Revolt over executive pay gains altitude in Switzerland

The Alpine nation’s bank secrecy laws are legendary, and its tax rates are low enough to lure the headquarters of formerly American companies such as Transocean, the drilling-rig company that was involved in the BP oil spill.

This month, though, Swiss voters enacted a bold measure that will hit businesses where it really hurts: in their executives’ paychecks. The result of the March 3 referendum means that every year, Swiss companies’ shareholders will cast a binding vote on the bosses’ compensation.

The new law also bans signing bonuses and exit packages known as golden parachutes and golden handshakes. And it comes with harsh penalties: Violators forfeit pay and could spend up to three years in prison.

The Occupy Wall Street movement may have started in the U.S., but its zeal for limiting executive pay is catching on faster in Europe. Two days after the Swiss vote, European Union finance ministers decided to cap bankers’ bonuses at twice their salaries.

On this side of the pond, government action on pay has been more timid. The Dodd-Frank Act required most U.S. companies to conduct say-on-pay votes beginning in 2011, but the votes are merely advisory. The law also requires each company to compare its chief executive’s pay to the average worker’s salary, but the Securities and Exchange Commission has yet to issue rules for calculating the ratio.

Should government be involved at all in the pay-setting process? Can’t we trust shareholders and directors to decide when compensation is appropriate?

Thanks to the financial crisis, we’ve learned that governments do have a clear interest in how bankers are paid. If their bonus plans encourage too much risk-taking, taxpayers are on the hook for a bailout.

For nonfinancial companies, the case for government involvement is harder to make. The best argument is that in most companies, managers have too much power because shareholdings are so widely dispersed. A mandated say-on-pay vote improves governance by giving shareholders a louder voice.

Radhakrishnan Gopalan, an associate professor of finance at Washington University’s Olin School of Business, says he has two concerns about say-on-pay votes. One is that they’re ineffective. “I don’t see this as having a big huge effect on changing or curbing the pay structure,” Gopalan says.

His other concern is that directors will let the opinions of certain large shareholders, such as public pension funds, outweigh their own knowledge of the company’s needs. Handing out a big chunk of stock for retention purposes may make sense under certain circumstances, even if it will cost the company some votes.

Broadly speaking, academics have two schools of thought on executive pay. One holds that the market doesn’t work, because shareholders are disengaged and boards are too clubby.

The other holds that the market does work, and that CEOs’ pay is usually proportionate to their value. Gopalan leans toward this view. “The firms are so large, by definition if the guy screws up he can destroy a lot of value,” he says. “If he does well, he can create billions of dollars in value.”

The Swiss experiment, then, will be interesting to watch. If the annual votes become routine, and big firms like Nestlé and Novartis and UBS continue paying large sums to their executives, we may look back on this month’s referendum as a nonevent.

Right now, it looks like a revolution.