Ratchet, Ratchet and Bingo
My article in Friday's Business Journal looked at two big recent news stories: Harrisburg's settlement of fraud charges with the U.S. Securities and Exchange Commission and the state attorney general's office – OAG for short – closing its investigation of Hershey Trust Co. and Milton Hershey School.
In the Harrisburg part of the story, my sources agreed the SEC’s action should make municipalities more cautious about releasing public statements regarding their finances. The SEC’s view appears to be that bond markets always deserve the truth, the whole truth and nothing but the truth.
Fair enough. But my sources also said there’s a simple way to minimize liability: File timely, accurate disclosures, the way you’re supposed to!
As for the Hershey entities, the OAG found no breach of fiduciary duty. The parties agreed to a number of reforms; one of my sources thought they were too mild, while another said he would not second-guess the board’s actions, past or future.
One of the reforms, involving financial compensation, is illustrative, I think. Base compensation for trust board members was lowered significantly, and a mechanism was specified for future changes.
Here’s how it will work, according to the agreement: Every two years, the trust will submit the names of five “industry-recognized independent consulting firms” to the OAG. If the OAG agrees the firms are acceptable, it will pick three; from those, the trust will pick one. That firm will study the pay practices of comparable organizations and make a recommendation for the board to act on.
This procedure, the OAG presumably believes, will keep board members’ compensation from getting out of balance with their duties and responsibilities. To which I say, a la Ernest Hemingway, “Isn’t it pretty to think so?”
Consider executive pay. Compensation studies have shown no power to rein it in, or tie it to performance; indeed, many analysts think they have the opposite effect. The notion is that they create a “Lake Wobegon” or ratchet effect: Everyone looks at everyone else’s pay, everyone wants to be average or better, and so you get a cycle of raises that inspire raises that inspire raises, with no one looking at the underlying fundamentals of performance.
The same thing happens with board pay, according to, among others, Warren Buffett. The Sage of Omaha acerbically attributes ever-loftier director compensation to “corporate America’s favorite consultant, Ratchet, Ratchet and Bingo,” according to this New York Times article.
Compensation surveys are about circularity, not competition. House prices used to be high everywhere you looked, too – that didn’t make those prices objectively valid, as subsequent events proved.
Here’s one suggestion, which I offer at least half-seriously: How about sealed bids? A board’s bylaws could include a standing RFP for use in soliciting applications; candidates would respond with their qualifications and salary requirements.
For a public company, you could put the hopefuls to a shareholder vote. Matters would be trickier with a private trust, but the main thing is to arrange it so you have real competition, not people voting themselves another 10-percent bump on RR&B’s say-so.
I’m sure experts better versed in these matters than I could think of many reasons why this would backfire. But would it be worse than how things are done now?