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September 21, 2009 2:46 PM

Munger Tolles Partner on Executive Pay: Change It

Posted by Zach Lowe

Last winter, Munger, Tolles & Olson partner Robert Denham got a call asking him to cochair a committee conducting a report on executive compensation at public companies--many of which are his firm's clients. After thinking it over for a few days, Denham accepted the project, helping the The Conference Board, a nonprofit that issues advice to businesses, compile recommendations on the topic. 

The report, released Monday, advises public companies to make major changes in executive compensation, partly to quell growing shareholder anger. The report recommends tying compensation more closely to long-term performance; eliminating golden parachutes, golden coffins and ultra-lucrative retirement packages; adopting clawback policies that allow companies to recoup ill-gotten compensation; and giving shareholders a bigger say on executive compensation.

Some corporations have already made these changes--60 percent of the Fortune 100 now have clawback policies, for instance, up from 18 percent two years ago. But for others, the Conference Board's recommendations will mean major changes. We asked Denham, former chairman and CEO of securities brokerage Salomon Inc., why companies should take the report's advice.

How did you get involved with this report? 

I was involved with the Conference Board in the 1990s, when I was chair of Salomon. I had a historical connection with them, so they reached out to me. 

Were you concerned about heading a task force that might produce a report that could potentially criticize Munger clients?

I thought about it for a day or two and talked to some colleagues to make sure I wasn't doing something that didn't make sense. Any time I take on anything outside my practice, I talk to my colleagues to check if what I'm doing is against the best interests of the firm. The firm has been very good about allowing me to do things outside of my law practice. 

Were you worried about upsetting the firm's corporate clients?

I didn't have a concern that clients were going to be bothered by the report. I was more concerned about whether it was something capable of making a difference and whether it would be a good use of my time. Most companies understand the need to get compensation right. 

The report has an underlying tone of tough love--that some of the recommendations might not make companies happy, but that it's in their best interest. Why should companies take the report's advice?

I've been concerned for a long time about the criticism that has developed over compensation issues. We've seen executive compensation grow at a much faster rate than the general economy, causing a lot of public concern that this is pay not for performance, but pay for failure. It's created a risk that corporations might lose the ability to use compensation as it ought to be used--as a way to drive business performance. 

What do you mean? Who would take that ability away?

It could be the government, it could be shareholders. Anytime you have government regulation, it tends toward one-size-fits-all solutions. It's hard to do that with compensation because if it's used to drive strategy, it's going to have to vary. You have more than 12,000 public companies, and they are all very different. If you can't use compensation in a way that fits the particular circumstances of a business, you've lost an incredibly valuable tool.

So the message seems to be: Make these changes before the government steps in and makes them for you. But what about shareholders? Their votes are nonbinding, right? 

Yes, but a vote against is quite a statement by shareholders and something that companies and their boards would like to avoid. 

The report recommends that compensation committees try to separate the impact of an executive's skill on a company's performance from sheer luck. Factoring out luck is tricky in economics. How would companies do that?

It can be hard to tease those apart. But there are ways to do it. You can compare the performance of a company with other similarly situated companies. If the CEO of Company X is consistently getting better returns than the CEO of another company that's a strong suggestion they are doing something right.

The report recommends scrapping perks like personal travel, retirement packages that credit executives with more years than they actually worked, and including the value of equity in determining postretirement benefits for top executives but not for lower-level executives. Isn't curbing some of these practices just common sense?

The unifying principle of these frequently criticized practices is that they are not tied to performance. We are calling for companies to concentrate on aligning compensation with performance, so it follows that you want to avoid having significant elements of compensation that don't connect with performance.

Did you receive performance-based compensation for your work on the report? 

[Laughs] No. I didn't get paid. It's something I did because I'm interested in it.

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