CED Paper Gives Corporate Governance Recommendations

March 24, 2006 (PLANSPONSOR.com) - In a recent policy statement, The Committee for Economic Development (CED) said the disparity of income between top corporate executives and average employees is a cause for serious concern.

“The procedure for determining executive compensation has been broken at far too many of our larger corporations, and CED believes that the solution to excessive compensation must be regarded as a matter of process and disclosure,” the CED said.   A recent poll indicates that chief financial officers are concerned about executive compensation issues as well and reveals strong support of proposed disclosure rules from the Securities and Exchange Commission (See SEC Comp Disclosures Get CFO Support).

To help reign in excessive executive compensation, the Committee made the following recommendations:

  • Compensation committees should adopt measurable, specific, and genuinely challenging goals for the performance of their businesses, and judge management by them.
  • The compensation process must be run by compensation committees composed of independent directors. And compensation consultants, when used, must be entirely independent of management. The compensation committee should have direct authority over all terms of any management contract, including all forms of compensation.
  • Management should have a substantial equity interest in its company.
  • Management should make a full, timely, and transparent disclosure of its compensation to shareholders.
  • Choices of forms of compensation should promote the long-term value of the firm, rather than exploit favorable accounting or tax treatment.
  • Severance compensation, like all other forms of executive compensation, should be reviewed carefully against criteria set by the compensation committee of the board, and the board should publicly provide full details of awards and explain publicly to shareholders the reasoning behind such awards.
  • Companies should have the right to recapture top executive bonuses if financial results by which they were justified turn out not to have been achieved when accounts are restated.

In its statement, the CED also expressed a vote of confidence in Section 404 of Sarbanes-Oxley (SOX) regarding internal controls.   The Committee said it endorses the Public Company Accounting Oversight Board and Securities and Exchange Commission implementation guidance based on their evaluation of the first-year experience, saying it should lower the costs and increase the value of Section 404 compliance.   The CED does not, however, recommend a broad exemption from SOX requirements for small capitalization companies (See Letter Urges Regulators not to Implement SOX Exemption), but nevertheless, supports the objective of mitigating the costs to smaller companies.

Other recommendations included in the CED’s statement include:

  • Making Audit Committees Autonomous and Vigorous– In order to accurately present a company’s position, the board of directors must have access to all pertinent data. This will only occur if a board’s auditing committee is competent, independent and establishes effective control over both internal and independent external auditors.
  • Ensuring that Users Understand that financial Information is Based on Judgments– Financial statements would be more useful if they were governed by fewer rules and displayed more judgment that lies behind estimated numbers. Stock analysts, the investing public, and regulators, must recognize the inherently judgmental character of accounting statements and financial information. Ranges of values, rather than precise numbers, should be explained and understood as such. In addition, financial statements should be supplemented with non-financial indicators of value.
  • Using Independent Nominating Committees to Select and Appraise Directors– A paradox of corporate stewardship is that, despite the principle that directors represent shareholders in the selection and retention of management, historically, most directors have been selected by management. In the CED’s view, the best approach to building high-quality boards is to assign to truly independent nominating committees the responsibility for recommending new board candidates and for evaluating the performance of existing board members. The nominating committee should also have the responsibility of recommending committee assignments.

  

Summarizing its goal in issuing the statement, CED co-chair and chair of the CED Subcommittee on Corporate Governance, Roderick Hills, said in a press release, “It is imperative that we take concrete steps to restore the practices and processes that are the foundation of good business ethics. Specifically, I believe that the auditing process must reflect responsibility by company leaders, not just a rigid adherence to accounting rules. The auditing process needs to be guided by an over-arching set of principles that guarantee that the CEO, Board of Directors, and other top company officials know that they are fully committed to providing a truly fair and clear presentation of the firm.”

The full CED policy statement, “ Private Enterprise, Public Trust: The State of Corporate America After Sarbanes-Oxley,” can be viewed from here .

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