Executive Compensation Top of Corporate Governance List

April 11, 2005 (PLANSPONSOR.com) - Executive compensation is turning into a key corporate governance issue for institutional investors, a new survey indicates.

According to a Pensions & Investments and Vivient Consulting study, 90% of respondents – which included pension funds, money managers and hedge funds – believe that the level of executive compensation is important or very important when evaluating a company. Seventy-eight percent thought that long-term cash-based incentives would induce better performance than other incentives such as restricted stock and stock options.

Why long-term cash-based incentives? Because “they tie to specific financial goals rather than tying executive compensation to stock price, which fluctuates by the market,” according to Susan Schroeder, a partner at Vivient Consulting.

Another area of interest is “pay-for-performance” measures. When asked how they establish if a company’s compensation is truly pay-for-performance, almost 30% stated that they look to transparent and measurable links between performance and salary, while 28% said that they look at peer groups. Almost 20% said that it is too difficult to determine this link, however.

Respondents also thought that the executive compensation policies that foster good governance were overwhelmingly ownership and pay-for-performance. Over 80% of respondents thought that it is important to require executives to hold their equity grants for a minimum period of time and to use a pay-for-performance system to compensate leaders. Also, 60% thought that it is essential to lay out stock ownership guidelines for executives.

Another area of concern for respondents is how to evaluate employee and executive stock option costs. According to the study,   26% employ the “as-reported” accounting expense number under FASB No. 123., while another 21% look at the number of shares available for grant plus options outstanding. Around 10% stated that they calculate their own expense numbers based on their own assumptions, the survey shows. Many respondents use more than one method, however.

Other Issues

Other issues that have been at the heart of corporate governance pushes over the past two years have included director accountability and transparency of financial reporting.

More than 90% of respondents thought that it is important or very important to make sure that the maximum number of independent directors are used. Respondents also showed a strong interest in annual director elections and limiting the number of public company board seats held by individual directors. They also supported holding performance appraisals for directors.

Involvement and Tools

Despite worries of a backlash against institutional investors who demand too much with regards to corporate governance, the survey found that 46% of respondents thought that institutional investors are “appropriately involved”, while 39% indicated they should be “more involved.” Only 13% said that institutional investors are too caught up in shareholder activism.

How do institutional investors participate? Sixty-eight percent say that their main method is through proxy voting, according to the survey. With their votes, institutions vote against management or board-sponsored incentive plans (30%), participate in shareholder lawsuits (26%), and communicate directly with management or the board (23%), according to the survey.

About   80% said that they agree that shareholders should have the right to vote on annual re-election of directors, poison pills, golden parachutes and bylaw amendments. About 66% also agree that shareholders should vote on term limits of directors, the survey reports.

A majority of respondents subscribe to governance rating services, such as Institutional Shareholder Services Inc., (27%), Standard & Poor’s Corporate Governance Scores, (7%), and Glass-Lewis (2%). Most participants said rating services are of “moderate” value when evaluating companies. Thirty percent stated that they considered such services valuable, while 11% said they are not valuable. Pensions favored ISS, while hedge funds favored S&P, according to the survey.

The survey results are based on responses from 100 pension funds, money managers and hedge funds. Pension funds made up 50% of respondents, while money managers (20%), hedge funds (20%) and other types of firms (10%) constituted the other half.