by Cydney Posner
This post from the Columbia Law School CLS Blue Sky blog, “Should Say-on-Pay Votes Be Binding?,” by two executives from the Institute for Governance of Private and Public Organizations in Canada, in exploring the issue raised in the post’s title, looks at the question of the effectiveness and impact of non-binding say-on-pay votes. Initially conceived as a way to allow investors to express their views on executive compensation and, presumably, rein in runaway executive pay packages, say on pay has not exactly had the consequences that had originally been anticipated.
While say-on-pay votes have been mandatory for most public companies in the U.S. since 2011, only non-binding advisory votes are required. In Canada, the vote is voluntary, although the post indicates that “80 percent of the largest companies have adopted the practice voluntarily or as a result of pressure from investors.” The UK has adopted a form of binding say-on-pay vote on the compensation policy of the company, which vote is mandatory every three years. If the policy is rejected, the company must continue to follow the prior policy or have a new vote. UK shareholders also have a non-binding annual vote to approve the total pay (a single number) for company executives. Apparently France is following suit, having recently enacted binding say-on-pay votes for French-listed companies (although the post indicates that the “enabling act is now stalled in the French senate, but some version akin to the UK’s should emerge soon.”)
But how effective has say on pay been? According to a Reuters/Ipsos poll described in this Reuters article, 59% of investors in U.S. mutual funds said CEOs at S&P 500 companies were paid “too much.” Nevertheless, it’s fairly well known that shareholders overwhelmingly approve executive pay packages. According to Compensation Advisory Partners, only four companies in the S&P 500 failed to receive majority support for their say-on-pay proposals in 2016 (as of June 16), and the median level of shareholder support was 95%, consistent with prior years. Among the Russell 3000, 22 additional companies failed to received majority support. As a result, it comes as no surprise that, according to academic studies, while say on pay may have “led to more dialogue between the company and large shareholders,” it “has not stopped the rise in executive compensation.” According to the post, 66% of corporate directors believe that say on pay has not “resulted in a ‘right-sizing’ of CEO compensation.”
SideBar: But see this PubCo post discussing a recent decline in CEO pay. According to an Equilar survey for the NYT, CEO pay for 2015 actually fell: the average among the 200 highest paid CEOs at U.S. companies with annual revenue of at least $1 billion (that filed proxies by April 30) was $19.3 million, down 15% from the $22.6 million average paid in 2014. Commentators cited in the NYT article observed that compensation committees “seem to have a lot more steel in their backs.” And it wasn’t just the top 200 that experienced a decrease; according to Reuters, CEOs of S&P 500 companies experienced a decrease last year from an average of $13.5 million down to $12.4 million. Notably, however, no commentators cited in these articles attributed the decline to the effect of say-on-pay votes.
But what’s particularly interesting about the post is its discussion of the “disturbing and unintended consequences” of say on pay, which include the following:
- Studies show that pay is not the determining factor for shareholders in deciding how to vote on say-on-pay proposals; rather, the post contends, shareholder votes tend to be based on stock price performance. According to the post, if a company’s “shares do better than those of its peers, almost any compensation package will be approved. This perverse result tends to increase the pressure on management to focus on short-term stock performance, sometimes through decisions that may negatively affect future performance.” [Emphasis added.]
- Why look to stock price performance? The authors attribute this result in part to the current complexity and sheer length of compensation disclosure, presumably one consequence of disclosure designed for say-on-pay proposals. And given that many investors hold shares in numerous companies, it may be easier for them to base their votes on stock performance rather than try to analyze complex compensation packages as detailed in lengthy proxy statement disclosures. (Of course, maybe they don’t even open their proxy envelopes!) According to the post, “for the 50 largest (by market cap) companies on the Toronto Stock Exchange in 2015 that were also listed back in 2000, the median number of pages needed to describe their executives’ compensation rose from six in 2000 to 34 in 2015, with some compensation descriptions consuming as many as 66.”
