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September 20, 2002
Conference Board Calls for Compensation Reform
The 12-member Blue Ribbon Conference Board Commission on Public Trust and Private Enterprise includes major business leaders like Intel Corp. Chairman Andy Grove and former senior government officials such as former Securities and Exchange Commission Chairman Arthur Levitt. The work of the commission is supported by the Pew Charitable Trusts.
The report, the first in a series of three reports, focuses on executive compensation. Subsequent reports will deal with reforms on other areas of corporate governance as well as accounting and auditing issues.
The commission said it "shares the public anger at the misconduct leading to the breakdown in public trust." Commission Co-Chairman Peter G. Peterson, chairman of The Blackstone Group, noted the "lack of fairness" of the unprecedented levels of executive compensation, particularly the compensation of certain executives, even as their companies and the retirement savings of their employees have collapsed.
Co-Chairman John W. Snow, chairman of the CSX Corporation, added, in referring to the malfeasance at Enron, WorldCom, and other companies: "These egregious failures evidence a clear breach of the basic contract that underlies corporate capitalism."
The commission's recommendations include:
* Retention and direction of compensation experts by compensation committees - not management.
* Compensation committees setting comp not by ratcheting up industry averages.
* Uniformly expensing stock options.
* Substantial director and top management stock ownership for extended holding periods.
* Avoiding "special purpose entity" comp to executives.
* Greater disclosure of equity dilution and employment agreements.
* Shareholder approval of option repricing.
* Advanced notice of executive stock sales.
Snow called for a more vigorous role for compensation committees, saying they "need to act more independently of management, hire their own consultants, and hold executive sessions without management to avoid the potential conflicts that arise when management is making recommendations about its own incentive packages."
'Excessive use' of stock options
Peterson stated: "The excessive use of stock options - especially fixed-price options - was encouraged by the fact that they did not result in a charge to earnings while providing substantial tax deductions. The quantity of such stock options resulted in an enormous incentive to manage companies for short-term stock price gains and the unprecedented bull market led to massive unanticipated gains in options unrelated to management's operating performance." The report declares that: "Executive compensation has become too 'delinked' from long-term performance goals in many corporations. There is an imbalance between unprecedented levels of executive compensation, with little apparent financial downside risk or relationship of this compensation to long-term company performance."
Four guiding compensation principles
The committee suggested a series of recommended principles as well as a series of specific best practices. The principles include:
1. Focus on a much tighter linkage between executive operating performance and executive compensation, rather than simply on the ups and downs of the stock market, which are often not closely related to the executive's contribution to the long-term value of the enterprise.
2. Focus on a fully independent, accountable, and vigorous compensation committee that takes primary responsibility of all aspects of executive compensation including employment, retention, and severance agreements.
3. Focus on accounting neutrality so as to avoid bias and favor of any one form of equity based compensation, and, at the same time, facilitate comparability of results as between companies.
4. Focus on full disclosure of all material information on an understandable and timely basis and, in particular, to reassure the public that management is not involved in stock transactions with advanced knowledge of material information not available to the public at that time.
Recommended best practices
1. The Compensation Committee should retain any outside consultants who advise it, and the outside consultants should report solely to the Committee.
2. The Compensation Committee should be unconstrained by industry averages and statistics or by the company's past compensation practices and levels, which, in certain companies, have been excessive.
3. Stock options should be expensed on a uniform and broadly accepted basis. This will eliminate the accounting treatment that makes stock options so desirable to companies at the expense of more performance-oriented forms of compensation including cash, and equity compensation.
4. Senior management and directors should: 1) be required to own a meaningful amount of company stock on a long-term basis; and 2) be subject to substantial minimum holding periods for equity received as compensation, in each case in order to align the interests of management with those of the corporation. Holding periods for senior executives and directors should generally not be less than the holding periods for other employees.
5. Companies should avoid the use of special purpose entities to compensate or enrich senior executives.
6. There should be a strengthening of requirements for conspicuous disclosure of all material impacts of stock options and other compensation arrangements, including overall costs and earnings dilution effects, as well as disclosure of all employment agreements for top executives, including severance arrangements.
7. Shareholders should approve modification of existing equity compensation arrangements, including repricing options or any actions that could dilute their holdings.
8. Executive officers should be required to give advanced public notice of their intention to sell their stock.
blue-ribbon" commission of the Conference Board proposed on Tuesday a wide-ranging series of reforms to strengthen corporate compensation practices and help restore trust in America's corporations and capital markets.