Say-on-Pay: Is Anybody Listening?

Dan Palmon is William J. von Minden Chair in Accounting at the Rutgers Business School. This post is based on a recent article by Professor Palmon; Stephani A. Mason, Assistant Professor of Accounting at the DePaul University Driehaus College of Business; and Ann F. Medinets, Assistant Professor of Accounting at Rutgers Business School. Related research from the Program on Corporate Governance includes: Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Populist anger in the U.S., Europe, and Australia has triggered an ongoing debate about whether executives receive excessive compensation, and if so, how to control it. Several countries have instituted say-on-pay rules (shareholders’ right to vote on executive compensation) aimed at reducing excessive compensation. Determining the effectiveness of say-on-pay is difficult because its tenets vary by country due to political, institutional, cultural, economic, and social factors that have shaped local governance and compensation practices. Policy issues like say-on-pay are complex and lack the necessary foundation of definitive assumptions and theories. Existing say-on-pay research is inconclusive, since some studies find no change in CEO compensation around its adoption, whereas other studies show that say-on-pay lowers CEO pay or changes its composition. A major factor that hinders the effectiveness of say-on-pay research is the many forms in which it comes. It can be implemented by shareholder proposals or through legislation, and the effect of say-on-pay measures can be binding or non-binding, depending on regulatory requirements or internal corporate policy.

The purpose of this study is to chronicle the history of say-on-pay in the Organisation for Economic Co-operation and Development (OECD) countries, to compare its implementation by groups, such as shareholder-initiated or legislated adoption and binding or advisory votes, to identify the issues associated with say-on-pay, and to explore the sources and possible remedies for observed deficiencies. We frame our discussion using the public interest theory of regulation because it has primarily been enacted in response to market failures in order to improve public good. That is, governments have mandated say-on-pay to correct excessive executive compensation. We provide a historical framework of say-on-pay around the world. Although the U.K. was the first to legislate say-on-pay in 2002, its origins are in the U.S. proxy rules. In 1992, the Securities and Exchange Commission (SEC) expanded the scope of allowable topics for shareholder proxy proposals to include executive compensation issues. In the years since, the Netherlands, Sweden, Norway, Denmark, Australia, US, South Africa, Spain, Belgium, Germany, Italy, Israel, Switzerland, and France have legislated some form of say-on-pay; the EU Shareholder Rights Directive approved a say-on-pay vote every three years on compensation policies; and Canada and Ireland allow shareholder proposals for say-on-pay. Our study also provides a literature review of the academic literature on say-on-pay, grouping papers into those that study 1) Advisory shareholder-initiated say-on-pay proposals, 2) Binding shareholder votes on equity compensation plans, 3) Implementing say-on-pay in OECD countries, 4) Factors affecting say-on-pay voting outcomes, 5) Theoretical and behavioral studies of say-on-pay, 6) Market reaction to say-on-pay, and 7) Say-on-pay and the market for executives.

Successful shareholder proposals result in periodic advisory votes to accept or reject the Board’s proposed executive compensation package. Mandated say-on-pay could include separate binding or advisory votes on compensation, or it might be part of the annual report with the votes applying to compensation packages, incentive plans, or other components, such as severance arrangements, non-completion clauses, pension agreements, option grants, or approval of capital authorizations required to meet obligations under share-based incentive plans. Votes can occur annually or on some other basis, may cover compensation policy, a compensation report, compensation of individual executives/directors, or specific elements of the compensation package, such as share-based compensation. They can also look forward at compensation to be set in the future or backward at compensation as executed in the past.

The empirical evidence is mixed on whether say-on-pay reduces the level or growth rate of executive compensation, although evidence shows that the composition shifts toward a larger equity component and more sensitivity of CEO pay to poor performance. Increased disclosure and shareholder engagement are two key non-quantifiable benefits of say-on-pay. Although the goal of say-on-pay has always been to give shareholders a voice in setting executive compensation, it also has created some unintended consequences, such as a movement to “one size fits all” executive compensation programs and a reduction on the impact of economic value creation, since there seems to be no material difference between the voting outcomes for firms that create economic value and those that destroy value. A number of studies do find a movement towards equity compensation and greater pay-performance sensitivity, but some of this shift has been attributed to scrutiny by proxy advisory firms. Based on say-on-pay data and research in the U.S. and U.K., say-on-pay votes have little effect on reducing CEO compensation levels. However, the votes do affect pay-performance sensitivity; CEOs of firms with negative votes face a greater penalty for poor performance than other CEOs. Despite government intervention on behalf of the public interest, perhaps shareholders never agreed that executives are overpaid.

Say-on-pay can be considered an ill-structured problem because various parties disagree about the problem that needs to be resolved and propose vastly different resolutions. There is no clear goal, set of operations, end states, or constraints, and there is uncertainty about the preferred outcome of shareholder votes on executive compensation. In order to determine the effectiveness of say-on-pay, there must be some consensus on the nature of the problem and the desired outcome. There also has to be some consensus on what led to say-on-pay. Moreover, say-on-pay cannot be understood in a vacuum. Instead, it must be analyzed as a part of corporate governance. As long as the corporate governance system as a whole does not serve shareholders’ interests properly, there is little that say-on-pay can achieve. A major limitation of this paper is its inability to assess the deterrent effect of say-on-pay. Without the threat of say-on-pay, excess executive compensation might have been even higher, but that is impossible to measure.

This complete article is available here.

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