Harvard's Bebchuk Urges More Shareholder Control of Executive Pay

The reports’ authors hope that their framework of analysis and prescriptions will be used by firms, compensation experts, investors, policymakers, and regulators in their efforts to improve executive compensation.

The first report concludes that the top executives at Lehman and Bear were able to cash out large amounts of performance-based compensation, both from bonuses and from share sale, during the years preceding Bear and Lehman’s collapse. “This cashed-out performance-based compensation was large enough to make up the losses on the executives’ initial holdings in the beginning of the period,” the report states.

The second report concludes that since the financial crisis of 2008-2009, there is a growing recognition among firms, investors, and public officials that equity-based compensation awarded to the top executives of public firms should be tied to long-term results and that rewards for short-term gains that may prove illusory can produce substantial distortions.

“Managers should be blocked from cashing out the equity for a specified period of time after vesting. Firms should avoid retirement-based holding requirements that could distort executives’ decision to retire, as well as undermine their incentive to focus on long-term value as they approach retirement. Instead, equity-based awards should be subject to grant-based and aggregate limitations on unwinding,” the second report states.

It also stresses the importance of adopting prohibitions on hedging and derivative transactions that can undermine the beneficial incentive effects of long-term equity-based plans.

“There is a need for robust anti-hedging policies,” Bebchuk said during the webinar. “If you don’t have such policies in place, the danger is that executives can enter into hedging and derivative transactions that can undo the effect of equity incentives. There is empirical evidence that executives do often enter into such transactions, and this is partly motivated by insider information.”

If firms merely adopt a limitation on unwinding, it would lead to greater incentives to enter into hedging and derivatives transactions, Bebchuk added. The answer, he said, is for companies to adopt an anti-hedging provision that would prohibit executives from engaging in any transaction that might allow them to gain from declines in the company’s stock. “This may be a case where one size largely does fit all. All companies should have this provision in place,” Bebchuk said.

Finally, the third report says that incentives encouraging bank executives to take excessive risks still exist and that corporate governance reforms aimed at tightening the link between compensation structures and shareholder interests cannot eliminate them.

This is where government reform must step in, the report’s authors conclude: “Monitoring and regulating bank executives’ compensation–along the lines we have put forward–can constitute a valuable component of financial regulation and can complement nicely the monitoring and regulation of banks’ investment, lending, and capital decisions.”

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