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October 28, 2008

Executive Pay Comes Under Fire from Activist Shareholders for Contributing to Financial Crisis
    by Robert Kropp

Study of shareholder voting by mutual funds shows SRI funds leading the way to increased shareholder activism on matter of executive compensation. --
Questions abound in the wake of the current meltdown of the financial industries. How could presumably knowledgeable corporate executives ignore the dangers inherent in mortgage-backed securities consisting of loans that were often bound to fail? Either through passivity or self-interested compliance, did boards of directors shirk their oversight duties, thus allowing corporate managers a free hand in contributing to the economic downfall? And what role could shareholders have played in order to bring executives to account for their activities?

Much has been made of one condition of the $250 billion federal bailout of nine of the nation's largest banks: that severance pay and recouping incentive payouts based on �inaccurate� performance measures be reduced. In the current climate, in which the performance of many CEOs has clearly been abysmal, the fact that CEOs of large U.S. companies averaged $10.8 million in total compensation in 2006, more than 364 times the pay of the average US worker, especially rankles.

But excessive executive compensation has been a target of resolutions by shareholder activists for years. A recent study by Fund Votes, which provides in-depth analysis of investment fund proxy voting, analyzed mutual fund voting patterns on shareholder-sponsored compensation resolutions across 47 mainstream fund groups and 6 SRI groups over five years of voting records.

Jackie Cook, the founder of Fund Votes, told, "Executive compensation is at the heart of a growing problem between shareholders and management. Corporate structure is supposed to be a system of checks and balances among shareholders, boards of directors, and management. So why does executive pay continue to grow, even in times of economic downturns?"

The Fund Votes survey found that the number of "say-on-pay" shareholder resolutions�which seek to afford shareholders the opportunity to ratify executive compensation packages�increased from three in 2006 to 79 in 2008. Overall support among mutual fund families reached 51% in 2008. Also significant is the fact that in 2008 only six of the 47 mainstream fund families gave no support to say-on-pay resolutions.

Not surprisingly, the Fund Votes survey found that the six SRI funds included led the way in bringing attention to the issue of runaway executive compensation. Among the SRI funds, average support for all shareholder resolutions on compensation was 84% in 2008. The average for mainstream mutual funds was 41% in 2008.

Cook said, "The number of advisory resolutions on executive compensation among S&P 500 companies reached 79 this year. The question that shareholders raise in light of these numbers is, are boards of directors now prepared to engage in constructive dialogue with shareholders on this issue?"

The Fund Votes survey notes, "Shareholder activists argue that tighter pay practices would follow if shareholders could annually cast a vote on an advisory resolution to ratify the boards� compensation reports. The �say-on-pay� proposals would effectively allow us to gauge the degree of shareholder satisfaction with the board�s compensation structure and incentive pay allocations from year to year. Clearly boards could use some constructive feedback from those whose interests are most aligned with the performance of the company."

In light of the current financial crisis, what is especially interesting in the Fund Votes report is the existence of say-on-pay resolutions in 2008 that targeted eight of the nine banks on the receiving end of the $250 federal bailout. In a research brief published on October 21, an analysis by Fund Votes found that "fourteen of the 61 fund groups surveyed failed to support even a single say-on-pay resolution at the eight bail-out banks targeted with this resolution in 2008. Twelve opposed all such resolutions and two abstained on all."

On the other hand, the research brief found, "Many large fund groups and all of the socially responsible investment groups surveyed supported every such resolution at the eight bail-out banks."

Considering the failure of mainstream mutual funds to act on the issue of executive compensation at a time when the economy was already beginning to unravel, Cook of Fund Votes could only speculate, "Perhaps they might not have opposed such resolutions if they had come to a vote now."

Could it be that outrage over the glaring discord between executive pay and executive performance finally lead shareholders and boards of directors in the direction advocated by the SRI community for years? There is some evidence that such might be the case.

The National Association of Corporate Directors (NACD), an organization dedicated to serving the corporate governance needs of corporate boards, responded to the current crisis by publishing a 10-point plan to strengthen corporate governance. Acknowledging that "the current economic crisis has eroded public and investor confidence in corporate governance," and that "American corporations must take action to restore the public trust," the NACD argued for such correctives as board responsibility for governance and accountability, corporate transparency, and director competency and commitment.

However, on the matter of shareholder involvement, the NACD called for no more than that "governance structures and practices should encourage" shareholder involvement and directors' communication with shareholders. Given the ease with which corporate management has sidestepped the concerns of activist shareholders and drawn the global economy into its current malaise, such advisory recommendations may fall short of their goal of regaining shareholder confidence.

A movement that may do more to bring corporate boards into line with the concerns of shareholders has originated with no less colorful a public figure than Carl Icahn, the corporate raider turned shareholder activist. Claiming that "one of the biggest problems we face today is the egregious mismanagement and reckless incompetence of many American corporate boards which utterly fail to do their primary job of holding managements accountable," Icahn called for the formation of the United Shareholders of America to "push back against board entrenchment and make it easier for shareholders to promote change in companies they own."

Perhaps desperate times call for strange bedfellows. But if such an advocate of profitability above all else as Carl Icahn comes to share the goals of an SRI community with long experience in calling for improved corporate governance, then a renewal of genuine checks and balances as espoused by Jackie Cook of Fund Votes may turn out to be a beneficiary of the current crisis.

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