American corporations today are like the great European monarchies of yore: They have the power to control the rules under which they function and to direct the allocation of public resources. This is not a prediction of what’s to come; this is a simple statement of the present state of affairs. Corporations have effectively captured the United States: its judiciary, its political system, and its national wealth, without assuming any of the responsibilities of dominion. Evidence is everywhere.

• The “smoking gun” is CEO pay. Compensation is an expression of concentrated power — of enterprise power concentrated in the chief executive officer and of national power concentrated in corporations. Median US CEO pay for 2010 was up 35 percent in the midst of a lingering recession, while CEO pay over the last decade has doubled as a percentage of pre-tax corporate income. Yet there has been no justification for current levels of CEO pay based on economic value added.

When Lee Raymond retired as CEO of ExxonMobil at the end of 2005, after six years at the helm of the merged firm and another six as head of Exxon before that, he walked away with more than a quarter billion dollars in realizable equity. In his final year alone, Raymond received in excess of $70 million in total compensation — an hourly wage of about $34,500 calculated at 40 hours a week for 50 weeks. No metric can justify such a raid on the corporate treasury and shareholder equity, but Raymond is only a particularly egregious and early example of what has since become common practice. Little wonder that the driving concern of banks receiving TARP “bailout” money was to pay it back so as to escape any restriction on executive pay.

• Retirement risk has been transferred to employees. During the same period that CEOs were doubling their own compensation, the “best” CEOs of the “best” companies abrogated the century-old commitment by employers to provide pensions to their workers. IBM has been the corporate leader in abolishing a “real” pension system for its employees. The 2006 elimination of on-going defined benefit plans will “save [IBM] as much as $3 billion through the next few years and provide it with a more ‘predictable cost structure’,” TK said at the time. Translation: The worker bees are on their own.

This is the essence of “capture” – CEOs are enriched, while all other corporate constituencies, including government, are left with liabilities. A relatively few autocrats have taken control over the policies and wealth allocation of the United States.

• The financial power of American corporations now controls every stage of politics — legislative, executive, and ultimately judicial. With its January 2010 decision in the Citizens United case, the Supreme Court removed all legal restraints on the extent of corporate financial involvement in politics, a grotesque decision that can have only one effect: maximizing corporate – not national — value. Today’s CEOs have been granted the power to direct political payments and organize PAC programs to achieve objectives entirely in their own self-interest, and they have been quick to use it.

More than $300 million was “invested” by corporations in the 2008 Presidential elections. The totals will be vastly higher in 2012 when the full impact of Citizens United is expressed, and the distribution will be politically agnostic. As Bill Moyers recently noted, President Obama “has raised more money from banks, hedge funds and private equity managers than any Republican candidate.”[1]

• Capture has been further implemented through the extensive lobbying power of corporations. Abraham Lincoln’s warning  about “corporations enthroned” and Dwight Eisenhower’s about the “unwarranted influence by the military/industrial complex” have been fully realized in our own time. Reported lobbying expenditures have risen annually, to $3.5 billion in 2010. Half of the Senators and 42 percent of House members who left Congress between 1998 and 2004 became lobbyists, as did 310 former appointees of George W. Bush and 283 of Bill Clinton.

Capture has focused on particular industries. Two powerful Democratic administrations have not been able even to propose a system of “single payer” health insurance.  Meanwhile, business interests have assured that whatever program of “universal coverage” emerges will lock in the interests of the insurance and the pharmaceutical industries.

History has yet to sort out whether the second Iraq War served any national objectives beyond military and industrial ones, but the suspicion that oil interests played a critical role in the rush to battle is enhanced by Vice President Cheney’s refusal to reveal the names of the participants in his energy transition committee. Simultaneously, the inability to force public disclosure of those participants offers a window into how thoroughly the energy industry controls its own agenda, destiny, and information flow. Not only has the industry succeeded in achieving and maintaining special regulatory and tax treatment; in multiple other ways, it functions virtually as an independent state.

• Capture has placed the most powerful CEOs above the reach of the law and beyond its effective enforcement. Extensive evidence of Wall Street’s critical involvement in the financial crisis notwithstanding, not a single senior Wall Street executive has lost his job, and pay levels have been rigorously maintained even when, as noted earlier, TARP payments had to be refinanced in order to remove any possible restrictions.

While several financial firms have paid civil penalties for their abuses, the amounts involved bear little relation to the malfeasance. US District Judge Jed S. Rakoff recently — and rightly — rejected the $285-million settlement agreed to between Citigroup Inc. and the Securities and Exchange Commission as “neither fair, nor reasonable, nor adequate, not in the public interest.”

Worse, such fines as have been imposed on the financial industry are basically being paid by the government itself. At the same time that various regulatory agencies boast of record setting penalties assessed against banks, the Federal Reserve pays banks interest on money that is not being lent, resulting in an “interest margin” realized by U.S. banks in the first six months of this year of $211 billion — more than ample funding for any penalties suffered.

• Finally, capture has been perpetuated through the removal of property “off shore,” where it is neither regulated nor taxed. The social contract between Americans and their corporations was supposed to go roughly as follows: In exchange for limited liability and other privileges, corporations were to be held to a set of obligations that legitimatized the powers they were given. But modern corporations have assumed the right to relocate to different jurisdictions, almost at will, irrespective of where they really do business, and thus avoid the constraints of those obligations.

As Nicholas Shaxson writes in Treasure Islands, “The privileges have been preserved and enhanced, but the obligations have withered.” Meanwhile, the U.S. Treasury is estimated to be losing $100 billion annually from off-shore tax abuses.

Government cannot and will not hold corporations to account. That much is now obvious.  Indeed, the dawning realization of this truth is what has informed the Occupy movement, but only the owners of corporations can create the accountability that will ultimately unwind the knot of government capture.

The essence of the problem is quite straightforward: a failed system of corporate governance. So is the cause: the unwillingness of trustee owners of America’s corporations to assert their responsibility, legal duty, and civic obligation to monitor and oversee the corporations they invest in. Fiduciary institutions own 80 percent of the outstanding shares of corporate America and thus bear at least 80 percent of the responsibility for present circumstances as well as 80 percent of the onus for saving the system itself. And the largest institutional investors — the Bill and Melinda Gates Foundation, Harvard University, and others — must take the lead because (a) they should and (b) all other courses have failed.

Urban park by urban park, campus by campus, the Occupiers are bearing sometimes inchoate witness to America’s capture by corporate interests. Now, men and women of conscience need to reoccupy the boardrooms of America’s corporations. The boardroom is where the takeover began, and it’s where capture can finally be undone and a government of, by, and for the people, not the corporations, restored to the land.

