COMPENSATION EXCESS LEADS TO CORPORATE REFORM Book: Bagley & Savage, “Managers and the Legal Environment” Chapter 21 Executive Compensation Reform Stock options-click here By Leticia Escoto ???

Character introductions My Name is Happy Clueless I’m The Scroll Ask me a Question? I have the answer.

COMPENSATION EXCESS has lead TO CORPORATE REFORM Why is executive compensation reform needed? COMPENSATION EXCESS has lead TO CORPORATE REFORM

See the next slide to see a graph of executive salaries compared to corporate and employee earnings.

Comparison Earnings for Employees-corportions & executives Sarbanes-Oxley Act of 2002

Corporate compensation Who sets the compensation for the corporate officer? The Board of Directors.

They are governed by federal regulation and state laws. Who Governs the boards Actions? They are governed by federal regulation and state laws.

Board of directors & influence by the Executive officers Is the Board independent of influence from the executive officers? Not really

Independent compensation committees Can’t there be an independent committee setting salaries? Good question. National Association of Corporate Directors which is a COMPENSATION COMMITEES oversight groups have called for independent compensation committees since 1990’s.

That sounds great. what’s the problem then? The reality is most executive compensations committees are not truly independent and are influenced by the directors they are setting compensation wages for.

Corporate conduct code Every state has their own corporate conduct Codes. They require corporate officers to show two basic Fiduciary responsibilities. Duty of Care Duty of Loyalty What kind of state laws?

Are all State laws the same? They are all similar except for Delaware. Section 102(b)(7) of the Delaware corporate code permits the certification of incorporation to include a provision eliminating the personal liability of the directors Are all State laws the same?

State law Governing Actions Are Private and public companies governed differently? State laws governs the actions of Boards For public and privately held companies equally

What Federal Reforms are there to try to regulate this problem? The first reforms were the securities act of 1933 and 1934. Two principal federal acts that regulate securities transactions and issuers.

What were the Securities Exchange Acts about? SEC act of 1933 & 1934 What were the Securities Exchange Acts about? Three fundamental beliefs of the Securities Exchange Act of 1933 & 1934 Investors should be provided with full information prior to investing Corporate insiders should not be allowed to use nonpublic information concerning their companies to their own financial advantage Investors who have been injured by misconduct should receive relief even in the absence of common law fraud

Roll of the securities and exchange commission Attempts indirect regulation by Disclosures and Shareholder Proposals -Requiring companies to provide detailed information about executive compensation to the shareholders What can the SEC do?

The SEC enacted regulation that tried to make corporations show a link between compensation and performance. What else can the SEC do?

SEC adoption of rules that expanded the compensation and performance disclosures required a proxy statements. 1. A table showing compensation of the company’s five highest paid executives. 2. A performance graph comparing the company’s five year cumulative. 3. A report from the compensation committee presenting its rational. How did they do that?

Why are disclosures needed? To provide a link between a firms pay practices and its financial performance.

Effectieness of reform Doesn’t look like it. Check out the link on recent executive excesses. Has Reform helped?

Sarbanes-oxley act of 2002 The Sarbanes-Oxley Act of 2002 sets high Standards of independence for Audit Committees Problem: They did not address the makeup of the compensation committee There is also the SEC governance rules of November 2003 on next slide What else can be done?

SEC Governance rules November 2003 For New York Stock Exchange and NASD. Require compensation committee to Approve and operate under a charter (NYSE only) Limit membership to independent directors Review and approve corporate goals and objectives relevant to CEO performance Approve CEO compensation based on goals and objectives determine the CEO;s long term compensation based on company’s performance and shareholder returns. Make recommendations to the board about non-CEO compensation, incentive compensation plan and equity based plans Prepare an annual report on executive compensation to be included in company’s annual proxy statement Return To graph previous next

References/ credits Executive compensation graph Bagley & Savage, “Managers and the Legal Environment”, chapter 21, 2006