Charles Elson has been an outspoken critic of executive compensation practices and levels, and boards of directors.
He believes executive compensation is way out of proportion to the value returned to shareholders, and he expresses doubt that new disclosure rules from the Securities and Exchange Commission that go into effect with next year's proxy statement will curb compensation levels. But he does think that the rate of escalation in executive compensation will slow in the next three to five years.
Elson is a professor, lawyer and expert on corporate governance who is a member of the advisory council of the National Association of Corporate Directors. He is director of the John L. Weinberg Center for Corporate Governance at the University of Delaware in Newark.
He recently spoke with Plastics News about compensation issues.
Q: How well are executive compensation levels aligned to performance?
Elson: In my view, executive compensation levels are not related to corporate performance and services rendered. Compensation levels are over and beyond what they need to be and are a waste of corporate assets and a disincentive to others who are being asked to cut costs for what they view as a corporate perk - that is, higher pay for executives.
Q: Is executive compensation leveling off?
Elson: Executive compensation has risen at a rate far beyond the rate of pay increases for other employees and at a rate much higher than the returns on shareholder value. It is continuing upward. You are seeing double-digit increases each year.
Q: What are some of the ramifications?
Elson: Employees have a disincentive to go the extra mile for the corporation. They will begin to believe that the costs they are being asked to cut will fund the CEO's compensation package. The CEO only plays a small role in a corporation's profitability. He or she is basically running an organization that already exists and that probably will exist long after he or she has departed. It is the people who work for the company who drive its profitability long-term.
Q: Who is to blame for excessive executive compensation levels?
Elson: You must blame boards of directors who continue to be beholden to the CEO rather than to the company shareholders. The packages they have created aren't particularly palatable. But the situation has begun to improve with the emphasis now being placed on adding more independent directors. I want directors on boards who are independent and have equity ownership in the company.
Q: Will new disclosure rules from the SEC lead to change?
Elson: Not directly. I believe in transparency, and disclosure is important. But the theory that disclosure rules will hold compensation in check or keep executives from asking for large compensation packages is wrong. I think CEOs making $10 million a year are beyond being embarrassed about their pay packages or asking for more compensation.
I think the issue really is whether the disclosure rules will push shareholders to elect more directors who are independent of the company and who take equity positions in the company. I don't buy into the theory that disclosure rules will lower executive compensation. They can't really do that.
Q: What effect will the disclosure rules have on directors?
Elson: Certainly, the information disclosed could embarrass directors. But it will not lower executive compensation. The problem is the scarcity of directors who are not controlled by the CEO. There is a greater likelihood that boards will seek more outside directors in response to changes in stock exchange listing practices and pressure from shareholders.
Q: How many independent directors should be on a corporate board?
Elson: I think it has to be at least 80 percent because the role of the board is to oversee management. The lower the level of independent directors, the greater the danger of management capturing control of the board.
Q: How much influence can independent directors have on executive pay?
Elson: It depends on their equity position in the company. The greater the amount of equity the outside directors hold, the greater their stake in the company and their independence from management will be, the more they will bargain with management on pay and the greater the likelihood that compensation levels will be more reasonable.
Q: What is the best way to design an effective, fair and reasonable executive compensation plan?
Elson: You need a one-year salary and bonus plan based on transparent metrics that can drive performance forward. You also need to use restricted stock rather than stock options for long-term incentives because it is more transparent and creates a better alignment with shareholder interests. It gives executives actual ownership rather than an opportunity to just make money short-term by cashing in options.
Q: Does the use of industry peer groups as a benchmark for executive compensation help?
Elson: Peer groups can be easily manipulated to make a case for higher salary levels. That is what happens more often than not, and it is fueled by the use of yardsticks by compensation consultants.
Q: What effect will Financial Accounting Standards Board 123R have on the use of stock options and other long-term incentives?
Elson: Now that you are required to expense options, it will force a lot of people into using restricted stock because there is no real good method of expensing stock options. With restricted stock, ultimately you are accountable to the marketplace because of your ownership. But it will take years for that change to play itself out and align compensation levels to performance.
Q: What in the executive compensation arena makes you optimistic that pay levels can be brought in line with performance?
Elson: The movement to independent directors. The movement to restricted stock is important. Increased investor activism. Increasing judicial concerns over executive pay.
Q: What suggests to you that executive pay levels cannot be brought in line with performance?
Elson: The continued double-digit increases in executive compensation levels.
Q: Where do you think executive compensation is headed over the next three to five years?
Elson: I don't expect the levels of executive compensation to come down. But I do think the rate of escalation in executive compensation will slow dramatically.