Commentary; CEO Politics
The Wall Street Journal
Tuesday, January 9, 2007
For an excellent example of why federal agencies so rarely
admit mistakes, look no further than the recent uproar over
the Securities and Exchange Commission's flip-flop on
stock-option disclosure. House Financial Services Chairman
Barney Frank is already planning to ride this error through
the next election as part of his campaign against CEO pay.
The SEC has been under attack since it announced -- on the
eve of Christmas weekend -- that it was modifying its July
disclosure rule on executive compensation. The commission's
new order tweaks the way stock option grants are disclosed,
with the goal of making total annual compensation figures
more accurate and consistent. Chairman Christopher Cox
admitted that the SEC had inadvertently adopted the wrong
version of one part of the rule, and was simply trying to
set things right.
That mea culpa counted little with Mr. Frank, who denounced
the SEC for loosening reporting requirements to provide a
"Christmas Eve" gift to corporate America. He also declared
that this "backtracking" by the agency meant his committee
now had an obligation to dive into the "problem" of
"unconstrained" executive compensation -- as if he needed an
This political opportunism is especially unfortunate because
the new SEC rule is entirely in keeping with Mr. Cox's goal
of bringing more "clarity and consistency" to corporate pay
disclosure. Even Mr. Frank praised the SEC's decision last
year to require companies to aggregate all of their top
executives' compensation -- pay, bonuses, perks, options --
into one bottom-line figure. When these reports begin to
become public later this year, investors will get a better
look at management costs and be able to compare those
numbers across companies.
Under the flawed SEC rule, companies would have had to
include, in their annual total compensation reporting, any
stock option grants awarded during the year. This would have
been highly misleading to the extent such grants weren't yet
exercisable and thus might never be "in the money." Under
the new rule, companies will instead include any options
that actually vest that year -- meaning options that
executives can truly turn into cash or stock.
Contrary to most media descriptions, the new rule won't
necessarily result in lower reported compensation numbers.
Under the old rule, a big grant would only appear in the
year it was awarded, then disappear in subsequent
disclosures. Under the new rule, the final figure will
include any and all previous option awards that vest in that
year -- leading, in many cases, to more substantial
bottom-line figures. Meanwhile, information about big annual
option grants is still readily available to investors,
albeit in a different section of the SEC compensation form.
This change will also harmonize the new compensation
disclosure forms with other corporate financial statements.
Under current accounting rules, companies only expense
options in their financial statements as the options become
exercisable. Given that the SEC's goal with its disclosure
rule was to make compensation figures more consistent and
understandable for investors, it would have made little
sense to set up two completely different ways of counting
The SEC's mistake is regrettable, but the agency might be
forgiven for overlooking what was a relatively minor point
in its gigantic 450-page July rule. And one reason it didn't
hold a public meeting on the new amendment is that all five
SEC Commissioners -- including its two Democrats --
unanimously agreed that the change was necessary.
Mr. Frank surely knows all this, but he is hunting bigger
political game -- namely, running against "excessive" CEO
pay and alleged "inequality" as Democrats gin up a campaign
issue for 2008. The left believes its neo-populism paid off
in November's election, and it wants to ratchet up the
rhetoric this year in Congress.
As part of his investigation, we can only hope Mr. Frank
explores the role that the last Democratic Congress played
in encouraging CEO stock option grants by limiting to $1
million the amount of executive cash compensation that
companies could deduct from taxes. (Bob Nardelli, Frank
Raines and Hank McKinnell, among others, are grateful.) But
then again, that would mean admitting that Congress made a
mistake; it's so much easier to demagogue CEOs and the SEC.