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Yankees third baseman Alex Rodriguez signed the biggest contract in baseball history in 2007—a 10-year contract worth potentially more than $300 million. Rodriguez receives an average $27 million annual salary, plus a $6 million bonus every time he matches the career home run totals of Willie Mays (660), Babe Ruth (714), Hank Aaron (755), and Barry Bonds (762). He pockets another $6 million if he breaks Bonds’s record.
That same year, Goldman Sachs’s CEO Lloyd C. Blankfein earned a record-breaking $70 million. Like Rodriguez, he earned two types of compensation—a $600,000 fixed salary and performance-based bonuses. But there’s one key difference: The standards and metrics that measure Rodriguez’s performance are clear. Blankfein’s are not.
Congress requires publicly traded companies like Goldman Sachs to disclose information—including total pay and performance targets—about their executive compensation contracts. The requirement assumes shareholders will use this information to hold companies accountable for executive performance. The government does not require the disclosures to be comprehensible, however.
Congress is tackling this disclosure deficit as part of its financial regulatory reform initiative. The bill passed by Congress includes helpful language directing the Securities and Exchange Commission to clarify disclosure rules on CEO compensation. Regulators should take this opportunity to ensure that disclosures to investors follow two principles:
1. Show us the money. Regulators should require companies to display executive compensation information in a standardized graphical format that allows for easy evaluation by ordinary investors. The information should allow shareholders to quickly gauge whether an executive’s performance warranted receipt of his or her performance-based pay, and whether the compensation awarded is commensurate with the value added to a company.
2. Make sure we understand. Regulators should in turn be required to evaluate disclosures for comprehensibility. SEC officials should write disclosure rules that focus on the understanding that readers take away, rather than merely focusing on the information companies provide. One approach is to apply a “reasonable person” test to compensation disclosures and require revisions if company reports are not easily comprehensible.
Corporate adherence to the twin principles of simplicity and comprehensibility will protect shareholders and empower investors to police excessive executive compensation.
Mandatory filings with the SEC, the federal agency charged with protecting investor interests, are often hard to understand. They are long and dense, and filled with financial jargon that even experts can have difficulty deciphering. This is a problem for shareholders as well as the broader economy. Regulators, policymakers, and the public at large have a stake in knowing whether corporate pay practices create incentives that are conducive to real and sustainable economic growth.
Improvements in disclosure will not necessarily correct other causes of excessive compensation, such as poor corporate governance. But they will make executive pay more transparent to investors, among them the tens of millions of ordinary people with a stake in public companies through investments in mutual funds and 401Ks.
Sima Gandhi is a Senior Policy Analyst with the Doing What Works project at the Center for American Progress.
Read the full report (pdf)
Download the executive summary (pdf)
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