Robert AG Monks is a shareholder activist and corporate governance adviser who has written widely about shareholder rights & responsibility, government capture, corporate impact on society and global corporate issues.

Mr. Monks is an expert on retirement and pension plans and was appointed director of the United States Synthetic Fuels Corporation by President Reagan, who also appointed him one of the founding Trustees of the Federal Employees’ Retirement System.  Mr. Monks served in the Department of Labor as Administrator of the Office of Pension and Welfare Benefit Programs having jurisdiction over the entire U.S. pension system.

Mr. Monks was a founder of Institutional Shareholder Services (ISS), now the leading corporate governance consulting firm.  He also founded Lens Governance Advisers and co-founded The Corporate Library (now Governance Metrics International).  He is a shareholder in and advisor to Trucost, the environmental research company.

This post is based on the executive summary of a Council of Institutional Investors white paper which was prepared by Robin A. Ferracone and Dayna L. Harris, Executive Chair and Vice President, respectively, at Farient Advisors, LLC; the white paper is available here.

Advisory shareowner votes on executive compensation were the big story of proxy season 2011, the inaugural year for “say on pay” at most U.S. public companies. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law in August 2010, requires U.S. public companies to provide their shareowners with a non-binding vote to approve the compensation of senior executives. The Securities and Exchange Commission’s (SEC) implementing rule, adopted on Jan. 25, 2011, requires say-on-pay votes to approve the compensation of the named executive officers (NEO) at larger companies at least once every three years. The SEC granted smaller companies a two-year exemption.

Say on pay gives shareowners a voice in how top executives are paid. Such votes are also a way for a corporate board to determine whether investors view the company’s compensation practices to be in the best interests of shareowners. Say-on-pay votes are purely advisory; U.S. companies are not required to change their executive compensation programs in response to the outcome. But SEC rules do require that in subsequent proxy statements, companies discuss how the most recent say-on-pay voting results affected their executive compensation decisions and overall programs. Such follow-on comments are to be included in the Compensation Discussion and Analysis (CD&A) section of the proxy statement.

Advisory votes on pay are not a new concept. Say on pay has been widely discussed in the United States as a way to hold directors accountable for runaway executive compensation for close to a decade, ever since the Enron (2001) and WorldCom (2002) scandals. The United Kingdom adopted mandatory say-on-pay votes in 2002, and Australia followed in 2004. Two U.S. companies — AFLAC and RiskMetrics — voluntarily held say-on-pay votes starting in 2008, with Motorola following in 2009, in response to strong investor support for shareowner resolutions requesting annual advisory votes on pay. The U.S. government required more than 350 companies that received federal bailout assistance after the 2008 global financial crisis to give their investors advisory votes on executive compensation, beginning with proxies filed after February 2009.

Analyzing Say on Pay

The Council of Institutional Investors, a leading advocate for say on pay, engaged Farient Advisors to analyze what motivated investors to vote against say on pay at companies where the proposal failed to receive majority support at 2011 annual meetings. The Council believes the report will benefit active investors by identifying compensation practices where support for change is greatest. It also could help them target initiatives for improved pay practices and provide useful input for structuring their voting policies. Companies will benefit, too, from knowing which compensation practices their owners view as detrimental to long-term shareowner value.

Between January 1 and July 1, 37 say-on-pay proposals fell short of majority support. Another 37 companies garnered significant, though less-than-majority opposition, with “against” votes of 40 to 50 percent. While 37 “failed” votes is a tiny fraction (less than 2 percent) of the 2,340 say-on-pay votes at U.S. companies in the first half of the year, the total was surprisingly large compared with the track record of say on pay in other countries.

Public attention has focused on the relatively high number of “failed” say-on-pay votes (proposals that failed to win majority investor support), the impact of proxy advisory firm recommendations on shareowner voting, the reasons for “against” vote recommendations by proxy advisers and, and most recently, shareowner derivative lawsuits at companies where say on pay garnered majority “against” votes. It is clear from our interviews and public filing research that some companies have changed or promised to change their pay levels and programs in anticipation of a strong vote against their say-on-pay proposals, or in response to a substantial percentage of “against” votes.

The report specifically examines:

• The driving factors that fueled majority opposition to say on pay at 37 companies
• The process investors used to determine how they would cast say-on-pay votes
• The influence that say on pay is having on executive compensation
• Potential next steps for shareowners to consider ahead of say-on-pay votes next year
• Potential next steps for companies where investor opposition to say-on-pay proposals was significant

Farient focused its investigation on advisory votes that failed to win majority shareowner support. Farient interviewed representatives from 19 Council member organizations (both U.S. pension fund and other members) about how they cast say-on-pay votes generally and more specifically at the 37 failed-vote companies. These investor participants consisted mostly of public employee pension systems (58 percent), followed by mutual fund firms (32 percent) and union pension funds (11 percent). (The total may not equal 100 percent due to rounding.)  Collectively, their assets under management exceed $7.9 trillion. Farient also interviewed proxy advisers and solicitors, and consulted its extensive database on executive compensation.

Farient found that investors cast advisory votes against executive compensation at the 37 companies for a variety of reasons, but the factors most frequently cited were:

• A disconnect between pay and performance (92 percent)
• Poor pay practices (57 percent)
• Poor disclosure (35 percent)
• Inappropriately high level of compensation for the company’s size, industry and performance (16 percent)

Other findings include:

• Investors were extremely thoughtful about evaluating executive compensation for say-on-pay votes
• Due to resource constraints, investors used proxy advisory firms’ analyses to varying degrees
• Investors considered multiple factors as well as inputs from various sources in determining their say-on-pay votes
• Investors evaluated performance and pay over multiple years, and focused primarily on total absolute shareholder return (TSR) over one-, three- and five-year periods
• Investors spent the most time and resources analyzing pay at “outlier” companies: those with large disconnects between pay and performance, high overall pay and/or low TSR in comparison to their industry or peers
• Investors focused on CEO pay, rather than the pay of other NEOs, and on the overall “reasonableness” of the level of compensation in view of the company’s size, industry and performance
• Investors mostly regarded the say-on-pay vote as an opportunity to voice their concerns about a particular pay program, not a referendum on directors’ oversight of compensation

Among majority “against” say-on-pay votes, about two thirds had opposition levels of 50–59 percent. The rest had “against” votes of 60–70 percent. About one-fourth (27 percent) were in real estate, homebuilding or construction-related businesses — industries that were hit hard in the economic downturn and mostly are still hurting. About one-fifth (19 percent) were energy-related companies. Nearly half were large companies, with annual revenues greater than $1 billion.

