions.

Blogger Mark Carey reports that:

Under the control of Chairman Christopher Cox, who has made executive pay his priority agenda, the SEC may soon begin to require complete disclosure in proxy statements for total compensation of the top five highest paid executives. Locating total compensation has been an elusive effort for most shareholders. The information is typically buried in corporate filings. The SEC is believed to propose a new table in corporate proxy statements that will provide a breakdown of total compensation, including stock options and their value.

The proposed changes to be announced at the January 17, 2006 meeting ... may also require: 1) a lower reporting threshold of total aggregate perks to $10,000; 2) disclosure of specific change in control payments; 3) new compensation table that would also include retirement pay; and 4) a new compensation table for executives.

According to law professor and blogger Larry Ribstein, the cost to corporations to provide such disclosures will be substantial:

The WSJ says that the disclosures are more than any company is doing, even the "roughly 25% of the 500 biggest public companies in the U.S. [that] now disclose more about executive pay than current rules require." So there's a lot of new direct costs down the pike. The story quotes a securities lawyer as saying "It will take real preparation." ...

And then we have the same big-small problem as under Sarbox: the per capitalization costs of disclosure are more -- possibly way more -- for small than for big companies, particularly if the disclosures require more than the companies are already doing for tax purposes. Moreover, the smaller companies are generally riskier, and therefore must compensate their executives more aggressively.

There likely will be additional indirect costs. New disclosure requirements, for example, almost always create new opportunities for securities fraud litigation when errors occur in the mandated disclosures.

These costs might be worth bearing if the new disclosure rules were likely to benefit investors, of course. The odds are that the new rules will not do much for investors, however.

The logic of the SEC's proposal is that enhanced disclosure will enable shareholders to complain to the board about excessively high compensation, challenge excessive compensation in derivative litigation, reject excessive compensation plans put to a shareholder vote, and vote out of office directors who approve excessive compensation.

The theory of rational shareholder apathy, however, predicts that most shareholders prefer to be passive investors. A rational shareholder will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs. Given the length and complexity of SEC disclosure documents, the opportunity cost entailed in becoming informed before voting is quite high and very apparent. Moreover, most shareholders' holdings are too small to have any significant effect on the vote's outcome. Accordingly, shareholders assign a relatively low value to the expected benefits of careful consideration.

If shareholders are rationally apathetic, more information will not lead to better decisions. Indeed, greater volumes of information will only make the situation worse.

Because the SEC's proposed new executive compensation disclosure rules thus will increase the cost to companies of complying with their disclosure obligations, but will not lead to more informed shareholder decision making, what then is their purpose?

One can infer that, in adopting these rules, the SEC got back into the therapeutic disclosure business. In other words, the Commission is using disclosure requirements not to inform shareholders, but to affect substantive corporate behavior. In this case, to put the brakes on executive compensation.

Therapeutic disclosure requirements undoubtedly affect corporate behavior, and it is troubling on at least two levels. First, seeking to effect substantive goals through disclosure requirements violates the Congressional intent behind the federal securities laws. When the New Deal era Congresses adopted the Securities Act and the Securities Exchange Act, there were three possible statutory approaches under consideration: (1) the fraud model, which would simply prohibit fraud in the sale of securities; (2) the disclosure model, which would allow issuers to sell very risky or even unsound securities, provided they gave buyers enough information to make an informed investment decision; and (3) the blue sky model, pursuant to which the SEC would engage in merit review of a security and its issuer. The federal securities laws adopted a mixture of the first two approaches, but explicitly rejected federal merit review. As such, the substantive behavior of corporate issuers is not within the SEC's purview.

Second, and even more disturbing, in this case the SEC's rules overstep the boundaries between the federal and state regulatory spheres. The last time the Commission tinkered with the executive compensation disclosure rules the SEC said that it wanted to bring shareholders into the compensation committee or board meeting room and thereby enable them to see specific decisions through the eyes of the directors. This goal, however, flies in the face of the separation of ownership and control created by state corporate law. Under state law, shareholders have no right to approve most board decisions, let alone to initiate corporate action. Of particular relevance in this context, shareholders have no right to participate in compensation decisions. In other words, they have no right to be brought within the meeting room.

It's disappointing that new SEC Chairman Cox has decided to make his first signature issue one whose costs exceed its benefits and which strikes a blow against the basic principles of competitive federalism that are the peculiar genius of American corporation law.
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6 Comments

Is is reallly, really so hard for a company to find out how much it's paying its CEO?
I mean, how burdensome can this possibly be? You have a multibillion concern, but the difficulty of identifying its 5 most highly paid executives and specifying how much comany money they are getting is intolerable??

this whole essay is a an exercise in illogic. I mean, how about this:

"New disclosure requirements, for example, almost always create new opportunities for securities fraud litigation when errors occur in the mandated disclosures."

Indeed, why should innocent errors cramp the style of executive geniuses like Bernie Ebbers.

