New-Era Executive Compensation: The Impacts of Dodd-Frank's "Say-on-Pay" for Hospitals

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Almost two years ago in July 2010, President Barack Obama signed a 1,408-page bill into law that aimed to reign in the dominating presence of the U.S. financial services sector — the Dodd-Frank Wall Street Reform and Consumer Protection Act (pdf).

According to the law's creed, which was named after Rep. Barney Frank (D-Mass.) and former Sen. Chris Dodd (D-Conn.), the United States planned to implement financial regulatory reform, based on the economic collapse of 2008, through increased accountability and transparency.

Dodd-Frank mostly looked to reform banks and other publicly traded, for-profit companies. However, it's not uncommon for non-profit organizations, such as hospitals, to adopt governmental regulations imposed on for-profits. Case in point is when hospitals adopt Sarbanes-Oxley standards for their accounting and audit activities.

One component of Dodd-Frank that has garnered the spotlight this year is the "say-on-pay" clause for executive compensation. The issue of compensation for hospital executives has been hotly contested over the past several years, and say-on-pay may be adding a new element as patients and other hospital stakeholders want to ensure hospital executives are compensated appropriately.

"Say-on-pay" background
Nestled within Dodd-Frank is Section 951, which covers accountability of executive compensation and shareholders' votes on executive compensation disclosures — better known as say-on-pay. The Securities and Exchange Commission released a fact sheet in January 2011, explaining exactly how say-on-pay would work. All public companies subject to federal proxy rules must do the following:

•    Provide shareholders with an advisory vote on executive compensation.

•    Provide shareholders with an advisory vote on the desired frequency of say-on-pay votes.

•    Provide shareholders with an advisory vote on compensation arrangement in larger merger transactions, commonly referred to as "golden parachute" packages.

Jim Otto, executive compensation practice leader and senior principal in the healthcare practice for Hay Group, says it's worth noting shareholders only get "advisory" votes — meaning the votes are nonbinding and cannot officially change the payouts for a company's top executives. However, this is another step the SEC has taken to improve transparency.

"This is part of the disclosure trend you started seeing 20 years ago," Mr. Otto says. "In 1992-1993, the SEC revised the disclosure rules for executive compensation. Say-on-pay is nonbinding, but it does have an impact on how compensation committees are paying their executives."

The first official say-on-pay votes took place last year with little fanfare, as most corporation shareholders voted "no" when asked if they had any objections to the executive payouts. However, say-on-pay made ripples throughout corporate America this past April. Fifty-five percent of shareholders for banking giant Citigroup rejected the $15 million pay package for CEO Vikram Pandit.

For-profit hospitals
So what does say-on-pay mean for hospitals? Since most hospitals in the United States are categorized as non-profits, the provision does not directly apply as a legal enforcement. However, there are several publicly traded, for-profit hospital corporations in the country — the largest being Nashville, Tenn.-based Hospital Corporation of America, Franklin, Tenn.-based Community Health Systems, Dallas-based Tenet Healthcare and several others — and say-on-pay falls directly within their ballpark.

Larry Van Horn, PhD, associate professor of healthcare management at Vanderbilt University's Owen Graduate School of Management, says say-on-pay measures would only affect for-profit hospital companies at the headquarters level, not at the individual hospital level. This is an important distinction, as most executives at the individual for-profit hospital level do not make nearly as much as the corporate executives, and as his prior research shows, many executives at investor-owned hospitals make less than their non-profit counterparts.

Mr. Otto of Hay Group adds that at the for-profit headquarters level, stock options have been the primary driver of higher compensation, which led to the inclusion of say-on-pay measures within Dodd-Frank. "We saw significant growth in the economy and stock market from 1991 through 2001," Mr. Otto says. "Stock options made a lot of people a lot of wealth. If there's one factor that contributed to increase in executive compensation, it was the stock options."

So far in 2012, there have been several instances where say-on-pay has been raised at a hospital operator's annual shareholders meeting.

This past May, CHS shareholders voted in a two-to-one margin against the hospital operator's executive compensation plan, according to a Wall Street Journal report. At CHS' 2011 annual meeting, the say-on-pay proposal received 87.1 percent approval. CHS CEO Wayne Smith received a 3 percent raise from 2010 to 2011, with total compensation reaching $21.58 million. Also in 2011, however, CHS' net income fell roughly 28 percent, while its shares lost about half of their value, according to the report.

In response, CHS officials said decisions about Mr. Smith's and other executives' compensation were made in early 2011 — well before the company's poor financial results. In addition, CHS' compensation committee will withhold a significant portion of the 2011 cash incentives for Mr. Smith and the other top executives, and there will be no base salary increases or target cash incentive award increases, according to an SEC filing.

Also in May, Naples, Fla.-based Health Management Associates held its annual shareholders meeting. Some members from the Service Employees International Union-United Healthcare Workers East shared their say-on-pay votes as stockholders while others protested outside of the meeting, arguing the for-profit hospital operator's executive compensation and profit structure overshadowed patient care. In 2011, Health Management President and CEO Gary Newsome's compensation rose 11.3 percent to $7.11 million, based on 2010's results.