Moving Forward

This first year of mandatory say on pay has been a learning experience for all participants. Farient encourages investors to conduct a “post-mortem” of their voting processes, including an assessment of any additional resources needed to evaluate say-on-pay proposals fairly and efficiently. Concerned investors should follow up to see what steps, if any, companies take in response to failed say-on-pay proposals, and consider appropriate action.

Farient also offers two critical areas for improvement in deciding how to cast a say-on-pay vote:

• TSR should not be the sole filter investors use to determine which companies’ pay plans deserve the most scrutiny. Problematic pay practices lurk at mediocre to modestly performing companies, too
• Assessing performance-adjusted pay — compensation that top executives could receive after performance is taken into account — and in particular the performance-adjusted value of equity — is more appropriate than focusing on the grant date value of equity incentives. The value on the date of grant, as determined by the stock price that day for shares (or options, using an options pricing model), does not reflect the compensation that executives ultimately earn

Companies that failed to win majority support for say-on-pay proposals, or that garnered substantial opposition, should reach out to key investors and engage them in dialogue about executive pay programs. They should also make sure their pay disclosures are clear and thoughtful and that their compensation programs are aligned with company performance. That means having a combination of pay that is sensitive to changes in performance, pay levels that are appropriate overall, and a substantial proportion of pay that is performance-based. In particular, companies should consider setting the magnitude of pay changes in response to performance, so that the changes swing proportionately with strong or weak performance.

In Closing

Legislation has forced both investors and companies to pay more attention to executive compensation. Compensation committees and boards have become much more thoughtful about their executive pay programs and pay decisions. Companies and boards in particular are articulating the rationale for these decisions much better than in the past. Some of the most egregious practices have already waned considerably, and may even disappear entirely.

Say on pay is a non-binding advisory vote. Investors agree that they do not want to dictate executive pay arrangements. Rather, they want to ensure that the executive pay programs of their portfolio companies incentivize executives to increase shareowner value for the long term. Moreover, if the pay programs are not benefitting long-term owners, investors want the ability to influence their portfolio companies to make the necessary changes. This seems to be what say on pay is all about.

Ann Yerger is Executive Director of the Council of Institutional Investors. This post is based on the executive summary of a CII white paper which was prepared by Robin A. Ferracone and Dayna L. Harris, Executive Chair and Vice President, respectively, at Farient Advisors, LLC; the white paper is available here.

This article was first published on the Harvard Law School Forum on Corporate Governance and Financial Regulation and is re-published with the author's permission.

CEOs for all their talents are not magicians. There isn’t a wave of the wand for a quick turnaround or a potion that will drive up a stock price. Or at least there aren’t ones available so far. Short of the disguised super hero, boards have to rely on their due diligence and judgment in assessing the right candidate.

Sometimes that doesn’t work out well.

Reader’s Digest CEO Tom Williams was fired in September 2011, less than five months after he took the job, replaced with a board member; Also in September, Hewlett Packard (HP) CEO Leo Apotheker, fired after eleven months, was replaced by board member Meg Whitman, former candidate for Governor of California and former eBay CEO. Other recent high-profile CEO firings include Carol Bartz at Yahoo! and Ernst Lieb at Mercedes-Benz USA.

In monitoring CEO departures, firings are often cloaked as resignations or retirements, and are under-reported. In the monthly reports done by outplacement firm Challenger, Gray & Christmas through the end of third quarter 2011, 922 CEO departures were tracked. September’s tally of 108 was the highest since September 2010.

The firing of a CEO and how he or she leaves their position often reveals a lot about them, their bosses, and their organization. At HP and Yahoo, for example, expectations about turnaround progress and financial results weren’t being met. For Daimler AG, Mercedes-Benz USA’s dazzling results in luxury vehicle leadership didn’t excuse the CEO’s failure to meet Daimler’s zero tolerance for ethical violations.

Apotheker hasn’t discussed publically his reaction to how he was fired. He had to have seen the media reports that HP shares rose 7 percent on the rumor September 21 that he was being replaced by Whitman at a board meeting the next day. He is reported to have gone to the meeting prepared to discuss strategy, the meeting’s original purpose.

Immediately upon being fired, Apotheker sent an upbeat email to employees thanking them for their efforts, accomplishments together, and dedication which he said inspired him. His consolation prize? A rich severance package that critics argue perpetuates the practice of rewarding CEOs for failed performance. During Apotheker’s tenure, HP’s stock price dropped $16.00 a share.

In an effort to distance the current HP board from the board 11 months prior that hired Apotheker, the new executive chairman Raymond Lane, went to lengths to point out that most of the 13 board members, including Meg Whitman, were appointed in 2011 after Apotheker’s selection. Lane said the new board evaluated Apotheker and found him lacking in leadership, execution and communication. Lane, sensitive to criticism HP’s board has faced in the past (a 2006 pre-texting scandal and the departure of former CEO Mark Hurd) is positioning the board as being new; however six of 13 members were on the board when one or both issue(s) came before it.

Yahoo has had its challenges. Bartz was hired in 2009 to replace co-founder Jerry Yang and lead a turnaround. Half the board members who voted to fire Bartz hadn’t been on board when she was hired. Shares increased from $12.90 to $13.70 in after hours trading on news of her firing September 6, 2011; financial results were about the same as when she had been hired.

Board chairman Roy Bostock, chair when Bartz was hired, fired her over the telephone when she was out of town on business - not a technique likely to catch on as an effective way to show respect and contain damage. (Yahoo is now pursing potential buyers for Yahoo’s core businesses as well as a CEO search.)

Bartz responded by emailing Yahoo’s 14,000 employees that she’d been fired over the phone by the board chairman. She wished them the best, saying it had been her pleasure to work with them. The next day she gave an interview to Fortune detailing how Bostock had handled the firing. She called the board members “doofuses” and used the salty language she is known for: “These people f---ed me over,” she said.

John Challenger, CEO of Challenger, Gray & Christmas, referred to Bartz’s exit as the “burning the bridge method.” Generally boards and leaders are cautious on the leader’s exit, Challenger said in a recent interview. “These issues are delicate and most people don’t want a messy divorce. The ideal is to do it quietly, and both parties move on.”

What is the best way for a leader to leave? “With grace,” Challenger replied, “because there is usually fault on both sides.”