I love this:
"If shareholders are rationally apathetic, more information will not lead to better decisions. Indeed, greater volumes of information will only make the situation worse."

We all know those investors don't want to worry their silly little heads about details like hundred million golden parachutes for CEOs.

I have a proposal for Mr. Bainbridge. He can write me a check for $100,000 and I guarantee I won't give him any information at all about what I do with it, not a word. Deal, Mr. B?

In executive compensation disclosures, less is really less
First, Prof.Bainbridge says that individual investors are not able to properly assess whether executive compensation is appropriate or not. There’s a bit of truth to that because compensation has much to do with market conditions and what comparative peers get. But that’s not the point to full disclosure; rather it’s a question of accountability. The uproar over Jack Welch compensation died because shareholders believed he deserved it, while the hullabaloos of in Disney led to ousting of its CEO. Thus, the question remains whether shareholders have the right to know.

Second, Bainbridge’s legalese aside, the idea of separation of ownership and control has its merits in the sense it allows managers to take risks needed for long-term growth. But the fine line of separation and appraisal again takes us to accountability. If shareholders have no rights than managers can treat public corporations as their own private assets, hence Hank Greenberg of AIG.

In the case of disclosure of executive compensation, less is really less. Kudos to the new SEC Chairman Cox for his initiatives.

couldn't agree more with "less is really less" analysis
I was struck by this:

"the idea of separation of ownership and control has its merits in the sense it allows managers to take risks needed for long-term growth. "

I have to confess I haven't a clue as to why gigantic compensation packages for top management given out in such a way as to be hidden in the books to be concealed from stockholders is a "risk needed for long-tem growth."

The real problem is valuation and the issue is ownership.
It is difficult to value non cash income and perks. This is especially true for securities whose value depends on future events. Since a large portion of executive pay is tied to the future the estimates of current value are probably not accurate and will provide prospective investors with a misleading picture of executive compensation.

The issue here is ownership. Is executive compensation that important to the owners. If it is then they will demand that information apart from the SEC. If potiential buyers want this data then they can request it and if that request is not honored they will make their buying decisions based on this.

In any case there is no need here for the force of the SEC to create more paperwork of questionable accuracy.

What "real problem??"
The non-cash income can be enumerated. 500,000 shares is completely understandable. Perks are not difficult to supply a money value: country club memberships, clothes, artwork, apartment rentals, etc. have value.

" If potiential buyers want this data then they can request it and if that request is not honored they will make their buying decisions based on this."

What if they are not "potential buyers" but owners whose stock is tanking? Why is their only choice selling if one of the drains on the stock price is su****ion of excessive executive compensation? What is the downside to simply providing the information as a matter of simply transparency and ordinary business ethics.

As far as "questionable accuracy" -- the only reasons for it to be questionable are questionable ethics or questionable competance.

Exec Comp Hard & where does this idea that stockholders benefit from less information come from?
"...propose amendments to the disclosure requirements for executive and director compensation, related party transactions, director independence and other corporate governance matters, and securities ownership of officers and directors.” ..."

In this article, the Professor continues to promote the idea that shareholders don't need too much information, because they can't expect to direct the disposition of their property (a sentiment that I first noticed on the piece about activist shareholder proposals) indeed its irrational to do so, because they are purchasing the right to income only (or they hould be) so we just allow the more or less free reign of the corporate elite plutocrats.

For those that want income only, the proper instrument is a bond, not a stock. Moreover, there's always been a REASONABLE right to inspect the books and I think the Professor takes a way too expansive view of "rational shareholder apathy" - from the idea that one PROBABLY won't be interested in some disclosure to opposing its production BECAUSE NOBODY SHOULD BE interested in it.

In some cases, some of the disclosure requirements above would be an unholy pain in the keister-BUT the reason they'd be such a pain is the endless debate LEGAL TYPES would be in- debating who's an executive, limits of materiality, constructivity in indirect transactions, the extension of the requirements to family, etc.

As for execuive pay, NOT A PROBLEM. Assuming the company is complying with Sarbanes Oxley, its should easily be able to identify the accounts that comprise the Wages and Benefits line on its annual statement.

If not, its a simple matter of looking at the payroll register, W-2 filings with the IRS and auditing the completeness, existence and validity of those assertions.

Security ownership/acqisitions/disclosures by insiders is already closely watched and many insider transactions must already be disclosed-so thats probably a matter of expanding existing 8K requirements, not inventing them. Additionally the exentual adoption of electronic reporting architectures (XBRL) will revolutize reporting.

These requirementsd if they are too onerous, are too onerous in light of the existing based of disclosure requirements. So perhaps its time to rethink OTHER requirements along with these.

I just don't understand the Professor's antipathy toward holding the corporate elite's feet to the fire and making them operate in PUBLIC. Other fiduciaries are regularly required to dislose such information-time for the FORTUNE 500 primadonnas to do so as well.





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