SideBar: A survey of 64 asset managers and owners with a combined $17 trillion in assets, conducted by Stanford University’s Rock Center for Corporate Governance, along with RR Donnelley and Equilar (referenced in this post in the WSJ), concluded that 55% of investors “believe that a typical proxy statement is too long.” The survey reported that “the ideal length of a proxy is 25 pages, compared to the actual average of 80 pages among companies in the Russell 3000.” (See this PubCo post.) Executive compensation disclosure appears to be the most problematic component in corporate proxies. As reported, only 38% of investors “believe that corporate disclosure about executive compensation is clear and easy to understand.” According to a Stanford GSB professor who was a co-author of the study, “Shareholders want to know that the size, structure, and performance targets used in executive compensation contracts are appropriate….Our research shows that, across the board, they are dissatisfied with the quality and clarity of the information they receive about compensation in the corporate proxy. Even the largest, most sophisticated investors are unhappy.” The study found that “[s]ixty-five percent say that the relation between compensation and risk is ‘not at all’ clear. Forty-eight percent say that it is ‘not at all’ clear that the size of compensation is appropriate. Forty-three percent believe that it is ‘not at all’ clear whether performance-based compensation plans are based on rigorous goals. Significant minorities cannot determine whether the structure of executive compensation is appropriate (39 percent), cannot understand the relation between compensation and performance (25 percent), and cannot determine whether compensation is well-aligned with shareholder interests (22 percent).”
- Instead of checking stock prices, it’s even easier for investors to rely on the recommendations of proxy advisory firms, such as ISS and Glass Lewis (which also take into account relative stock price performance in formulating their vote recommendations). As a result, the influence of proxy advisory firms has increased substantially. According to the post, 83% of directors very much or somewhat agree that their influence has increased.
- One consequence of the increase in influence of proxy advisory firms has been a certain similarity in executive compensation packages. The post indicates that, to win the recommendation of these firms, boards, comp committees and consultants find it “wiser and safer to toe the line and put forth pay packages that will pass muster…. The result has been a remarkable standardization of compensation, a sort of ‘copy and paste’ approach across publicly listed companies. Thus, most CEO pay packages are linked to the same metrics, whether the companies operate in manufacturing, retailing, banking, mining, energy, pharmaceuticals, or services. For the companies on the S&P/TSX 60 index, the so-called long term compensation for their CEOs in 2015 was based on total shareholder return (TSR) or the earnings per share (EPS) growth in 85 percent of cases. The proxy advisory firm ISS has been promoting these measures as the best way to connect compensation to performance.”
SideBar: A similar view is expressed in this Bloomberg article, which contends that the transparency resulting from say-on-pay votes and related proxy disclosures “has had a homogenizing effect,” leading companies to avoid innovation that might make them conspicuous or fail to satisfy “best practices” as contemplated by ISS and other proxy advisory firms. Advisory firms, it is argued, “take little account of any business’s specific circumstances.” The article observes that over half of the CEOs in the S&P 500 “received compensation last year that was at least in part linked to stock returns, a metric preferred by ISS.” (See this PubCo post.)
Notwithstanding “or perhaps because of, the limited usefulness of non-binding say-on-pay votes,” some groups are advocating that executive pay be submitted to a binding shareholder vote, which, in the event of failure to receive majority approval, would require the board to make changes and submit a new proposal to shareholders.
But the authors do not favor this change. First, in light of “the complexity of current compensation programs, what are shareholders voting on, and what does a negative vote really mean? In case of a negative vote, will the company carry on with its current policies, which may be worse than the proposed and rejected policies? At a more fundamental level, the setting of pay policies should be the preserve of the board, as Canadian corporate law clearly states. When egregious pay packages are given to executives, a say-on-pay vote, compulsory or not, binding or not, will always be much less effective than a majority of votes against the election of members of the compensation committee. But that calls upon large investment funds to show fortitude and cohesiveness in the few instances of unwarranted compensation which occur every year.” Instead of asking whether say-on-pay votes should be binding, perhaps the authors are implicitly asking whether say on pay should be eliminated altogether?
SideBar: See this PubCo post discussing a shareholder proposal submitted to a large publicly held investment manager requesting that its board issue a report to shareholders evaluating “options for bringing its voting practices in line with its stated principle of linking executive compensation and performance, including adopting changes to proxy voting guidelines….” According to an article in the Financial Times, an online petition supporting the objective of the proposal was signed by more than 4,000 of the investment manager’s clients and over 75,000 of its shareholders.