Some CEO departures seem like the proverbial bolt out of the blue. Mercedes’ Lieb enjoyed a five-year tenure of successful turnaround, great sales results, market leadership, industry respect, and high dealer approval. But that wasn’t the whole story.

In April 2010, Daimler AG and its subsidiaries in Germany, China and Russia pleaded guilty to violating U.S. anti-bribery laws and were fined $185 million. As part of a deferred prosecution agreement with the Justice Department, changes were made in how Daimler handled compliance throughout the world. Changes that apparently Lieb didn’t apply to himself. He is reported to have used company money for personal expenses, disregarding warnings he received.

Lieb was fired October 18, 2011. He remains with Mercedes in a capacity the company hasn’t yet explained. He has made no public statement. Mercedes USA CFO Herbert Werner replaced him, pending finding a permanent replacement. By removing Lieb from his CEO post, Daimler Chairman Dr. Dieter Zetsche sent a message throughout the Daimler organization that achieving outstanding business results doesn’t supersede compliance and ethical behavior.

So what lessons can be drawn from all this?

First, and maybe most importantly, hire the right CEO to begin with. Given the turnover in boards, directors would be well served to read the excellent, and still relevant, 2002 Harvard Business Review article Don’t Hire the Wrong CEO by Warren Bennis and James O’Toole.

Turnaround situations have little margin for error so how a board and CEO work together requires a unique partnership. Neither the executives nor the directors came off well in the Yahoo and HP examples. Each turnaround has to balance the urgency of expectations against the reality in which a CEO needs to create success. In the search for the winning strategy, how Yahoo and HP directors work with their changes in leadership this time around will reveal what, if anything, has been learned.

Shareholders aren’t served by blame games – where leaders call boards incompetent or boards make leaders scapegoats. If directors and leaders don’t take the time to develop the skills to work through difficult conversations in the boardroom, the issues when they surface in the media undermine confidence in the company.

Modeling and following ethical standards matter. Lieb apparently didn’t understand what was at stake for Daimler in needing to raise the bar on its adherence to compliance and ethics.

Just as there is no magic wand to deliver results, there is no short cut to understanding what is expected. Leaders rise and fall on how they get that message.

Gael O’Brien is a Business Ethics Magazine columnist. Gael is a thought leader on building leadership, trust, and reputation and writes The Week in Ethics.

Brian Tayan and I recently co-authored a book, titled Corporate Governance Matters, which takes an organizational perspective, rather than a legal perspective, on the important topic of modern corporate governance. Our purpose is to examine the choices that organizations can make in designing governance systems and the impact those choices have on executive decision-making and the organization’s performance. The book relies on an extensive body of professional and scholarly research, and aims to correct misconceptions and cut through the considerable rhetoric surrounding corporate governance. We hope the book provides a framework that enables practitioners to make sound decisions that are well supported by careful research.

Our book covers a wide range of topics regarding corporate governance. These include a discussion of the environment in which the organization competes to understand how various forces influence the mechanisms it adopts to discourage self-interested behavior by management. In addition, we spend considerable time examining the board of directors, including the structure, processes, and operations of the board, along with the board’s functional responsibilities, such as oversight and risk management, succession planning, compensation, accounting and audits, and the consideration of mergers and acquisitions. We also examine the role of the institutional investor to understand how diverse shareholder groups and third-party proxy advisory firms influence governance choices. The book also includes an assessment of commercial and academic governance ratings systems.

Many of the conclusions of the book are phrased in the negative. While the lack of positive correlations may disappoint some, this has important implications for the current debate on governance and your evaluation of the types of governance systems that organizations might require. Some of the central lessons we draw in the book including the following:

Testing Remains Insufficient

First, the lack of positive correlations suggests that most of the best practices—either those recommended by blue-ribbon commissions and high-profile experts or those required by regulators—have likely not been tested, or important influencers have not properly understood the results of those tests. We saw this clearly in the passage of both Sarbanes-Oxley and the Dodd-Frank Act, in which considerable disconfirming evidence was not considered when restrictions were placed on nonaudit services provided by the auditor and greater shareholder democracy was required.

Instead, we share the sentiments of Myron Steel, Chief Justice of the Delaware Supreme Court, who recently wrote:

Until I personally see empirical data that supports in a particular business sector, or for a particular corporation, that separating the chairman and CEO, majority voting, elimination of staggered boards, proxy access with limits, holding periods, and percentage of shares—until something demonstrates that one or more of those will effectively alter the quality of corporate governance in a given situation, then it’s difficult to say that all, much less each, of these proposed changes are truly reform. Reform implies to me something better than you have now. Prove it, establish it, and then it may well be accepted by all of us.

This standard should be a precondition to all governance changes, both those mandated by law and those voluntarily adopted. Governance changes are costly, and failed governance changes even more so. They are costly to the firm in terms of reduced decision-making quality and inefficient capital allocation, and they are costly to society in terms of reduced economic growth and value destruction for both shareholders and stakeholders. We believe that careful theoretical and empirical work can go a long way toward better understanding what works and does not work so that changes can be made in a cost-effective manner. There is no question to us that “governance matters.” The fundamental challenge is to understand when and how it matters.

The Current Focus Is Misdirected

Second, the lack of positive correlation signals that much of the discussion focuses on the wrong issues, such as independent chairman, staggered boards, risk committees, and director stock ownership guidelines. As such, efforts to improve governance systems (and the regulations that tend to come with them) are likely misdirected. Instead of focusing on features of governance, more attention should be paid to the functions of governance, such as the process for identifying qualified directors and executives, strategy development, business model analysis and testing, and risk management. To illustrate this point, consider the following sets of questions:

CEO Succession

• Does the company have a CEO succession plan in place?
• Is the CEO succession plan operational? Have qualified internal and external candidates been identified? Does the company engage in ongoing talent development to support long-term succession needs?

Risk Management

• Is risk management a responsibility of the full board of directors, the audit committee, or a dedicated risk committee?
• Do the board and management understand how the various operational and financial activities of the firm work together to achieve the corporate strategy? Have they determined what events might cause one or more of these activities to fail? Have these risks been properly mitigated?

Executive Compensation

• What is the total compensation paid to the CEO? How does this compare to the compensation paid to other named executive officers?
• How is the compensation package expected to attract, retain, and motivate qualified executive talent? Does it provide appropriate incentive to achieve the goals set forth in the business model? What is the relationship between large changes in the company stock price and the overall wealth of the CEO? Does this properly encourage and long-term performance without excessive risk?

In each of these, the first question asks about a governance feature, the second about a governance function. A focus on the latter will almost certainly yield significantly more benefit to the organization and its stakeholders.

