(Commentary by David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program, And Brian Tayan, MBA ’03, Stanford GSB; Date: 3-09-2010)
Compensation Committee – Merits of Shareholder-Sponsored Proxy Proposals requesting that boards disallow more than one current or former CEO from serving on compensation committee
Source: Time Warner Inc., Form DEF 14A, Filed April 9, 2009
This proxy season, the AFL-CIO has submitted shareholder-sponsored proxy proposals to companies including Eli Lilly, Goldman Sachs, and Time Warner that would disallow more than one current or former CEO from serving at the same time on the compensation committee.
According to the AFL-CIO, the proposals were based on academic studies that suggest that companies with more than one CEO on the compensation committee tend to have higher pay than companies that do not. In theory, when CEOs serve on the compensation committee, they engage in “back scratching” and other forms of reciprocity by approving larger pay packages with the expectation that other CEOs will do the same for them. As a result, compensation negotiations are not an arms-length negotiation and pay packages artificially rise.
This is likely a simplistic view. Most academic studies on the relation between board structure and executive compensation have weak or inconclusive findings. (One exception is that boards with “busy” directors who serve on multiple boards do tend to award larger compensation on average. These results are robust and widely accepted. [See: Core, J., Holthausen, R., Larcker, D. (1999), "Corporate governance, chief executive officer compensation and firm performance", Journal of Financial Economics, Vol. 51 pp.371-406.]
Still, let’s see how the AFL-CIO proxy proposal would apply to a company such as Time Warner. Last fiscal year, the compensation committee comprised Frank Caufield (co-founder of venture capital firm Kleiner Perkins), Mathias Dopfner (CEO of Axel Springer), Michael Miles (former CEO of Phillip Morris), and Deborah Wright (CEO of Carver Bancorp). If the proposal were accepted and passed, two of these individuals would have to step down. Who would replace them? Only three directors qualify: Robert Clark (professor at Harvard), Jessica Einhorn (professor at Johns Hopkins), and Kenneth Novack (former vice chairman of AOL). Is there any evidence to suggest that these individuals would be more qualified than those who step down? Robert Clark is a professor of corporate governance. Does that make him more capable of setting compensation? Jessica Einhorn serves on the boards of four other organizations, making her a “busy director.” As we just noted, busy directorships are correlated with elevated compensation. Kenneth Novack is a former employee of the company. Insiders are correlated with lower governance quality in certain areas, such as mergers and acquisitions.
When we attach names to the committee, the complexity of the decision becomes clear. Rather than arbitrarily restrict the committee structure, investors should evaluate committee members on a case-by-case basis taking into account their qualifications, objectivity, and independence of judgment. This is likely to lead to much better outcomes than establishing one-size-fits-all restrictions that ignore the importance of relevant details.