The beginning of 2006 usually gives pause to look back on the past year and reflect.  When CEOs look back on the past year their vision may be obscured by the stacks of cash that were bestowed upon them.  It was reported last week that despite small stock gains and slowing growth executive pay continued to swell in 2005. [1]  Always a hot topic, and often over 400 time the amount earned by rank-and-file employees at large companies, executive pay is on the top of many people’s watch lists for 2006.[2]  This article will take a look at how some justify executive pay, what recourse shareholders have to stop executives being paid too much and the proposal the SEC has made regarding disclosure of executive compensation.

Compensation On the Rise

Although much of the data of 2005 executive pay will not become available until March or April when the majority of proxy statements are filed with the SEC, indications are already showing that executive pay continued to rise in 2005.[3]  Already at exorbitant level after rising 30% in 2004, executive compensation is expected to increase at similar rates this year. Some investors claim not to care about high executive pay so long as the company is yielding high returns to shareholders.  However, neither stock prices nor profits rose as much in 2005 as they did in 2004.[4]  Thus, this justification does not seemed warranted in explaining 2005’s increase in pay.  Others explain the need for high executive compensation in order to retain talent and prevent turnover, claiming that without the high payout many current executives would move to other professions.[5] This claim has slightly more merit as many sectors experiencing serious labor shortages have increased wages to retain talent.[6]  Yet, even proportional to wage increases in other sectors, executive pay continues to grow exponentially. 

Another one of the major problems regarding executive pay is that investors often do not realize how much executives are getting paid.  In corporate filings it is fairly easy to locate the salary and bonus of CEOs averaging $2.4M in 2004.[7]  Tougher to track is the perks and stock options also give to CEOs and other executives as compensation.  In 2004 the median fair market value of these perks and stock options was a staggering $3.6M.[8]

Current Disclosure Rules

Section 402 of Regulation S-K expressly governs the disclosure of executive compensation packages.[9]  Section 402 is inclusive of all disclosures that must be made under several Acts.[10]  Disclosure in mandated for the CEO and four highest paid executives other than the CEO unless their total of such salary and bonuses is $100,000 or less.[11]  The disclosure requirements apply to any cash, stock, stock option, or other compensation payment.[12]  Furthermore, the section “requires clear, concise and understandable disclosure of all plan and non-plan compensation awarded to, earned by, or paid to the named executives officers … and directors.” Perks must be reported as a lump sum when they total more than $50,000 or 10% of salary.  Individual perks only need to be listed if it amounts to 25% of all perks the executive receives.[13]  The regulation also specifies that such disclosures should be made in form that shareholders can understand.  To facilitate this goal section 402 requires the information is provided in a table format. 

Current Recourse

Even when shareholders do realize just how much executives are being paid, it is very difficult for change to be implemented.  Excessive compensation generally falls into the category of corporate waste.  However, when boards of directors have made a decision such as how much an executive should be paid courts apply the business judgment rule (BJR).  BJR is a principle applied by the courts (as opposed to a statutory rule or common law) which states, absent fraud illegality or conflict of interest, the court will defer to the judgment of the board.  Resultantly, it is exceedingly difficult to get a finding of corporate waste. 

However, executive compensation continues to gain more media attention.  And with the rise of corporate scandals the belief that executive compensation schemes need to change is widespread.  While shareholders have tried to induce change through shareholder proposals and there is much skepticism over the number of investors actually taking this initiative and how effective they are at actually getting through to the Board compensation committees.[14]

Proposed changes by the SEC

The SEC has not been deaf to the public cries for changes in executive compensation and has recognized that current rules are out of date.[15]  The SEC admits that companies may not be disclosing all compensation under current requirements.[16]  While it is not in the authority of the SEC to restrict payments to executives, in January the SEC has published for comment proposed rule that would amend disclosure polices related to executive compensation.  The changes would not determine how Boards determine executive compensation packages, but they would require disclosure of “a clear explanation of how they arrived at both the amount and the measurement.”[17]  These proposed changes “would affect disclosure in proxy statements, annual reports, and registration statements.”[18]  The proposed rules provide for a narrative disclosure to accompany the tabular disclosure of compensation in the form of a Compensation Discussion and Analysis.  Three main categories would be included in this section: 1) compensation over the last three years, 2) holdings of outstanding equity-related interest received as compensation that are the source of future gains, and 3) other post-employment payments and benefits. [19] Additionally the proposal requires that the perks be itemized if they total $10,000 or more.[20]  Also, the proposal improves disclosure of retirement benefits.  New tables reflecting this information would be added to the disclosures.[21]  The proposals would expand the 8-K disclosure requirements to include employment arrangements and material amendments made regarding named executive officers.[22]  Additionally, the proposals would require the use of disclosures in plain English.[23]   The goal is for investors to have one bottom line figure for total annual compensation that is an accurate representation of salary, perks and bonuses.[24]

[1] CEO Pay Soars, Even Higher Than Before (Feb. 3, 2006), http://money.cnn.com/2006/02/03/news/companies/ceo_salary.reut/index.htm.

[2] Nathan Knutt, Executive Compensation Regulation: Corporate America, Heal Thyself, 47 Ariz. L. Rev. 493, 500 (2005).

[3] CEO Pay Soars, Even Higher Than Before (Feb. 3, 2006), http://money.cnn.com/2006/02/03/news/companies/ceo_salary.reut/index.htm.

[4] Id.

[5] Full Disclosure, Fortune, Feb. 6, 2006, available at http://money.cnn.com/magazines/fortune/fortune_archive/2006/02/06/8367966/index.htm

[6] Chris Isidore, Are Bigger Paychecks Around the Corner (Feb. 3, 2006), http://money.cnn.com/2006/02/02/news/economy/jobs_wages/index.htm.

[7] Full Disclosure, Fortune, Feb. 6, 2006, available at http://money.cnn.com/magazines/fortune/fortune_archive/2006/02/06/8367966/index.htm

[8] Id.

[9] 17 C.F.R. 229.402 (2005).

[10] Section 402 incorporates the disclosure requirements of the Securities Act of 1933, 15 U.S.C.A. 77a (West 2005), the Securities Act of 1934, 15 U.S.C.A. 78a (West 2005), and the Energy and Policy Conservation Act of 1975, 42 U.S.C.A. 6362 (West 2005).

[11] 17 C.F.R. 229.402(a)(3)(ii) (2005).

[12] 17 C.F.R. 229.402(a)(7)(ii) (2005) (the regulation includes any “plan, contract, authorization or arrangement, whether or not set forth in any formal documents.”).

[13] Christopher Cox, SEC Chairman, Chairman’s Opening Statement; Proposed Revisions to the Executive Compensation and Related Party Disclosure Rules, Jan. 17, 2006, available at http://www.sec.gov/news/speech/spch011706cc.htm

[14] CEO Pay Soars, Even Higher Than Before (Feb. 3, 2006), http://money.cnn.com/2006/02/03/news/companies/ceo_salary.reut/index.htm

[15] Cox, supra note 13.

[16] Id.

[17] Id.

[18] SEC Votes to Propose Changes to Disclosure Requirements Concerning Executive Compensation and Related Matters, Jan. 17, 2006, available at  http://www.sec.gov/news/press/2006-10.htm.

[19] Id.

[20] Cox, supra note 13.

[21] Id.

[22] SEC Votes to Propose Changes to Disclosure Requirements Concerning Executive Compensation and Related Matters, Jan. 17, 2006, available at  http://www.sec.gov/news/press/2006-10.htm.

[23] Id.

[24] Cox, supra note 13.