A mistake that many experts make is to assume that the presence of the feature necessarily implies that the function is performed properly. That is, if a succession plan is in place, the assumption is that it is a good one; if there is a risk committee, the company takes risk management seriously; if compensation is not excessive, it encourages performance. We have seen clear evidence that this is not always the case. If experts and proxy advisory firms are to add any value, they should shift from a service that verifies that features are in place, to one that evaluates the success of various functions. This no doubt would require a substantial increase in analytical skills and processes, but it is a shift that markets would likely value.

Important Variables Are Clearly Missing

Third, the lack of positive correlation suggests that important variables that impact governance quality have been inappropriately omitted or underemphasized in the discipline. After all, governance is an organizational discipline. As such, the analysis should incorporate organizational issues—such as personal and interpersonal dynamics, and models of behavior, leadership, cooperation, and decision making. Without offering a comprehensive list, we believe the following elements are central to understanding how a governance system should be structured and when and where it is likely to fail:

• Organizational design — Is the company decentralized or centralized in structure? Have internal processes been rigorously developed, or did they evolve from historical practice?
• Organizational culture — Does the culture encourage individual performance, or cooperation? How are successes and failures treated? Is risk-taking encouraged, tolerated, or discouraged?
• The personality of the CEO — Who is the CEO, and what motivates this individual? What is his or her leadership style? What are the individual’s ethical standards?
• The quality of the board — What are the qualifications of these individuals? Why and how were they selected? Are they engaged in their responsibility, or do they approach it with a compliance-based mindset? What is their character?

As evidence, we see some of these aspects in the literature, but often peripherally and without thorough consideration. For example, an analysis of the linguistic patterns of the CEO and CFO is shown to have some relation to the probability that the company will have to restate earnings in the future. Strong leadership, clear access to information, and parameters around corporate risk taking are important in ensuring that the company develops an appropriate risk culture. Directors with extensive personal and professional networks facilitate the flow of information between companies. This can lead to improved decision making by both allowing for the transfer of best practices and acting as a source of important business relationships.

We believe that these types of analyses should be pursued further and with greater rigor. Doing so will require tools and techniques across disciplines. It is a mistake to think that corporate governance can be adequately understood from a strict economic, legal, or behavioral (psychological and sociological) perspective. All of these views are necessary to understanding complex organizational systems.

Furthermore, this necessarily implies that the optimal governance system of an organization will be firm-specific and take into account its unique culture and attributes. Adopting “best practices” will likely fail because that approach attempts to reduce a complex human system into a standardized framework that does not do justice to the factors that make it successful in the first place. This explains why two companies can both succeed under very different governance structures.

Context Is Important

Finally, governance systems cannot be completely standardized because their design depends on the setting. For example, governance systems differ depending on whether you take a shareholder perspective or a stakeholder perspective of the firm, as well as the efficiency of local capital markets and labor markets. They also differ depending on your view of the prevalence of self-interest among executives.

Consider, for example, John Bogle, the founder of Vanguard, who has written about self-interested behavior among executives:

Self-interest got out of hand. It created a bottom-line society in which success is measured in monetary terms. Dollars became the coin of the new realm. Unchecked market forces overwhelmed traditional standards of professional conduct, developed over centuries. The result is a shift from moral absolutism to moral relativism. We’ve moved from a society in which “there are some things that one simply does not do” to one in which “if everyone else is doing it, I can, too.”

The extent to which you believe this is the norm in society will have a direct impact on the extent to which you believe control mechanisms should be in place to prevent the occurrence of self-interested behavior and the rigor of those controls. Nevertheless, in the end, a balance must be struck. Excessive controls will lead to economic loss by retarding the rate of corporate activity and decision making. Lenient controls will lead to economic loss through agency costs and managerial rent extraction.

As our book seeks to demonstrate, context is critical to designing an effective corporate governance system.

David Larcker is the James Irvin Miller Professor of Accounting and Director of the Corporate Governance Research Program at Stanford University.

It's impossible to discuss the role of Corporate Social Responsibility (CSR) in today's business without acknowledging the elephant in the room. The economic collapse that began in 2007 was largely the result of a colossal failure of leadership in both the finance industry and the U.S. government. The once venerable investment banking industry has devolved into an unsupervised and unregulated market, a giant that casts its dark shadow over the entire economic system. And while most of us are still wading through the debris of the Great Recession, Congress has yet to enact any truly game changing regulation, and Wall Street compensation still incongruously exceeds the pay of today's brain surgeons.

For a comprehensive history of how we got here, watch the film Inside Job, but here is the abbreviated version: The banking community created complex high risk financial instruments whose singular purpose was to drive maximum short term profits. The government did nothing to protect us, except to determine that tax payers must bailout these companies that were considered too big to fail. The credit crisis, the housing market collapse, illegal foreclosures and long term unemployment ensued, while the banks continue to thrive, rewarding themselves with lavish pay and bonuses.

So where did this dichotomy come from? How did it happen that the goals of investment banks are in direct conflict with the health and well-being of the entire economic system? And how can we reconcile the profound gains achieved on Wall Street with what Umair Haque calls America's "jobpocalypse"?

Mr. Haque makes the point in The Capitalist's Paradox that what's standing in the way of great capitalism today might just be yesterday's capitalists--"trying at every turn to stifle competition, squelch information, earn an unfair advantage, and extract value from people, nature, and the future, instead of creating authentic, thick, shared value for them."

I cannot disagree. But I would also add that for those of us who work in the world of CSR, it seems unfathomable that an industry as powerful as Wall Street would continue to operate in such a self-serving and destructive manner. Every day, we see examples big and small of how a new culture of business leadership is emerging, one in which corporations resolve to instill positive values and evaluate the long term effects of every decision they make. CSR broadens the definition for business success, raising the bar to include the Triple Bottom Line: People, Planet and Profits.

In order to successfully integrate CSR into business, we have to start by changing the culture of Wall Street, and that change has to come from within. There are some bright spots in the leadership of the financial sector, these are key individuals who are mindful of the impact that their business has on the world around them. By showcasing these game-changers in our conferences and including them in our conversations, we can shine a light on those working tirelessly to change the rules of the game. Bill Ackman is a good example. Mr. Ackman is the billionaire founder of hedge fund Pershing Square Capital, and a very outspoken critic of the conflict of interest at the ratings agencies. Mr. Ackman continues to call out the corruption in the ratings process and offers solutions to fix the very unhealthy dynamic between the rating agencies and the investment banks. Mr. Ackman is also a philanthropist; his Pershing Square Foundation provides grants to entrepreneurs who facilitate change in education, global health care, poverty alleviation, and human rights.

