The mood was downbeat during the 2015 annual shareholder meeting at Barrick Gold, the world’s largest gold mining company. Barrick’s share price had tumbled 33 percent in the past year, and doubts swirled around upper management’s ability to weather a tough gold market.
But there was a glimmer of good news at the Toronto mining company, at least for one person: Chairman John Thornton saw his compensation rise 35 percent, to nearly $13 million.
The contradiction between the Barrick’s performance and its leader’s pay rankled shareholders, who voted overwhelmingly against the pay deal. This week, Thornton told investors, “We have heard you loud and clear,” and announced plans to overhaul his company's executive compensation system.
Those kinds of battles could soon become more common. On Wednesday, the Securities and Exchange Commission proposed new rules that would require publicly traded companies to make public the relationship between executive compensation and corporate financial performance.
The 2010 Dodd-Frank Act empowered the SEC to enact a number of measures around executive pay, including an as yet unwritten requirement that companies compute the ratio of CEO compensation to earnings of average workers. Pay for CEOs grew 12 percent in 2014, compared with about 2 percent for private, nonsupervisory workers.
The new disclosures promise to give shareholders concerned with executive pay new ammunition for proxy battles. Under the proposed rules, companies would be required to publish tables showing their executives’ actual compensation alongside the company’s financial performance over the previous five years, as measured by stock performance and dividends, as well as the returns of similar companies.
Though simple on its face, calculating these measures invites debate. Dodd-Frank required the comparison to include executives’ “actual pay,” a phrase the bill didn’t define. Should stock options, for instance, be counted as compensation in the year they are granted, the year they vest or the year the executive exercises the options?
Companies grant stock awards and stock options that often take years to become available to employees, a way of building loyalty and incentivizing success.
“Everybody agrees philosophically that pay for performance is desirable,” says Fabrizio Ferri, who studies executive compensation at Columbia Business School. “How to define pay is where it gets complicated.”
The proposal would create a standardized measurement in which executive pay included the value of equity awards as they vest, rather than when they were granted.
Under this definition of “actual pay,” executive compensation would be a measure of “what they got in their hot little hands,” says Robin Ferracone, CEO of executive compensation consultant Farient Advisors.
Not everyone agrees with this measure. The AFL-CIO, the nation’s largest labor federation, argues that counting awards only once they vest overlooks decisions to grant equity in a particular year. Compensation decisions for performance in 2015, for instance, might not come into view until they vest in 2017.
Regardless of how pay is eventually calculated, the rule will likely bring new attention to how executive pay squares with company performance. Shareholder gripes over executive pay took on new importance in the years after the financial crisis, which saw CEOs earning exorbitant bonuses as their companies tanked.
“Now you see discussions of pay and performance you never used to see five years ago,” says Ferracone.
Though only 2 percent of companies lost shareholder “say on pay” votes in 2014, the topic regularly animates investors. “The disconnect between pay and performance is the key reason behind shareholder votes,” says Ferri.
Investor victories may come rarely, but companies give concerns over pay and performance ample attention. “By and large, most companies do respond to the votes,” Ferri says. His research has found that although these votes don’t usually result in diminished CEO pay, they do push directors to become more transparent and involved.
The way companies respond, however, has also become a point of contention. While directors might follow Barrick’s lead and reduce executive compensation, they might also cut back on research and development or issue stock buybacks to goose share prices.
These concerns were voiced by the two dissenting Republican SEC commissioners, who also worried that the new rules were “one-size-fits-all” fixes that would unduly burden smaller companies. Chairman Daniel Gallagher wondered whether the rules would push companies to pursue “short-term performance at the expense of long-term shareholder value creation.”
Rather than changing executive behavior, some worry the rules might just change accounting practices. “Once you put forward a way to measure things, it will push companies to meet that,” Ferri says.
The SEC still has not settled on more controversial CEO-to-employee pay rules, also mandated by Dodd-Frank. In 2013, the average CEO earned nearly 300 times the average worker, according to the Economic Policy Institute. In 1965, the ratio was 20-to-1.
The proposed pay and performance rule will enter a two-month comment period, after which commissioners will draft and vote on a final rule.