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Photograph by Benjamin Child

October 10, 2017

Below is the Corporate Governance Alliance Digest, with compliments from Eleanor Bloxham, Founder and CEO of The Value Alliance and Corporate Governance Alliance, and John M. Nash, Founder and President Emeritus of the National Association of Corporate Directors (NACD).


If you would like to receive your own complimentary email copy going forward, you may sign up here.



The New Legal Impetus to Fix Pay and Where It Could Take Us
By Eleanor Bloxham


Risks exist in compensation plans. Will boards begin to fix them?

U.S. disclosure requirement on the risk in compensation plans (a short history)


In April of 2006, before the looming financial crisis was widely recognized, I wrote to the SEC recommending that they require disclosure about the risks embedded in corporate compensation plans. (All compensation programs come with risks, I argued, and shareholders and other stakeholders had a right to know what they were and how the compensation risks were ameliorated in oversight and in the plans, themselves.) See the SEC comment letter here

The purpose of the recommendation was to create awareness at the board level (and in the company) of various trade-offs in building compensation programs, to motivate an examination of the risks the programs generate, to stimulate a discussion by boards on how compensation programs shape ethics, decision making and corporate culture – and encourage board action to better shape the programs to produce superior outcomes for all shareholders and stakeholders.

After the financial crisis was well recognized, in December of 2009, with the clear risks of compensation programs top of mind (re: producing negative outcomes for customers, shareholders and economies), a modified version of my suggestion was promulgated by the SEC in new proxy disclosure requirements. See the SEC press release here

General board member reaction

After the SEC proxy disclosure requirement was put into effect, many board members did not focus on the requirement with any zeal. Many rejected the idea that any of their company’s compensation plans could possibly create risk.

And in a show of dismissiveness, some moved the responsibility of assessment to a member of management - often a risk professional who (a) had no proficiency in making such a determination and/or (b) was not independent of the board and management in making such an assessment, in a role that reported into the CEO at best or some other operational executive at worst. Or they consulted a pay advisor who also lacked the requisite expertise. (Pay consultants are not strategy, risk or performance experts.) See this example:

The education and awareness I hoped would ensue at the board level seemed to have fallen into the waste bin of good ideas never acted upon. I started to question whether my approach had made sense, as the disclosure was creating a “feel good” check the box response rather than the deep inquiry I’d hoped for.

Now, however, in a shareholder derivative lawsuit involving Wells Fargo, the risk and compensation disclosure requirement is being tested in the courts.

Pending case law to add muscle to the requirement?

On October 4, 2017, Judge Jon S. Tigar of the Northern California District Court found that “Plaintiffs have plausibly alleged that the Director Defendants made material and misleading statements through their participation in and approval of Wells Fargo’s public filings.”

The Court highlighted the compensation and risk disclosure by Wells Fargo that its “compensation scheme discouraged employees from taking ‘inappropriate risk . . . that is not in the best interest of customers.’’

The Court observed in determining plausibility that “according to Plaintiffs, these statements were false and misleading because Wells Fargo’s ‘risk controls and oversight policies . . . were not strong and robust but were rather . . . weak and near-nonexistent’ and because Wells Fargo’s compensation scheme actually encouraged employees to engage in illegal behavior, according to the findings of the OCC in its Consent Order.”

Rejecting claims by the directors that statements in the proxy were puffery (rather than misleading), the Court said:

The statements in the Proxy Statements regarding Wells Fargo’s internal controls and risk management amount to more than mere puffery.

For example, the 2014, 2015, and 2016 Proxy Statements each outlined a specific set of “compensation risk management policies and practices’ and described “active oversight and monitoring” that would “not encourage excessive risktaking.” Plaintiffs allege that “[t]hose statements misleadingly conveyed that Wells Fargo’s compensation structures emphasized risk management and encouraged long-term stockholder value” …

These allegations go far beyond mere puffery, and state an actionable claim for relief under Section 14(a).

Whether the directors of Wells Fargo lose or win, the case has already made a mark by highlighting ways in which lackadaisical, boiler plate disclosure on the risks in compensation programs can land directors in hot water -- and should act as a prod to boards to put more effort into a thorough examination and discussion before dismissive statements related to the risks in compensation programs are made.

Current known risks in compensation programs

There is a growing body of evidence, anecdotal and research-based, that paying executives in stock or based on stock-price is materially risky and deleterious to a company’s culture, ethics – and its shareholders and stakeholders.  Consider, anecdotally, the well-known cases of Enron, WorldCom, Lehman Brothers and Wells Fargo.

On the research-side, there’s an important post-crisis study by Columbia and Pace University researchers and the Fed outlining the negative impacts on companies and economies of compensation programs that pay executives in stock (and stock options). See study and a sampling of articles on the study here (let me know if you’d like to see more):

And while some may think that merely extending the time horizon for the stock payout solves the problems created by existing plans, an MSCI research study that received Wall Street Journal coverage on October 5, 2017 demonstrates that extending the time horizon on stock payouts does not provide the linkage to performance that shareholders seek. See

Plaintiffs and investors: what we can expect

As the body of evidence grows and awareness of the risks of stock and stock option payouts (and pay linked to stock price) increase, boards that fail to disclose those risks may find that that their failure to disclose is used by plaintiffs to add muscle to lawsuits. And sooner than one might expect, a board’s lack of awareness of these risks in their compensation programs (and failure to report them) could be generally considered board mal-practice.

Add to the mix growing shareholder pressure to move away from the myopic concentration on stock price (for example, consider the Investor Stewardship Group’s requests on pay and pay disclosure) and we can expect to see boards not only increase their diligence in disclosure but also begin to explore better alternatives to stock-based rewards. See

As part of that exploration, boards will discover that to make reasonable decisions on the risk trade-offs of compensation programs and ameliorate any remaining risks in oversight, they will need to implement a level of decision making hygiene that is rare in companies today – but relatively simple to execute with the right know-how.

Decision making hygiene

Today, many companies muddy the waters in setting strategies, budgets and resource allocations, metrics and compensation with multiple haphazard approaches. Going forward, boards will begin to recognize they need to ensure all (these) decisions align – and do that by asking at each step, how do we fulfill our mission and make choices, recognizing the impacts on all stakeholders? This is what I argued for in the valuation approach I articulated 15 years ago, an approach to managing and overseeing a company that recognizes the importance of all stakeholders in creating sustainable economic value.  See:  

General board member reaction

Conversations with over 50 public company CEOs and board members over the summer show an openness to consider new ways of approaching corporate decision making and compensation. (True this sample may be a bit lop-sided in that the real laggards would tend to exclude themselves from the opportunity to engage in such dialogue.) But most of those I spoke with this summer view stock price, as a measure of performance, to be convenient but not appropriate to encouraging the behaviors needed to meet the goals of building strong, sustainable businesses that serve all stakeholders.

And negative sentiments about stock as a payout mechanism and stock price as a measure have been echoed time and again in conversations I’ve had with other directors, CEOs and executives in a variety of settings over the last five to seven years.

The time is now

With the Wells Fargo case in full view, the time is past for board members to ignore the importance of robust compensation risk disclosures for investors and new decision making and pay programs at the companies they oversee.

It is true that I may be disappointed once again. But there is momentum for change on many fronts – and because of that momentum and the possibility of better decision-making hygiene at the board and company level, the prognosis is optimistic. 


This edition of the Corporate Governance Alliance Digest is copyrighted. If you wish to quote from or use the ideas in this Digest, please acknowledge the Digest and its authors appropriately. Copyright 2017. All rights reserved. The Value Alliance Company.

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