There are other values-based finance leaders who are working to build transparency into the investment banking business. David Blood, of Generation Investments, is a pioneer working to transform the culture of the financial industry for the better. Mr. Blood is a proponent of Sustainable Capitalism, a movement which seeks to maximize long-term value creation, by integrating environmental, social and governance (ESG) factors into investment strategies. Likewise, Jacques-Philippe PivergerGlobal Syndicate of Pinebridge Investments is an inspirational leader and a serial social entrepreneur, doing selfless work for the and the Haiti Project. On the business side, there is Curtis Ravenel, Global Head of Sustainability at Bloomberg. Curtis is a pioneer in ESG investing who is leading Bloomberg's push for corporate sustainability and responsible investing.

Wall Street has always claimed to attract "the best and the brightest" young talent to their industry. If true, then this is very good news, because many of today's brightest graduates are expressing an interest in careers that create social and environmental value, along with financial profitability. Just two years ago, nearly 20% of the Harvard graduating class signed "The M.B.A. Oath," a pledge that M.B.A.'s will act ethically, and refrain from advancing their "own narrow ambitions" at the expense of others. Perhaps the young graduates themselves will transform Wall Street by rejecting a scorched earth investment strategy, in favor of one that has a foundation in social responsibility. Let's hope that this movement becomes a beacon that is bright enough even for Wall Street to see.

Ann Charles is CEO of BRANDfog, offering social media and Corporate Social Responsibility strategy for CEOs.

Cash bonuses paid to New York City securities industry employees declined by nearly 8 percent to $20.8 billion in 2010, as Wall Street firms shifted toward more deferred compensation and higher base salaries, according to an estimate released by New York State Comptroller Thomas P. DiNapoli.

For the average Wall Street worker, however, that still translated into a 2010 cash bonus of $128,530, according to DiNapoli’s estimate.   And although cash bonuses were down, it's estimated that total compensation on Wall Street rose 6 percent last year, DiNapoli said.

“Cash bonuses are down, but that’s not an indicator of a weakness on Wall Street,” DiNapoli said. “Wall Street is changing its compensation practices in response to regulatory reforms adopted in the aftermath of the greatest financial meltdown since the Great Depression.  Past practices rewarded short-term gains at the expense of long-term profitability.”

Profits of the broker/dealer operations of New York Stock Exchange member firms, the traditional measure of Wall Street profitability, totaled $27.6 billion in 2010, “making 2010 the second most profitable year on record after the $61.4 billion record set in 2009, which was fueled by federal bailouts, low interest rates, and proprietary trading,” according to DiNapoli.

DiNapoli’s office annually releases its estimate of bonuses paid to securities industry employees who work in New York City.  Bonuses paid by New York City-based firms to their employees outside of the City (whether in domestic or international locations) are not included.  DiNapoli’s office said the estimate is based on tax collections and reflects cash bonus payments and deferred compensation for which taxes have been prepaid. The estimate does not include stock options that have not yet been realized or other forms of deferred compensation.

The securities industry in New York City added 3,600 jobs between August 2010 and December 2010, according to DiNapoli, and trends in unemployment insurance data suggest job gains may have been even stronger during this period.  The securities industry in New York City lost 30,700 jobs during the recession, a decline of 16 percent, or 3.5 times the rate of total job loss in New York City, according to the state comptroller’s data.

An audio file of Comptroller DiNapoli's press briefing on this report is available here.

Among the December 2009 proxy rule changes approved by the SEC was a requirement that companies discuss and analyze risks that are reasonably likely to have adverse effect on the company’s reputation and/or sustainability.  This means companies must not only identify the risks facing them but also determine the probability and severity if realized and how that relates to the company’s compensation policies and programs.

But it is virtually impossible for a company to succeed without taking risk.  Success is not guaranteed.  And it is reasonable that CEOs and other executives should be rewarded for succeeding in spite of the risk.  But companies and more specifically the boards of directors have to know the severity and probability of risk.  What boards are learning is that it is not a smart business decision to take on a risk that could destroy the company even if the probability is low.  Paying excessively to executives to take on this risk makes it even worse.

SEVERITY & PROBABILITY OF RISK

A starting point would be to categorize severity of risk as: low (or none), reasonable or severe.  A severe risk would cause major damage to the company possibly sending it into bankruptcy, and/or rippling through the economy with disastrous results.   Reasonable risk is what companies are expected to include in their plans, whereas low risk targets would result in under-performing companies.

The probability of occurrence could similarly fall into three categories: low or (none), moderate and high.  Combining the severity of risk with the probability of occurrence results in nine combinations.

Severe risk with:

• High probability
• Moderate probability
• Low probability

All severe risk situations, regardless of probability should be avoided.  Some have argued that the securitization of loans was a low probability situation.  But we saw how that turned out.

Reasonable risk with:

• High probability
• Moderate probability
• Low probability

Reasonable risk situations are what companies should be considering and a major factor in designing the pay-for-performance plans.

Low risk with:

• High probability
• Moderate probability
• Low probability

Low risk situations should focus the emphasis on the salary plan not the incentive program.

EXECUTIVE PAY

With the backdrop of probability and severity of risk, it is possible to examine executive pay in terms of: low, reasonable and excessive.  The one receiving the most attention is of course excessive pay.  Given the five pay elements: salary, employee benefits, executive benefits, (or perquisites), short-term and long-term incentives, an overly generous payment of any could be excessive but the most likely candidates are the incentive plans, both short and long-term.

EXCESSIVE PAY

There are three scenarios for excessive pay.  It can be tied to severe risk, reasonable risk and little if any risk.  The first scenario is when the pay is appropriate given the level of risk, but the plan should never be designed to reward achievement that can severely damage the company, if not send it into bankruptcy.  One does not have to look further than the subordinated mortgage debacle.

The reasonable risk situation is when the pay is greater than justified in relation to the risk.  This is probably the most common situation.  And incentive payment of any amount is probably excessive when there is little if any risk.

REASONABLE PAY

The objective of any well-designed pay plan is reasonable pay for achieving reasonable performance targets based on an assessment and probability of risk.

Pay-for-performance should be focused on stretch targets but not high-risk targets.  No pay plan should be structured to pay for successfully meeting performance targets that could drive the company into bankruptcy.  However, if there is low to no risk, payments should be moderate.

LOW PAY

If performance is low, it is expected that pay will be low.  If not, it can be argued that pay is not reasonable maybe even excessive.  In fact, there probably should be no pay under the annual and long-term incentive plans.  The only pay should be in salary.

