Measuring Executive Pay – and Responsibility

When Nintendo slashed the price of its 6-month-old 3-D game device by nearly a third (to $169.99) a few weeks ago, company President Satoru Iwata voluntarily took a 50% pay cut.

That wasn't the first time in history that a corporate CEO took a pay cut, of course. But what made the event more unusual was Iwata's choice of whom to blame for the botched rollout of the Nintendo 3DS — himself.

“I feel greatly accountable for having to make the markdown shortly after the launch, for having damaged our consumers' trust, for having made a significant impact upon the financial forecasts,” he stated.

That was in stark contrast to the position taken by another CEO halfway around the world, when asked whether he should accept responsibility for the legal and public relations disaster facing his company by resigning.

“Nope,” Rupert Murdoch replied to a British parliamentary committee investigating phone hacking by his News Corp. minions. “People I trusted have let me down,” he said. “It's for them to pay…. Frankly, I'm the best person to clean this up.”

Spreadsheet: California's highest-paid CEOs

Customarily, the CEO's role in a corporation comes under the spotlight once a year, during the spring proxy-issuing season. That's when the outsized compensation paid to mediocre or underperforming chief executives gets put on display, like baby pandas at the zoo, for wide-eyed onlookers.

The Iwata and Murdoch cases drew public notice last month because of the press of events (the disastrous rollout of the Nintendo 3DS and the ethical scandal at Murdoch's London tabloid News of the World).

And, of course, because of the stark contrast between how the two CEOs regard their responsibilities.

But it's proper to pay even more attention to these issues right now, because federal regulators are drawing up new rules for executive pay disclosures — and because the rules have become the focus of a new fight in Washington over how much CEOs should get paid and how that figure should be communicated to the public.

The immediate issue is a provision of the Dodd-Frank Act, the corporate and Wall Street regulatory overhaul act passed last year to address some of the financial abuses uncovered in the wake of the 2008 crash. In the year since its passage, Dodd-Frank has become a favorite target of business leaders and conservative lawmakers who blame it for creating “uncertainty” in corporate boardrooms, and therefore hampering job creation.

One of the fiercest attacks involves a little-noticed provision requiring that companies disclose the ratio between the average pay of all employees and that of the CEO. This ratio, as it happens, all but defines the pathology of income inequality in the United States; over the last 30 years, according to figures from the Bureau of Labor Statistics and elsewhere cited by its author, Sen. Robert Menendez (D-N.J.), it has ballooned from 42-to-1 to more than 300-to-1. In the same period, according to data compiled by economist Emmanuel Saez of UC Berkeley, the richest 10% of U.S. income earners captured 98% of all income growth, and the bottom nine-tenths got 2%.

The disclosure provision plainly has gotten under Big Business' skin. Although Dodd-Frank includes rules requiring that shareholders get a vote on executive pay and for a “clawback” of pay based on inaccurate financial statements, “there has been a more substantial amount of commentary on the pay ratio than any other provision relating to executive compensation,” Paul Hodgson, a senior researcher at the shareholder research firm GMI, told me.

A bill to repeal the pay ratio provision has been passed by a House committee, and even if it fails to become law, the Securities and Exchange Commission will face enormous pressure to go easy when it issues rules implementing the provision later this year.

Corporate lobbyists argue that compiling the numbers will be a huge burden for multinational companies forced to compile information from dozens of incompatible payroll systems and will require reams of explanatory pages in corporate documents.

Plus, they argue, who cares? They say the ratio isn't germane to an investor's decision on whether to buy into a company, though they add inconsistently that it could mislead investors who foolishly compare pay policies at, say, investment banks with those at shoe manufacturers.

To be fair, even some corporate disclosure activists sympathize with this view. Hodgson acknowledges that other pay ratios are more informative, such as the one measuring the pay of the CEO versus that of other top executives (too big a differential means the CEO has too much power). On the other hand, he says, “the torrent of concern and objections from the corporate community makes me very suspicious.”

Are they fighting the rule because they're embarrassed at what it would show? There's indirect evidence for that from Whole Foods Market Inc., one of the few companies that already discloses the ratio. Whole Foods does so because it's not embarrassed: It caps its executive salaries at 19 times the average wage of its workforce. In 2010, the cap was $705,037.

That's not quite the whole story: The ratio has expanded since the 1980s, when it was 8-to-1, and Whole Foods also awards stock incentives and cash bonuses to its executives. But it says that generally no more than 10% of all option grants can go to its top 30 executives, and the cash bonuses are based on very specific performance criteria.

In 2010, according to Whole Foods' latest proxy, the benchmarks awarded $5,000 in bonus for every tenth of a percentage point in same-store sales improvement, among other things; I don't think I've ever seen a performance measure so lacking in wiggle room.

Not everything that Whole Foods co-founder and co-CEO John Mackey says or does is so angelic, but it's fair to say that if every U.S. corporation followed his lead on executive compensation, the world would be a better place.

In an age when Rupert Murdoch can argue that his failings as a CEO make him the perfect choice to clean up his own mess, we need more metrics of CEO performance, not fewer. Who says so? Warren Buffett, for one, who observed in his 2009 letter to Berkshire Hathaway shareholders that CEOs and directors of failed companies “have largely gone unscathed.

“Their fortunes may have been diminished by the disasters they oversaw, but they still live in grand style,” he continued. They “have long benefited from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.”

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