Executive Pay - Regulation

Regulation

There are a number of strategies that could be employed as a response to the growth of executive compensation.

• Disclosure of salaries is the first step, so that company stakeholders can know and decide whether or not they think remuneration is fair. In the UK, the Directors' Remuneration Report Regulations 2002 introduced a requirement into the old Companies Act 1985, the requirement to release all details of pay in the annual accounts. This is now codified in the Companies Act 2006. Similar requirements exist in most countries, including the U.S., Germany, and Canada.

• A say on pay - a non-binding vote of the general meeting to approve director pay packages, is practised in a growing number of countries. Some commentators have advocated a mandatory binding vote for large amounts (e.g. over $5 million). The aim is that the vote will be a highly influential signal to a board to not raise salaries beyond reasonable levels. The general meeting means shareholders in most countries. In most European countries though, with two-tier board structures, a supervisory board will represent employees and shareholders alike. It is this supervisory board which votes on executive compensation.

• Another proposed reform is the bonus-malus system, where executives carry down-side risk in addition to potential up-side reward.

• Progressive taxation is a more general strategy that affects executive compensation, as well as other highly paid people. There has been a recent trend to cutting the highest bracket tax payers, a notable example being the tax cuts in the U.S. For example, the Baltic States have a flat tax system for incomes. Executive compensation could be checked by taxing more heavily the highest earners, for instance by taking a greater percentage of income over $200,000.

• Maximum wage is an idea which has been enacted in early 2009 in the United States, where they capped executive pay at $500,000 per year for companies receiving extraordinary financial assistance from the U.S. taxpayers. The argument is to place a cap on the amount that any person may legally make, in the same way as there is a floor of a minimum wage so that people can not earn too little.

• Debt Like Compensation - It has been widely accepted that the risk taking motivation of executives depends on its position in equity based compensation and risky debt. Adding debt like instrument as part of an executive compensation may reduce the risk taking motivation of executives. Therefore, as of 2011, there are several proposals to enforce financial institutions to use debt like compensation.
• Indexing Operating Performance is a way to make bonus targets business cycle independent. Indexed bonus targets move with the business cycle and are therefore fairer and valid for a longer period of time.

• Two strikes - In Australia an amendment to the Corporations Amendment(Improving Accountability on Director and Executive Remuneration) Bill 2011 puts in place processes to trigger a re-election of a Board where a 25% "no" vote by shareholders to the company's remuneration report has been recorded in two consecutive annual general meetings. When the second "no" vote is recorded at an AGM, the meeting will be suspended and shareholders will be asked to vote on whether a spill meeting is to be held. This vote must be upheld by at least a 50% majority for the spill (or re-election process) to be run. At a spill meeting all directors current at the time the remuneration report was considered are required to stand for re-election.

• Independent non-executive director setting of compensation is widely practised. An independent remuneration committee is an attempt to have pay packages set at arms' length from the directors who are getting paid.