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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISor through bad performance measures (e.g., paying mortgage brokers on the number of loansthey write, as opposed to the number that might actually get paid back).We find no evidence in bonus asymmetries for banking CEOs in Europe or the USA.We do find that the compensation structure for European banks relies less on salaries andmore on bonuses than the structure for non-bankers. Moreover, we find the average andmedian bonus for European banking CEOs fell 70% and 100% between 2006 and 2008,compared to modest drops of 14% and 10% for non-banking CEOs. Indeed, we found thatbonuses for European banking CEOs fell even more than bonuses in the USA banking sectorfrom 2006 to 2008 (which in turn fell much more than in the USA non-banking sector).Finally, we find that banking CEOs in Europe hold much more stock and options than doEuropean non-banking CEOs, and that the value of these holdings fell much more forbanking CEOs than non-banking CEOs. These results – coupled with our result that bonusesin the banking sector are strongly related to shareholder returns – suggests that performancemeasurement issues are also not to blame for excessive risk taking by European bankingCEOs.5.2. Should Executive Pay be Regulated?As documented in this study, the reality is that executive pay is already heavilyregulated on both sides of the Atlantic. Throughout Europe and the USA, there are disclosurerules, tax policies, and accounting standards designed explicitly to address perceived abusesin executive compensation. There is also direct intervention, such as the prohibitions onoption grants and incentive bonuses in bailed-out banks in the USA and France. Common toall existing and past attempts to regulate pay are important (and usually undesirable)unintended consequences. For example, the 1984 USA laws introduced to reduce goldenparachute payments led to a proliferation of change-in-control arrangements, employmentcontracts, and tax gross-ups. Similarly, the 1993 deductibility cap on non-performancerelatedpay is generally credited with fueling the escalation in pay levels and option grants inthe 1990s, and the enhanced disclosure of perquisites in the 1970s is generally credited withfueling an explosion in the breadth of benefits offered to USA executives.The unintended consequences from regulation are not always negative. For example,reporting requirements in the 2002 USA Sarbanes-Oxley bill (in which executives receivingoptions had to report those options within 48 hours) are generally credited for stopping theunsavory practice of “option backdating,” even though the authors of the bill had no idea thepractice existed. As another example, the draconian regulations imposed on USA banks-121-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISaccepting government bailouts had the positive effect of getting USA investors paid backmuch more-quickly than anyone expected, in order to escape the regulations. Even the 1993deductibility cap – which backfired in its attempt to slow the growth in CEO pay – had thepositive effect of greatly increasing the alignment between USA CEOs and theirshareholders. But, these positive effects are accidents and cannot be relied upon. Forexample, while the 50% tax on banking bonuses in France and the UK may cause these firmsto rely more on equity-based compensation rather than cash bonuses (which would be apositive outcome), the more plausible response will be an increase in base salaries (i.e., anegative outcome).Thus, our strong recommendation is to resist calls for further government regulation,and indeed governments should re-examine the efficacy of policies already in place. Part ofthe problem is that regulation – even when well intended – inherently focuses on relativelynarrow aspects of compensation allowing plenty of scope for costly circumvention. An aptEuropean analogy is the Dutch boy using his fingers to plug holes in a dike, only to see newleaks emerge. The only certainty with pay regulation is that new leaks will emerge inunsuspected places, and that the consequences will be both unintended and costly.A larger part of the problem is that the regulation is often mis-intended. The regulationsare inherently political and driven by political agendas, and politicians seldom embrace“creating shareholder value” as their governing objective. While the pay controversiesfueling calls for regulation have touched on legitimate issues concerning executivecompensation, the most vocal critics of CEO pay (such as members of labor unions,disgruntled workers and politicians) have been uninvited guests to the table who have had noreal stake in the companies being managed and no real interest in creating wealth forcompany shareholders. Indeed, a substantial force motivating such uninvited critics is one ofthe least attractive aspects of human beings: jealousy and envy. Although these aspects arenever part of the explicit discussion and debate surrounding pay, they are important andimpact how and why governments intervene into pay decisions.Our concerns about regulation notwithstanding, we do support legislation for enhanceddisclosure of individual compensation arrangements (including stock options), currentlyabsent in Austria and Greece and only recently imposed in Spain and Portugal. Our support isadmittedly self-interested (as consumers of these data), and we recognize that enhanceddisclosure will lead to more (and not less) controversies over pay. Moreover, based on theexperiences of Canada and other countries introducing disclosure requirements, we predictthat enhanced disclosure will lead to both higher levels of pay and convergence towards-122-
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