New SEC CEO Pay Rule Gets Low Marks

05/07/2015 05:39 pm ET | Updated May 07, 2016

In my more than two decades of work on runaway executive pay, sparking public outrage has never been the problem. The real challenge has been persuading the public there's something we can do about it.

To help change that, we've been publishing a list of more than 30 creative and practical reforms in our annual Institute for Policy Studies Executive Excess reports. We assign each reform a report-card style grade, based on how far it would go towards advancing economic fairness and stability in executive pay policy and practice.

The CEO pay proposal issued by the Securities and Exchange Commission April 29 gets one of our lowest marks. The new rule -- an effort to implement just one of a half dozen exec pay reforms in the 2010 Dodd-Frank financial reform law -- requires U.S. corporations to disclose the relationship between their executive pay and financial performance.

Los Angeles Times columnist Michael Hiltzik has already given this SEC proposal a thorough thrashing. He deftly points out that the rule's narrow "performance" metric -- total shareholder returns -- will only increase incentives for executive bad behavior.

"Predatory pricing, skimping on product quality, mistreatment of suppliers, and the manipulation of local communities to extract tax breaks and subsidies for factory locations all reflect the drive to upstream all corporate returns to the shareholders," Hiltzik notes. "The SEC's executive compensation proposal further chisels the myth of shareholder value into the rules of corporate behavior."

Other observers of the executive pay scene worry that the new SEC rules could cause confusion since the new reporting requirements on performance will include the value of realized equity-based pay rather than the grant date value in the calculation of executive compensation.

"If an executive has just received a massive options grant, he might look underpaid this year, but overpaid in 10 years when he cashes it in," points out Rosanna Landis Weaver, who heads a program focusing on executive compensation at As You Sow.

For all these reasons, we stand by the low mark we've been giving this monitor-pay-by-performance form since Dodd-Frank made it the law in 2010.

We base our reform ratings are on five criteria:

Does the reform encourage narrower CEO-worker pay gaps?

Extreme pay gaps -- situations where top executives regularly take home hundreds of times more in compensation than average employees -- run counter to basic principles of fairness and, at the same time, endanger enterprise effectiveness. Management guru Peter Drucker believed that the ratio of pay between worker and executive can run no higher than 20-to-1 without damaging company morale and productivity.

Does the reform eliminate taxpayer subsidies for excessive executive pay?

Ordinary taxpayers should not have to foot the bill for excessive executive compensation. And yet they do. Government contracts and subsidies routinely make mega millionaires out of corporate executives. And all chief executives benefit from a tax provision that lets corporations deduct unlimited amounts from their income taxes for the expense of executive pay.

Does the reform encourage reasonable limits on total compensation?

The greater the annual reward an executive can receive, the greater the temptation to make reckless decisions that generate short-term earnings at the expense of long-term corporate health. Government policies can encourage more reasonable compensation levels without micromanaging pay levels at individual firms.

Does the reform bolster accountability to shareholders?

On paper, the corporate boards that determine executive pay must answer to shareholders. In practice, shareholders have little impact on corporate behavior. The "Say on Pay" provision in Dodd-Frank only gives shareholders a nonbinding vote on executive pay packages.

Does the reform extend accountability to broader stakeholder groups?

Executive pay practices, as the 2008 financial crisis vividly demonstrated, impact far more people than shareholders. Effective pay reforms need to encourage management decisions that take into account the interests of all corporate stakeholders, including the consumers, employees, and communities where corporations operate.

What reforms get high marks when we apply these criteria? All these below now happen to be in play in Washington.

CEO-worker pay ratio disclosure: Nearly five years after President Barack Obama signed the Dodd-Frank legislation, the SEC still has not implemented this commonsense transparency measure. The reform would discourage both large pay disparities that can lower employee morale and productivity and excessive executive pay that can encourage excessively risky behavior.

Ending taxpayer subsidies for executive bonuses: In 1993 Congress set a $1 million cap on the individual executive pay corporations could deduct from their income taxes. But that cap did not apply to "performance-based" pay, including stock options and other "incentive" pay. Several bills have been introduced to address this problem, the most recent version by Senators Reed and Blumenthal and Congressman Doggett. The Joint Committee on Taxation estimates that eliminating this loophole would generate $50 billion in revenue over 10 years.

Ending the preferential capital gains treatment of carried interest: Under current law, hedge and private equity fund managers pay taxes at a 15 percent capital gains rate on the profit share -- "carried interest" -- they get paid to manage investment funds, rather than the 35 percent rate they would pay under normal tax schedules. Last year, the top 25 hedge fund managers raked in a combined $11.6 billion. Seems they could afford to pay their fair share of taxes.

Pay restrictions on executives of large financial institutions: Within nine months of the enactment of the 2010 Dodd-Frank law, regulators were supposed to have issued guidelines that prohibit large financial institutions from granting incentive-based compensation that "encourages inappropriate risks." Regulators are still dragging their feet on this modest reform.

Many other creative CEO pay reforms are gaining support at the state level in this country and in nations around the world. A shortage of solutions is not the problem. A lack of political --and regulator--will is.