Say-on-Pay Under Dodd-Frank

Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article that first appeared in the New York Law Journal by Mr. Bachelder, with assistance from David T. Ling and Andy Tsang.

Say-on-pay has completed most of its first proxy season under the Dodd-Frank Wall Street Reform and Consumer Protection Act. [1] For this purpose, say-on-pay means a non-binding vote by shareholders of a publicly traded company pursuant to Dodd-Frank Section 951 to approve or disapprove the executive compensation program at that company. [2]

During the 2011 proxy season so far approximately 40 companies in the Russell 3000 have reported that a majority of their shareholder votes disapproved of the executive pay program at the company. This represents about 2 percent of the approximately 2,300 companies in the Russell 3000 that have had say-on-pay votes so far during the 2011 proxy season. [3] At another approximately 130 companies, between 30 percent and 50 percent of votes cast were negative votes or abstained. (Abstentions were very few.) Thus, during the 2011 proxy season so far, approximately 170 companies in the Russell 3000 had less than 70 percent of votes cast in favor of the company’s pay programs. [4]

During the 2010 proxy season, before Dodd-Frank Section 951 took effect, three (1 percent) of the approximately 300 votes on say-on-pay (most of them mandated under TARP), resulted in majority votes disapproving the executive pay program. As of the writing of this column at least nine shareholder derivative actions (two of them against a single corporation, Janus Capital Group) have been filed based on negative shareholder say-on-pay votes in 2011. In 2010, two of the three negative say-on-pay votes resulted in derivative actions. (Both 2010 cases are reported to have been settled.)

Those who support the idea of say-on-pay point out that: (a) say-on-pay brings greater attention to executive pay policies and practices; (b) shareholders feel more connected with the process of setting executive pay—a process that many shareholders have believed was beyond their reach to influence significantly; and (c) directors and management give increased attention to whether executive pay is consistent with shareholders’ views.

But say-on-pay also raises a number of questions. The basic question is whether the individuals who constitute most of the “ultimate ownership” of American enterprises are being served well by say-on-pay under Dodd-Frank Section 951. Estimates are that approximately 25 percent of the value of publicly traded equity in U.S. corporations is held directly by individuals. A major part of the remaining equity value is attributable indirectly to individuals through their interests in institutional shareholders. The following paragraphs address this overall question.

