Shareholder resolutions calling for companies to exclude pension income from total corporate income when calculating incentive pay for top executives look like an effort to close the barn door when the horse has already bolted.
What really is needed is a revision of FAS 87, the pension accounting rule; and that might be coming. The Financial Accounting Standards Board is considering revamping the rule, while Harvey L. Pitt, chairman of the Securities and Exchange Commission, wants to make financial statements in general easier to understand and thus more meaningful in detailing a company's finances.
Certainly, pension accounting and executive compensation are among the hardest items for shareholders to decipher. The seemingly convoluted pension accounting rule, however, has one good purpose: It helps influence corporations to continue offering pension plans. It does this by allowing them to recognize pension fund investment return in excess of the assumed rate of return as income.
And it allows corporations to average pension investment gains and losses over several years, easing sharp swings in overall corporate income. But pension income still can have a perverse effect, creating a misleading appearance of the financial health of a company for investors.
It's the bad use of the accounting rule - the inclusion of pension income in corporate earnings when calculating executive compensation - that has investors up in arms, and with justification. The inclusion of such pension income often means executives will receive bonuses even though the company has performed badly and true corporate earnings are negative.
Shareholders supporting changes in pension accounting often are trying to reduce executive compensation, which they justifiably believe is often excessive. The shareholders are justified in their wrath because even when corporate profits and shareholder value plummet, top executive pay does not decline, despite the poor performance.
However, excluding pension income from corporate earnings now could effectively wind up boosting executive compensation. That's because pension income likely will be negative in the next few years, reducing reported earnings, just when any of the resolutions would become effective.
The resolutions have been proposed at Verizon Communications Inc., General Electric Co., International Business Machines Corp. and Qwest Communications International Inc. The resolution failed at Verizon, although it received 43% of the vote, substantial support for a first-time proposal. Quoting an accounting expert, the resolution noted: "The `earnings' created by pension plans will not inure to common stock investors; pension assets are dedicated to a separate class of stakeholders ... the present and prospective pensioners."
Despite the Verizon loss, shareholders' efforts will bring more attention to the imperative of refining pension accounting, something P&I has promoted. Similar resolutions almost certainly will emerge next year, and some companies may well decide to emulate McDermott International Inc., which, when faced with a similar proposal this year, excluded pension income from top executive incentive pay.
However, even if passed, the resolutions will not solve all the problems with executive compensation. Much, if not most, of top management compensation comes in the form of stock options, not bonuses.
The FASB adopted the pension accounting rule in a different era, before pension reversions were pretty much foreclosed by onerous tax disincentives. So there was justification for considering pension income part of corporate income, but the FASB rule has become an anachronism in this important respect. Now FASB might change that. The long time it has taken FASB to begin to recognize the problems of pension accounting is symptomatic of the larger problem with setting accounting standards, as witnessed in the Enron Corp. scandal.
Shareholders, if they really don't like the way top executives are paid, ought to elect directors more to their way of thinking. It won't be easy. But it is the best way to improve the relationship of pay with operating performance. And the 43% of the vote at Verizon should encourage dissident shareholders that they have the power to effect change.