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Jeffrey M. Kanter
The Sarbanes-Oxley Overview- A Post Mortem
The “New” Compensation Committee
Practising Law Institute
September 4, 2003
2
Background
• Broadest – sweeping legislation since 1933 and 1934 Acts
• Got its start in 70s after Penn Central bankruptcy
– Proposed an accounting oversight board
• Picked up again in the mid-90s
– Pulled in 1999; with dot-coms and economy as they were, would never pass
• Until Enron
• Signed July 30, 2002
• 3-5 year process to get out of hole – but real change already
3
Recent State of Executive Compensation
• Numerous scandals with significant executive compensation implications:
• Widespread practices on the “slippery slope”– Option repricings without shareholder approval
– Equity grants from plans not approved by shareholders
– Change in control severance pay to executives not severed
– Loan forgiveness following stock price declines
– Special “retention” awards in conjunction with declining operating results and share price depreciation
• The result – widespread shareholder and public skepticism– Perception of executive compensation perhaps never lower
4
Factors Influencing Change
• Corporate governance initiatives…to name a few– NYSE
– Conference Board
– National Association of Corporate Directors
– Institutional Shareholders
• Shareholder activism– With their votes
– With their attorneys
5
The Clear Messages
• Constrain executive compensation
• Increase executive/director accountability
• Shift control over dilution to shareholders
• Improve transparency and reliability of financial disclosures
• Disable insider ability to profit from non-public information and fraudulent financial results
• Increase independence of executive compensation decision making
6
Recurring Themes for Compensation Committee Best Practices
• Truly independent members
• Retain authority to hire and fire any consultants who advise it
• Wide net of responsibility (i.e., all aspects of compensation, such as contracts, perquisites, executives of subsidiaries, etc.)
• Active role for Chair (including annual meeting presence)
• Written charter; defined responsibilities
7
• Then…– Meeting one-hour before
Board meeting– Rubber stamp– Over-reliance on market data
and competitiveness– Total compensation reviews
every five or so years– Management supporter– Attendance to entitlement
mentality– Consultants
• Supporting management’s proposals
– Shareholders views considered nuisance
– Interlocks
• Now…– Meeting hours before with
numerous calls before then– More informed and
accountable– Market data only one of many
factors examined– More frequent and
comprehensive reviews– Less tolerance for failure– Enough is enough—pay for
performance– Consultants
• Consulting directly to the Committee
– Actively listening to shareholders
– Independence
Changes in Corporate Governance –Then and Now
8
Best Practices in Corporate Governance of Executive Compensation—Principles
Instead of…
• Action justified by competitive surveys
• Action is legally permissible and defensible
• Action qualifies for minimum or no disclosure
• Opaqueness and complexity
• Action satisfies Management
Consider…
• Action has strong business rationale and intuition
• Action is reasonable, fair and appropriate
• Transparency—disclosure without embarrassment
• Simplicity—understood and accepted
• Aligning executives’ self-interests with shareholders
9
Best Practices in Corporate Governance of Executive Compensation—Committee Chair and Members
• Members should be truly independent
• Rotate members frequently, e.g., every 2-3 years– Chair should rotate less frequently, e.g., every 5-6 years
• Chair – Should have significant recent and relevant executive
compensation experience
– Should be present at annual meeting
• Proactively seek out information– Consultants, analyses, work-product
• Annual self-evaluation
• Sponsor outside education in executive compensation for new members and refreshers for current members
10
Best Practices in Corporate Governance of Executive Compensation—Committee Support
• Committee may hire and fire its own independent consultants
– If no independent advisors, Committee should be involved in hiring and firing management’s consultants
• Strive for balanced advice from consultants
– Consultants should work “with” both management and the committee
• Review management proposals with unbiased eye toward protecting internal and external constituencies
• Prevents dueling consultants
11
• Committee Chair has more routine access to HR/Compensation executive
• External or internal advisors should confirm that the Committee’s decisions on executives’ pay are accurately carried out
– No compensation should be paid to executive officers other than pursuant to Committee authorization
Best Practices in Corporate Governance of Executive Compensation—Committee Support
12
Best Practices in Corporate Governance of Executive Compensation—Procedures
• Develop Committee charter
• Maintain preset calendar
• Executive session at end of every regularly scheduled meeting
• Analyses of CEO pay and pay action recommendations should come to Committee without foreknowledge of CEO
• Allow sufficient time for non-routine matters
• Maintain regular, direct contact with outside consultant
• Establish guidelines for those decisions requiring full Board approval
13
Best Practice in Corporate Governance of Executive Compensation—Concerns?
• Wresting too much power away from management may impede appropriate designs
– Committee not sufficiently involved on a daily basis to fully understand the issues, culture and strategy of the organization
• Separate consultants for management and the committee may lead to ineffective result
– Confrontation between management and the board
– Dueling consultants (are companies hiring two auditors?)
• Confusion as to what constitutes best practices
• Increased time and cost, exacerbated by supply/demand pressure of qualified directors and differentiated pay for committee chairs
Our offices are located:
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New York
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2121 Avenue of the StarsSuite 990Los Angeles, California 90067310-277-5070 phone310-277-5068 fax
Website address:www.fwcook.com
Jeffrey M. Kanter’s Email: [email protected]