  • 1. Who are the shareholders expressing their views on executive pay under Dodd-Frank Section 951? Most of the votes being cast in say-on-pay votes are cast by institutional shareholders. Current estimates are that approximately 75 percent of the publicly traded equity value in U.S. public corporations is held by institutional shareholders. [5] (As might be expected, share ownership of major corporations is concentrated in the very largest institutional shareholders. It is not untypical for 20 percent or more of the total shares outstanding of the very largest U.S. corporations to be held by only five to 10 institutional investors.)
  • 2. Who are these institutional shareholders? Based on value of their holdings, mutual funds make up the largest group. Next are corporate and government pension funds. [6] The institutional shareholders just noted are “mezzanine” owners of U.S. enterprises in the sense that they are not the ultimate owners. Many or most of the ultimate owners or beneficiaries of the shares held by these institutional shareholders, as already noted, are millions of individuals. These include individual investors as well as employees and retirees. (Many employees and retirees are themselves investors through their voluntary contributions to 401k plans). These ultimate owner beneficiaries are interested in durable performance and the creation of durable wealth that will sustain them in their long-term responsibilities including provision for themselves in their retirement.
  • 3. What are the objectives and responsibilities of the institutional shareholders noted in paragraph 2? They have no fiduciary responsibility to the corporations in which they own stock (and, ordinarily, no responsibility to the other shareholders in such corporations). Their responsibilities are to their own shareholders and their attention is to the management of the portfolios they hold for the benefit of those shareholders. They buy, hold and sell based on portfolio strategies and stock market results. Those factors are far more significant to these investment managers than the current and long-term effectiveness of executive pay at a specific company. The compensation of these investment managers is tied to portfolio value. (A fee, for example, might be 1 percent of “net asset value.”). At least one report indicates that, on average, shares of stock in a portfolio of an institutional shareholder are held for approximately 1.5 years. [7] Thus, many institutional shareholders have a doubtful stakeholding in the fundamental long-term soundness of executive pay design and practices at many of the companies as to which they are casting say-on-pay votes.
  • 4. Who is advising these institutional shareholders on how to vote on say-on-pay? The principal source of advice, apart from proxy statement discussion and tables, are reports of shareholder advocates, the largest of which is Institutional Shareholders Services (ISS). Shareholder advocates have been the subject of much criticism. [8] This criticism, at least in part, is based on the fact that a shareholder advocate may, in some cases, be both a consultant to the corporation that is the subject of the say-on- pay vote and also an adviser to shareholders on how they should cast their vote on say-on-pay at that corporation. [9]
  • 5. What are the costs to the executive pay process caused by say-on-pay? The executive pay process traditionally has been handled by the management of a corporation, subject to oversight by its board of directors (usually the compensation committee of the board). These parties are assisted by advisers including compensation consultants and legal counsel. In what specific ways will say-on-pay impact on these parties to the executive pay process?
    • (a) For Management. Added costs and time will include, in many cases, review of negative “marks” by institutional shareholder advisers like ISS on specific elements of a company’s pay program. In addition to making specific item-by-item criticisms of the pay practices at a broad base of companies, during the 2011 proxy season ISS made recommendations to shareholders at approximately 300 companies that they vote to disapprove the company’s executive pay program. In many cases, companies will need to prepare explanations in proxy statements to reconcile discrepancies between their own policies and negative comments by shareholder advisers. For those actually sued, there will be the time and costs associated with litigation. In many cases, modifications may be made to executive pay plans and practices in response to high negative votes or to settle litigation (even when based on meritless claims).
    • (b) For Boards of Directors. Directors (especially those on compensation committees) of corporations with high levels of negative votes on say-on-pay may face a risk of losing re-election. [10] As noted in connection with management, if litigation occurs, or is threatened, substantial time and legal expenses may be incurred, not only by the corporation but also by the director if he or she wants his or her own counsel. Typically, individual directors, as well as officers, are provided with indemnification by a corporation’s bylaws. [11] In addition, protection typically is provided under D&O insurance policies. However, indemnification protection may be limited as to scope and, in the case of D&O policies, as to amount.
    • (c) Consultants Advising Compensation Committees. Consultants to compensation committees were named as defendants in all except two of the lawsuits noted above in 2010 and 2011. Compensation consultants will need to assure themselves that they have professional liability insurance that adequately takes into account risks resulting from Dodd-Frank Section 951.Premiums charged for such protection undoubtedly will increase. Most consultants will seek to pass these costs along to the companies they are advising, as part of their professional fees or reimbursements. But how free and independent will these consultants feel in giving advice in the future if they risk a lawsuit in giving that advice?
  • 6. Who is “watching the store” on executive pay on behalf of the millions of individuals who constitute the “ultimate owners”? State laws on corporate governance provide that individual directors, in their capacities as fiduciaries for the shareholders, oversee those in charge of the management of the corporation. This requires directors themselves to ensure that the pay system is working properly at the companies at which they serve. The shareholders of these companies tend to be institutional shareholders who are not, as to substantial portions of their portfolios, long-term holders (with certain exceptions, such as index funds). Further, these institutions have no direct involvement in the pay process. Yet they can “second guess” (on a non-binding basis) the executive pay decisions of those charged with the fiduciary responsibility of getting these decisions “right.” Is this intervention by institutional shareholders in the traditional “watchdog” role of the director helping or hurting the ultimate owners/beneficiaries of American corporate enterprise?
  • 7. Is say-on-pay more a vote on Corporate Performance than one on pay itself? There is significant correlation between negative say-on-pay votes and total shareholder return (TSR) for the one-to-three-year period immediately preceding the year of the vote. [12] This suggests that at least some of those casting negative say-on-pay votes may be confusing a vote on the corporation’s executive compensation program with a vote on the corporation’s stock performance.

