Independent Yet Captured: Compensation Committee Independence after Dodd-Frank
50 Pages Posted: 15 Sep 2017
Date Written: 2014
In response to the financial crisis of 2008 to 2009, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 includes several far-reaching executive compensation reforms. Because most scholars have focused on the so-called “say-on-pay” provision, they have not sufficiently analyzed another Dodd-Frank reform that requires public companies to have compensation committees composed entirely of independent directors. This Article fills that void. Although it is sensible to make compensation committee members independent of management, the reform does not go far enough to achieve its goal. The independence requirement is not sufficient to prevent directors from being captured by management because it does not take into account organizational behavior literature regarding group dynamics. Ostensibly independent directors might still be subject to organizational behavior factors — such as norms of reciprocity, groupthink, polarization, social cascades, and herding — that could lead them to approve excessive compensation packages.
This Article thus proposes two additional reforms to augment the independence of compensation committee members: (1) mandatory continuing professional education regarding compensation issues and (2) a rotation system for compensation committee membership. Directors will be less susceptible to the organizational behavior factors noted above if they are equipped with knowledge about complex compensation issues and tasked with approving compensation for only a limited period of time. These recommendations draw on similar requirements under the Sarbanes-Oxley Act of 2002, which mandate that (1) all members of the audit committee be financially literate, (2) at least one audit committee member have financial expertise, and (3) the lead and concurring partners of a company’s auditing firm rotate off the client engagement after five years.
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