However, the low-paying scenario may also describe a situation where the executive has met the performance expectations but because of a poorly designed plan, the person is underpaid.  This is hypothetically possible but hard to find in the for-profit sector.

Low pay may also be the result of a draconian clawback because of an after-the-fact determination of the appropriate amount of pay for continued performance.  Careful analysis of risk before finalizing the pay plan should minimize such a draconian action.

BOARD OF DIRECTOR & COMPENSATION COMMITTEE RESPONSIBILITIES

When companies become too big for the owner to continue to control day-to-day operations, the owner looks to bring in professional managers to take on the responsibility.  To think like owners, these managers are given cash and stock incentives.  It is reasonable to expect the cash to meet current needs and the stock to be an asset for later needs.  Stock plans were created in the 19^th century to make professional managers think like owners.  Acquired stock was not to be sold until leaving the company, preferably at retirement age.

But today many boards and their compensation committees have lost their way.  They permit executives to cash out stock options and stock awards, thereby breaking the link with the shareholders.  And to make matters worse some companies have approved incentive plans that pay out lavishly in the presence of major risks, thereby threatening the sustainability of the company.

Bruce Ellig is the author of more than 100 articles and seven books including his most recent, the updated and revised edition of The Complete Guide to Executive Compensation. Much of the material in this paper has been taken from this book.  Ellig served as worldwide head of HR for Pfizer Inc. for the last 11 years of his 35 years with the company.

It’s probably safe to say that Don Blankenship had something to celebrate with the new year. Last Friday, the CEO of Massey Energy retired, and according to company disclosures he received $2 million that day. He’ll get another $10 million in July, plus consulting fees for two more years, CNN reported.

Blankenship, dubbed the “Dark Lord of Coal Country” in a November profile in Rolling Stone, saw his company come under scrutiny last year when its Upper Big Branch mine in West Virginia exploded in April, killing 29 miners. Public attention largely shifted when, just weeks later, BP’s Deepwater Horizon oil rig exploded, killing 11 workers. The Wall Street Journal reported today, however, that lawmakers are demanding an end date for the investigation of Massey Energy, which has continued for months in private and with few updates provided to the families of the deceased miners.

The Labor Department’s Mine Safety and Health Administration has long faced criticism for its failure to take swift action against risky mine operators found to be violating safety standards. Part of the challenge is the agency’s backlog of appealed safety citations. Companies frequently contest citations, delaying enforcement action or avoiding it altogether.

In September, we wrote about a government report that faulted MSHA  for “lack of leadership” in administering a program that was supposed to identify and penalize mines with patterns of violations. As we noted, the agency had never once tried to exercise its authority by designating a mine as having a “pattern of violations,” a status that opens the door to tougher enforcement, including court- ordered shut downs.

A month later, the agency—which had pledged to toughen enforcement going forward—asked a federal judge to shut down a Kentucky coal mine operated by Massey Energy.

The company poses a particular challenge to regulators. The Washington Post reported this week that for years the company managed to strike deals and get passes from regulators:

Massey's approach to federal regulation has been notable for two tactics that, according to critics, allow the company to thwart or skirt safety requirements. First, Massey has persuaded regulators to forgo safety rules on a case-by-case basis. Second, the company routinely contests federal citations in a manner that makes it virtually impossible for the government to force quick safety overhauls in the nation's most hazardous mines.

Under Blankenship, Massey had mastered the art of the regulatory waiver, a way to legally circumvent federal mining laws. The MSHA has approved 30 petitions from Massey to operate its mines outside of safety mandates, more than for any other company. Most were in the past decade.

… The waivers allow Massey to mine through gas wells, to construct escapeways lower than the legally-mandated five feet and to create fewer ventilation channels to provide miners with clean air.

In Congressional testimony this summer, Blankenship acknowledged that Massey Energy contests many citations but said the company “does not ‘game the system’” or place profits over safety.

Massey, according to the Post, is also the nation’s largest mountaintop removal mining company, meaning it produces more coal than any other company through a controversial technique of blowing up the tops of mountains in order to get to the coal. The practice boomed when restrictions were lifted during the Bush administration, but it now faces enhanced scrutiny from environmental regulators under the Obama administration.

Opponents of the practice lost a leader this week with the passing of West Virginia environmental activist Judy Bonds, who had been steadfast in her campaigns against Massey.

ProPublica is an independent, non-profit newsroom that produces investigative journalism in the public interest.   This article is republished with permission under a Creative Commons license.

The reason the number of books, articles and consultants providing leadership advice keeps growing – Google delivers over 10,000,000 options in .35 seconds – must be because leadership decisions rarely allow for a do-over.

When Angelo Mozilo succeeded in having Countrywide Financial join Fortune’s list of Most Admired Companies in 2005, and Barron’s named him one of the 30 best CEOs in the world, the then- largest mortgage lender in the country was already on a fast track for derailment – a crash that helped cause the 2008 economic meltdown.

In the spirit of wanting to avoid the all-too-human proclivity for history repeating itself, there continue to be post-mortems and debate over what needs to change in business and regulation to avert another economic crisis.

In the Countrywide autopsy are several clues about the vulnerability of leaders – how personal baggage and ego unchecked can drive unintended outcomes and turn a deaf ear to the very criticism that contains information needed to get back on course.

In the Watergate era, several political operatives who went to jail came out Born-Again Christians. In the aftermath of the economic crisis, no business leader has gone to jail yet; will basic qualities of leadership that foster strong, long-term financial results and thriving cultures come back into vogue?

Weighing a Trade-off

Angelo Mozilo is the first high-profile CEO involved in the meltdown to be held personally accountable. Earlier this month, he settled the Securities and Exchange Commission (SEC) suit that alleged he committed civil securities fraud.  Banned from ever serving as an officer or director of a public company, he agreed to pay $67.5 million, of which Bank of America -- which acquired Countrywide in 2008 as it collapsed -- will cover $45 million.

His top lieutenants -- David Sambol, former president, and Eric Sieracki, former CFO -- also settled with the SEC: no one admitted wrongdoing.

In 2007, when the mortgage market problems were well known, an analyst asked Chairman and CEO Mozilo if, knowing what he did then, would he have done things differently at Countrywide in 2005 and 2006?  Mozilo replied yes theoretically, but continued: “Our volumes, our whole place in the industry would have changed dramatically because we would have arbitrarily made a decision that was contrary to what everything appeared to be....It would have been an insight only a superior spirit could have had at the time.”