“Business Roundtable”

In Business Roundtable and Chamber of Commerce v. SEC (D.C. Cir. July 22, 2011), the U.S. Court of Appeals for the D.C. Circuit vacated the Securities and Exchange Commission’s so-called “proxy access” rule, Rule 14a-11 under the Securities Exchange Act of 1934, which would have allowed certain qualifying shareholders to effectively “write in” their own nominees for director on a company’s annual proxy materials. The D.C. Circuit concluded that the SEC had abused its discretion in adopting Rule 14a-11. (The effectiveness of the rule had been suspended by the SEC pending the circuit court’s decision.)

The court’s decision to vacate Rule 14a-11 suggests questions (at least from a public policy standpoint) that might also be raised as to say-on-pay. The court found the SEC gave inadequate weight to, among other things, “management distraction and reduction in time a board spends on strategic and long-term thinking” in complying with the proxy access rule. In addition, the court found Rule 14a-11 an opportunity for large institutional shareholders like union and government pension funds to impose their biases (not necessarily profit-oriented) upon corporations.

The court quoted Chancellor Leo A. Strine of the Delaware Court of Chancery who had written, in a Harvard Law Review article, “state governments and labor unions often appear to be driven by concerns other than a desire to increase the economic performance of the companies in which they ‘invest.'” [13] Similar concerns could be expressed with regard to such shareholders on the subject of say-on-pay.


Say-on-pay on its face is an opportunity for shareholders to approve or disapprove on a non-binding basis the corporation’s executive pay policies and practices. In fact, however, it contains significant problems. These problems reflect interference with the management of executive pay, and with the oversight of that management by directors at public corporations. In effect, institutional shareholders become another tier of overseers of executive pay. The institutional shareholders (and their advisers) have their own agenda which often does not coincide with the best design and implementation of executive pay. This intervention will constitute a significant distraction to officers and directors of many corporations, and there will be significant costs attached to this.

A Suggestion. Dodd-Frank Section 951 provides that it is not intended to change the fiduciary rules applicable to officers and directors of public corporations. The problem nevertheless remains that a negative say-on-pay vote may be taken into account as evidence of failure by such officers and directors to meet their fiduciary responsibilities.

In light of this, it is suggested that, in the context of “Sue-on-Pay” shareholder litigation of the type discussed earlier in the column, a rule be adopted that a negative say-on-pay vote cannot be introduced as evidence of a breach of fiduciary duty in connection with the management and oversight of executive pay unless two successive votes by shareholders at the corporation have resulted in majority votes against the executive pay program. This would give management and the board of directors the opportunity to respond to the initial negative vote and would help reduce the distraction that say-on-pay is causing at many public corporations.


