SEC Commissioner Luis A. Aguilar delivered a speech, as a part of the Corporate Governance Lecture Series at the Emory University School of Law, in which he asserted that, in order to restore trust between Wall Street and Main Street, it is crucial to have corporate governance practices that foster the principles of (i) accountability, (ii) transparency and (iii) engagement. Framed within the context of the executive compensation process, Commissioner Aguilar stated that these principles should drive the establishment of an effective corporate governance regime, and highlighted a few of the ways in which the SEC incorporates these important principles into its rulemaking and enforcement programs.
On the principle of accountability, Commissioner Aguilar commented that corporate governance can only embody accountability if shareholders know that performance will be measured: good performance will be rewarded, poor performance will not and misconduct will not be tolerated. Regarding both executive compensation and say-on-pay, the Commissioner suggested that SEC enforcement actions are a key mechanism for imposing accountability on “corporate officers and gatekeepers.” Commissioner Aguilar emphasized the importance of this in instances in which self-dealing or other breaches of duty result in violations of the SEC rules regarding fraud, reporting requirements, books and records, and financial controls. A robust enforcement program, he argued, helps to “reinforce the principle of accountability by punishing those in a position of trust and responsibility who cross the line.”
The Commissioner also addressed the principle of transparency. Without it, he said, it is extremely difficult to have accountability. Commissioner Aguilar stated that the SEC promotes the principle of transparency by “requiring that public companies shine a light on the information that investors need to make good investment and voting decisions.” He remarked that this is accomplished through SEC rules which require the public disclosure of a description of a company’s business, its board and management, and financial and operating data, both historical and forward-looking, among other information. Commissioner Aguilar noted that access to audited financial information and other required public disclosure is particularly important when shareholders hold officers and directors responsible for corporate performance, and that all of these disclosures enhance transparency.
Concerning the disclosure rules relating to executive compensation, the Commissioner cited the Dodd-Frank mandated rules, which include disclosures as to:
- the relationship between executive compensation actually paid and the financial performance of the issuer;
- company policies regarding the hedging of equity securities held or awarded to directors and employees; and
- the ratio between the compensation of the chief executive officer and the total annual compensation of its average worker (known as “Pay Ratio”).
Commissioner Aguilar urged the SEC to adopt rules requiring the mandated pay-for-performance and hedging disclosures which, taken together with the Pay Ratio Rule, he argued, will “foster accountability by making compensation decisions more transparent, and will help investors to make more informed investment decisions when they exercise their rights as shareholders and owners.”
Lastly, Commissioner Aguilar addressed engagement. Traditionally, he commented, the primary opportunity for shareholders to communicate with a company was at the annual shareholder meeting, which was neither practical nor provided sufficient opportunity for shareholders to exercise their rights as owners of the company. Focusing on (i) informal engagement with investors, (ii) engaging retail shareholders, and (iii) shareholder proposals, Commissioner Aguilar urged the further development of mechanisms through which shareholders can communicate with their companies, which he believes will be mutually beneficial for shareholders and companies.
Commissioner Aguilar concluded by stating that the underlying corporate governance issue regarding executive compensation is not simply about the amount of the compensation, but also about whether the decision-making process enables accountability through transparency and shareholder engagement.
Lofchie Comment: Over time, the Pay Ratio Rule will almost certainly demonstrate that the pay ratio of successful companies reveals a greater discrepancy than that of unsuccessful companies, since people at the top receive a larger portion of their pay through bonuses. The various ratios cited in the Commissioner’s speech are not meaningful without significantly more underlying information. For example, pay ratios might be significantly different between domestic companies with a larger U.S. work force and global companies with a significant number of foreign employees earning locally appropriate though lower wages. Financial regulators should focus on adopting rules that are genuinely meaningful. The Pay Ratio may be a popular rule, but that does not make it meaningful disclosure.