According to Health Management's Schedule 14A filing with the SEC, its compensation programs "are designed to provide incentives that drive our financial performance and result in greater stockholder returns," and "a significant percentage of our executive compensation program is weighted toward company performance." Consequently, Health Management only uses one factor when determining executive pay: adjusted EBITDA, which is a measure of profit.

For SEIU Research Coordinator Sandra Sebastian and the rest of the union, this was one of their biggest concerns — that top leaders were only being compensated based on profit without factoring in patient quality and other indicators of "performance." She also noted that Health Management's peers use a broader set of criteria than only adjusted EBITDA, and compensation experts "denounce" only using that one metric.

"If you only have this one criterion, it sends the wrong message," Ms. Sebastian says. "We wanted to ask Health Management to broaden their compensation policy to also include quality of care when considering compensation."

In response, Health Management published a news release, saying the say-on-pay vote was still "overwhelmingly approved with a vote of more than 92 percent." MaryAnn Hodge, vice president of marketing and communications at Health Management, also referred to a prepared statement: "While stockholders of Health Management Associates were participating in our company's annual meeting last month, a handful of organizers from the SEIU demonstrated outside the proceedings. Disruptive efforts designed to garner media coverage and intentionally spread misinformation about our associates, our hospitals and our company serve no purpose other than to further the economic interests of the SEIU.  

"Health Management supports the rights of its employees to decline to join a union. The company also supports the rights of employees to join a union if they freely choose. Health Management will not allow these activities to distract us from our mission of delivering superior healthcare."

However, Ms. Sebastian says their 30,000 members only want to ensure they are receiving the right care in Health Management's markets. "Members who have dedicated their lives to providing quality care are receiving care themselves, and we want them to receive care that is the best quality as possible," Ms. Sebastian says. "We need to voice their concern as a stakeholder and as a community member as well."

Those two instances of say-on-pay at CHS and Health Management, as well as in other publicly traded industries, might suggest this issue is here to say, says Kevin Ryan, JD, partner at EpsteinBeckerGreen. "I don't see this debate going away," he says. "The new standard operating procedure of having shareholders voice their opinion on an executive compensation packages in [the for-profit] sector is actually something that has been seen on the not-for-profit side for the past several years."

Non-profit hospitals
Indeed, the non-profit hospital sector has actually endured greater accountability and transparency measures than the for-profit arena, especially in executive compensation, for many years now. Non-profit hospitals receive tax exemptions and are generally seen as institutions of and for the community, and the Form 990 has provided the public an outlet to see literally any part of a non-profit hospital's or health system's operations — including the top salaries and compensation figures of the CEO, CFO and other primary executives.

While non-profit hospitals do not undergo a federal say-on-pay vote, some have been subjected to additional compensation restrictions initiated by various groups. For example, in New York, Gov. Andrew Cuomo proposed a $199,000 salary cap of taxpayer money for executives of state non-profit organizations, including hospitals. The SEIU-United Healthcare Workers West also submitted more than 15,300 signatures to the Santa Clara County Registrar of Voters in California with the hopes of adding a measure to November's ballot that would limit the salaries of executives at El Camino Hospital in Mountain View, Calif., to no more than twice the salary of the governor, which was $173,987 in 2011.

These measures have sent a strong message, much like say-on-pay votes, that communities do not want to see excessive executive pay, and hospitals are trying to react. "In the tax-exempt world, a lot of high salaries and perquisites have significantly decreased in presence," Mr. Otto says. "We're seeing that organizations are taking a hard look at the total package, including perks, and are answering the questions: Is this serving a business purpose? Is this a key element to compensation program, or do we do away with it?"

Non-profit hospital compensation committees, in a way, serve as the say-on-pay votes for the communities they serve as well. The problems, however, are that these committees have to juggle and comprehend a lot of compensation data, and they have to judge executive pay on an evolving healthcare model. "It's unclear what the world will look like in five years," Dr. Van Horn says. "Hospitals are turning into integrated systems that have insurance products and/or physicians and other parts of the healthcare value chain. Defining what a benchmark is for executive compensation is going to be more difficult."

Both for- and non-profit hospitals will have to deal with their versions of say-on-pay in the immediate future, and one drumbeat has consistently been heard — the voices of the stakeholders are growing louder, even if they are "nonbinding." "Legally, non-profit hospitals have to operate as stewards of a community's investments," Dr. Van Horn adds. "They can't be run so there's excess compensation accruing to individuals. [All] hospitals are going to be increasingly under scrutiny, and I would expect more attention will be paid to this and [say-on-pay]."

More Articles on Hospital Executive Compensation:

11 Hospital, Health System Executive Compensation Trends

48 Statistics on For-Profit Hospital Operator Executive Compensation

Are Hospital Executives Overpaid, Underpaid or Paid Fairly?

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