That sounds like the trade-off would have meant losing their artificially-created place in the industry to respond to the reality that their strategy was very vulnerable to changes in the housing boom. It would also have meant owning their mistakes and correcting them.

Actually, there were members of Mozilo’s management team who expressed opposition to his strategy; they were ignored.  In 2003 he had announced that Countrywide intended to dominate the mortgage market by increasing its market share from about 10 percent to 30 percent by 2008. His chief investment officer was among the dissenters. In early 2005, the company president warned that the real estate boom was waning and recommended tighter loan restrictions; he was passed over for a promotion and left the company. Mozilo’s 30 percent goal changed the direction of the company by driving ever more aggressive strategies and products. However, privately Mozilo warned in 2005- 2006 internal emails to his lieutenants that these products were toxic and the strategies had huge implications, which was a basis for the SEC suit.

In an interview in 2005, Mozilo admitted he was driven by a chip on his shoulder, saying he hired others with chips similarly driven. An Italian American, son of a Bronx butcher from a poor family, he referred often to his self-made status. He was obsessed with taking market share away from Ivy League types who he thought were snobs looking down on him and the mortgage business.

He became a poster child for excessive executive compensation and defiantly said it was based on his performance and he’d earned it: “nobody called me when I was making nothing for years and years and said ‘can I help.’”

He earned the dubious distinction of being one of the 25 highest paid executives of the decade.

Mozilo’s parents had been too poor to own their own home. He co-founded Countrywide in 1969 with the mission of making home ownership affordable for everyone. He improved Countrywide’s record in lending to minorities and low income families, but ironically, the products promoted after 2003 designed to increase market share, called predatory by Congress and others, resulted in massive foreclosures, hurting the very people the company had originally sought to help.

Lessons and Contrasts

The lessons from Countrywide’s failure are many: The company lost touch with its mission. It got carried away by its own success and grew so fast after 2003 that its culture changed and customers were no longer protected by its lending practices. Its strategy didn’t take into account the consequences of going after 30 percent market share or provide a back up plan if the economy shifted. Ethical considerations didn’t factor into decisions and Mozilo’s leadership seemed increasingly focused on him as the face of the company, achieving his personal goals.

There are many examples of companies that, as a result of their leadership, came out of the crisis positioned to overcome past deficiencies. They stand in stark contrast to Countrywide and Mozilo.

Starbucks was one of the countless companies hurt in the downturn, causing Chairman Howard Schultz to take back the role of CEO in 2008 and architect a turnaround.  In a Harvard Business Review interview last summer, he said that Starbucks had suffered from hubris, because they really hadn’t had much competition, and that had caused them to overlook what was coming.

Schultz was asked recently what advice he’d give to a new CEO.  He talked about the level of insecurity any new CEO has being a strength if the CEO doesn’t act like he or she has to know everything, be in total control and not show weakness. He commented,  “I would say one of the underlying strengths of a great leader and a great CEO – not all the time, but when appropriate – is to demonstrate vulnerability, because that will bring people closer to you and show people the human side of you.”

The economic crisis exposed that the assets touted by Countrywide, other subprime lenders, Lehman Brothers and others couldn’t be counted on in the long term.

Schultz, talking about Starbucks turnaround, said: “The challenge was how to preserve and enhance the integrity of the only assets we have as a company, our values, our culture and our guiding principles and the reservoir of trust with our people.”

Gael O’Brien is a Business Ethics Magazine columnist. Gael is a thought leader on building leadership, trust, and reputation and writes The Week in Ethics.

When financial results aren’t what they seemed to be – and a company is forced to issue material financial restatements - how does it recoup the incentive pay and bonuses that were awarded to senior managers on the basis of rosier outcomes?

It’s not a simple process, as evidenced by reactions to a provision in the newly-enacted Dodd-Frank financial reform legislation viewed by governance advocates as effective in increasing management accountability for financial results.

Under the law, companies must develop policies to recoup improperly awarded compensation from all current and former “executive officers” for three years preceding the date on which the company was required to file a restatement.

Such financial restatements are not uncommon.  From 2002 through 2009, there were over 2,900 negative restatements of net income by listed public companies, according to an analysis by the law firm Latham & Watkins.

And most companies do not have clawback policies in place.  Only about 17% of 3,680 companies have disclosed clawback policies that at least cover senior management, up from a handful in 2005, according to proxy advisers ISS, as reported in The Wall Street Journal.

Large companies are more likely to have clawback policies: 71 of the largest U.S. companies have policies in place, according to a new survey by the law firm Shearman & Sterling.  But even those will likely need to be revised and updated in response to forthcoming SEC regulations regarding the Dodd-Frank requirements.  The SEC has said it will publish rules in time for the 2011 proxy season.

Proper Risk Management

When designed properly, a policy allowing for clawback of pay from high-level executives “is a significant mechanism for corporate accountability,” says former GE senior vice president Benjamin W. Heineman, Jr., writing on the Harvard Law School Forum on Corporate Governance and Financial Regulation.

The problem, according to Mr. Heineman, is that hundreds of companies that don’t have policies must now design one.   Among the questions they need to answer: Which executives are covered by a policy?  What event triggers implementation of a clawback?  What types of compensation should be recovered?  What is the forum for resolving issues?  Is a “holdback” (cancelling unvested benefits) better than a clawback?

Mr. Heineman makes a number of recommendations for what he calls a “broad, flexible holdback/clawback approach” for holding senior leadership accountable to what he says is the fundamental mission of the corporation: “proper risk taking balanced with proper risk management and the robust fusion of high performance with high integrity.”

Clawbacks are not entirely new.  The Sarbanes-Act of 2002 gave the SEC the power to recover restatement-related compensation and stock profits from Chief Executive Officers and Chief Financial Officers.

But the Dodd-Frank Act expands the breadth of the clawback requirement, according to the Latham & Watkins analysis, because it requires reimbursement from a broader pool of “executive officers” and forces the company (not the SEC) to take action.   The Dodd-Frank legislation also expands the period subject to compensation clawback and, importantly, does not require a restatement to have been the result of “misconduct” by an executive, as required by Sarbanes-Oxley.

Latham & Watkins suggests that the Dodd-Frank clawback provision may provide shareholder plaintiffs and shareholder activists “with a major new weapon.”

“We will not be surprised to see shareholder plaintiffs bring derivative suits challenging the implementation of the company’s clawback policy and attempting to exercise the company’s rights to repayment,” the firm says. “Whether such suits will find any measure of success and how often they will be filed is difficult to predict.”