Pay without Performance: The Unfulfilled Promise of
Executive Compensation was the best book published in 2004 in the field of
corporate governance. Lucian Bebchuk and Jesse Fried focus on one aspect of
corporate governance, executive pay, and clearly demonstrate that many features
of executive pay are better explained as a result of shear managerial power,
rather than arm's-length bargaining by boards of directors.
After thoughtful analysis, they find "systematic use of compensation
practices that obscure the amount and performance insensitivity of pay, and the
showering of gratuitous benefits on departing executives." The cost of current
corporate governance systems is weak incentives to reduce managerial slack or
increase shareholder value and "perverse incentives" for managers to "misreport
results, suppress bad news, and choose projects and strategies that are less
Their recommendations on improving executive compensation are clearly aimed
at eliminating or reducing some of the most egregious of the practices of those
they document. Interestingly, the recommendations are written to shareholders,
apparently because there is little likelihood such reforms will be raised by
even "independent" directors without further corporate governance reforms. A few
examples are as follows:
Although many directors now own shares,
their related financial incentives are still too weak to induce them to take on
the unpleasant task of firmly negotiating with their CEOs. Recent reforms
requiring a majority of independent directors, and their exclusive use on
compensation and nominating committees, may be beneficial but “cannot be relied
on” to produce the kind of arm's length relationship between directors and
executives needed. CEOs retain influence over director compensation and rewards,
as well as social and psychological rewards. "The key to reelection is remaining
on the company's slate." Remaining on good terms with the CEO and their director
allies continues to be the best strategy for renominatation.
- To reduce windfalls in equity-based plans, shareholder should encourage
that at least some of the gains in stock price due to general market or
industry movements be filtered out. "At a minimum, option exercise prices
should be adjusted so that managers are rewarded for stock price gains only to
the extent that they exceed those gains (if any) enjoyed by the most poorly
- Executives should be prohibited from hedging or derivative transactions to
reduce their exposure to fluctuations in the company's stock and should be
required to disclose proposed sale of shares in advance to reduce perverse
incentives to benefit from short-term gains that don't reflect long-term
- Do not provide large payments to executives who depart because of poor
- The compensation table should include and should place a dollar value on
all forms of "stealth" compensation, such as pensions, deferred compensation,
postretirement perks and consulting requirements.
- Allow shareholders to propose and vote on binding rules for executive
Executive compensation "requires case-specific knowledge and thus is best
designed by informed decision makers." They conclude, "While we should lessen
directors' dependence on shareholder, we should also seek to increase directors'
dependence on shareholders." After discussing the now failed "open access" SEC
proposal to grant shareholders the right to place a token number of candidates
on the ballot after specified "triggering events," the authors propose the
following significant corporate governance reforms:
In their conclusion,
the authors recognize the "political obstacles to the necessary legal reforms
are substantial" and that "corporate management has long been a powerful
interest group." The demand for reforms must be greater than management's power
to block them. "This can happen only if investors and policy makers recognize
the substantial costs that current arrangement impose." Pay without Performance
will certainly contribute to such recognition. It should be required reading for
every fund fiduciary, SEC board and staff, as well as all members of Congress.
Shareholders should read while sitting down.
- Access to the ballot should be granted to any group of shareholders that
satisfies certain ownership thresholds. Their example is 5%, held for at least
- Such slates should be able to replace all or most incumbent directors in
any given year.
- Companies should be required to distribute the proxy statements of
shareholder nominated candidates and should be required to reimburse
reasonable costs if they garner "sufficient support."
- Legal reforms should require or encourage firms to have all directors
stand for election together.
- Shareholders should be given the power to initiate and approved proposals
to reincorporate and/or adopt charter amendments.