Dodd-Frank IV: A Revolution in Corporate Governance?

Pay Czar Ken Feinberg's final report on executive compensation is out and its findings that bankers' pay was "ill-advised" and the product of "bad judgment" is hardly new. As John Cassidy highlights economists and others have reached a "rare consensus" that managerial pay played a central role in the financial crisis. Far be it from me to argue with that conclusion, especially in light of my recent work Lessons from the Subprime Debacle which formalizes exactly that thesis. However, contrary to Cassidy's conclusion, I think the Dodd-Frank Act holds the potential for a revolution in corporate governance that could permanently alter the power of CEOs over public firms in America, and that Feinberg's report may ultimately facilitate change. Here is a run down of the key Dodd-Frank provisions touching upon corporate governance:

Section 951: Gives shareholders a say on pay via non-binding shareholder resolution to approve compensation including severance pay. Subject only to SEC exemption rules. Takes effect in 6 months.

Section 952: Requires all listed companies to have independent compensation committees with the power to directly retain compensation advisers including independent legal counsel. SEC rule making regarding the definition of independence is required and then the exchanges must implement SEC requirements. This process will take some time and the SEC can also issue exemptions. Nevertheless, companies must begin to comply within 1 year, and many issuers will no doubt take steps to comply very soon.

Section 953: Requires the SEC to issue rules requiring more expansive disclosures to shareholders re compensation, "including information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions." This could take time as the section includes no timetable for the SEC and they will certainly be busy on other fronts. But, when implemented it will another source of information that will exert market pressure on management.

Section 954: Requires SEC to require exchanges to require listed companies to promulgate policies authorizing compensation claw-backs. The policies must include a claw-back for inappropriate compensation based upon restatements of financial reports paid over the three years prior to any accounting restatement.

Section 957: Requires rules of exchanges to prohibit broker votes without shareholder direction in all "significant" votes, including compensation and director votes. This is a huge step toward real corporate democracy. According to the Council of Institutional Investors 16.5 percent of all votes cast at shareholder meetings in 2008 were broker votes, cast without direction from beneficial owners. These votes invariably benefited management. Moreover, this rule is effective now, meaning exchanges must promptly promulgate rules on this point or be put out of business. The SEC must promulgate rules defining what shareholder votes are significant, beyond director and compensation votes.

Section 971: Gives SEC power to require companies to give shareholders access to management's proxy to nominate directors. SEC rule-making is pending. Progress on this issue has been glacial at best. Perhaps this section can operate to break the log jam.

Section 972: Requires SEC regulations within six months to mandate disclosure regarding why or why not a public firm separates or does not separate the position of CEO and Board Chair.

In all, these changes hold the potential for a real revolution in corporate governance. The power of the CEO in the public firm has receded in the past 10 years with respect to such key elements of the public firm as the audit committee and the nominating committee. This is yet another step in the federal redesign of corporate governance to stem excessive CEO autonomy. Combined with prior steps and vigorous administrative rule making perhaps this changes will resolve problems associated with excessive CEO autonomy. If the SEC fails to act decisively prepare for more corporate scandals driven by excessive agency costs from too much managerial power.