Compensation Representatives: A Prudent Solution to Excessive CEO Pay

Currently, CEO pay is determined by a company's board of directors, subject to limited shareholder approval in certain circumstances. However, as Lucian Bebchuk and Jesse Fried have argued, directors and CEOs do not necessarily engage in real arms length bargaining over CEO pay. Instead, CEOs may exert managerial power to extract economic rents. To address the problem, Bebchuk and Fried have proposed granting large shareholders the right to nominate candidates for the board, and would require the company to pay the expenses for the proxy fight if the nominee received a designated minimum level of support. This article accepts the fundamental point that the CEO pay-setting process is flawed and that reforms are necessary. Nonetheless, it recognises that high CEO pay may be attributable to factors other than managerial power, and it questions whether certain of Bebchuk and Fried's proposed solutions might have negative consequences beyond CEO pay. Therefore, to remedy the problems in the pay-setting process, it proposes that large shareholders be allowed to appoint "compensation representatives" to look after the interests of all shareholders on matters relating exclusively to CEO pay. Compensation representatives would have the right to attend all compensation-related meetings, to question board members, to make recommendations, and to report their views to shareholders. Shareholders could use the representative's report as a basis for rejecting unreasonable pay arrangements. This approach would insert into the pay-setting process parties who are immune to CEO pressure and responsive to shareholder concerns. It would address compensation process flaws, without fundamentally altering the relationship between the shareholders and directors. Its implementation is highly feasible, since it could be adopted by shareholder by-law, without changing existing law. Finally, it could be vindicated or discredited by the market itself. As such, it would constitute a prudent solution to excessive CEO pay.