[1] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111- 203, §951, 124 Stat. 1376, 1899 (2010) (“Dodd-Frank Section 951”). Dodd-Frank Section 951 amended the Securities Exchange Act of 1934 by adding Section 14A (codified as amended at 15 U.S.C. §78n-1) (“Exchange Act Section 14A”).
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[2] Dodd-Frank Section 951 also requires any publicly traded company to hold a shareholder vote at least once every six years on the frequency of the say-on-pay vote. See Dodd-Frank Section 951(a)(2); Exchange Act Section 14A(a)(2); 15 U.S.C. §78n-1(a)(2). The first such vote on frequency was required in 2011. The longest interval between say-on-pay votes permitted under Dodd-Frank is three years. See Dodd-Frank Section 951(a)(1); Exchange Act Section 14A(a)(1); 15 U.S.C. §78n-1(a)(1). In 2011, according to one survey, at 1,792 (80.7 percent) of the companies holding frequency of say-on-pay votes, a majority of shareholders voted for holding say-on-pay votes annually; 412 (18.6 percent) voted for holding votes once every three years; only 16 (0.7 percent) voted for holding votes once every two years. See “Preliminary 2011 Post Season Report,” published by Institutional Shareholder Services (August 2011), at page 4. Document available at
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[3] See “Voting Analytics: An Analysis of Voting Results and Performance at Russell 3000 Companies,” published by Equilar (July 2011), at page 1. Document available at Because Dodd-Frank did not take effect as to annual meetings occurring before Jan. 21, 2011, the number of companies at which say-on-pay votes have taken place is somewhat lower than it otherwise would have been at this stage of the 2011 proxy season.
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[4] See Id. at page 1.
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[5] Matteo Tonello and Stephan Robimov, “The 2010 Institutional Investment Report: Trends in Asset Allocation and Portfolio Composition,” published by the Conference Board (November 2010). Document available at See in particular Table 13 at page 27 of the report.
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[6] Other categories of institutional shareholders include insurance companies, foundations, sovereign wealth funds and institutional traders trading for their own accounts or for private investors.
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[7] The 1.5 year average is an approximation derived (as a reciprocal) from an annual portfolio turnover rate of 75.9 percent shown in a 2010 report. See “Investment Horizons: Do Managers Do What They Say?” published by Mercer and the Investor Responsibility Research Center Institute (February 2010), at page 22. Document available at The statistic should not be taken too literally. For example, index funds, by their nature, are locked into the securities they are indexing. Also, many institutions hold stocks of particular companies for periods longer than 1.5 years as well as for shorter periods. But it does reflect a short-term mind-set as to a substantial portion of the portfolios held by institutional shareholders.
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[8] For a very thorough, critical examination of the role of shareholder proxy advisers, see “A Call for Change in the Proxy Advisory Industry Status Quo,” published by the Center on Executive Compensation (January 2011) (“Proxy Advisory White Paper”). Document available at
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[9] At least some shareholder advisers take the position they have “firewalls” within their organizations to prevent conflicts of interest. See, for example, ISS Brochure, last updated March 30, 2011, available at The effectiveness of such firewalls, however, has been questioned. See, for example, Proxy Advisory White Paper, supra at note 8, at page 46.
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[10] This is especially true at those corporations that require a majority vote for a director to be elected. According to a recent report, approximately 75 percent of the S&P 500 now have a majority vote standard for the election of directors. On the other hand, for public companies outside the S&P 500 it appears that approximately two-thirds continue to have plurality voting for directors. See, for example, “Building a Better Proxy Vote” (July 11, 2011) at
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[11] Under a law such as Delaware’s General Corporation Law (see Section 102(b)(7)) directors may also be exempted from liability to the corporation provided they have performed in good faith and meet certain other criteria.
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[12] According to the Equilar survey, supra at note 3, of the 38 companies with negative votes on say-on-pay, approximately 73 percent were below the median total shareholder return for 2010 for the 2,252 companies included in the Equilar study. Approximately 87 percent of the companies receiving a majority of negative votes were below the three-year median TSR for the same companies. A typical report by a shareholder advocate, such as ISS, starts with a presentation of the short-term performance (one to three years) of the stock of the corporation in question before the report makes its recommendations, including its recommendation as to the say-on-pay vote.
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[13] Leo E. Strine, Jr., “Toward a True Corporate Republic: A Traditionalist Response to Bebchuk’s Solution for Improving Corporate America,” 119 Harv. L. Rev. 1759, 1765(2006).
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One Comment

  1. Kyle Reddingfield
    Posted Tuesday, December 13, 2011 at 11:16 pm | Permalink

    Great article; very helpful. It blows my mind that anybody would attempt to use negative say-on-pay votes as evidence of breach of fiduciary duty — especially considering Section 951 — but I suppose it was only a matter of time. I noticed on that these kinds of provisions are meant to protect shareholders, but with the majority of shareholders who vote against executive pay being institutional, one has to wonder if they are less interested in appropriate compensation and more interested in increasing company profits.

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