The Efficacy of Shareholder Voting

David Larcker is the James Irvin Miller Professor of Accounting at Stanford University.

In the paper, The Efficacy of Shareholder Voting: Evidence from Equity Compensation Plans, which was recently made publicly available on SSRN, my co-authors (Christopher Armstrong of the University of Pennsylvania and Ian Gow of Harvard Business School) and I examine the efficacy of shareholder voting in effecting changes in corporate policy. We focus on the effects of shareholder voting on equity-based compensation plans on firms’ executive compensation policies for two reasons. First, equity compensation plans are widespread and require shareholder approval, making votes on these plans the most common subject of shareholder voting after director elections and auditor ratification. Second, equity compensation proposals attract much higher levels of shareholder disapproval than most other company-sponsored proposals that are put to shareholder vote (e.g., director elections and auditor ratification nearly always receive in excess of 90% shareholder support), making them a more powerful setting for empirical analysis.

Of the 619 management-sponsored proposals rejected by shareholders between 2001 and 2010, 183 (30%) related to equity compensation plans. For the 2,659 management-sponsored proposals where Institutional Shareholder Services (ISS), a leading proxy advisory firm, recommended a vote against the proposal, 1,719 (65%) related to equity compensation plans. Moreover, ISS recommended against 27% of the 6,270 equity compensation plans considered between 2001 and 2010. Although only 2% of equity compensation proposals fail to receive the required level of shareholder support, this is substantially larger than the 0.07% failure rate for director elections, which have received considerably greater attention in recent research on shareholder voting and executive compensation.

Yermack (2010) argues that “circumstantial evidence suggests that many firms have reacted to the rising tide of negative votes [for share authorization] by scaling back their equity compensation plans.” However, there is little rigorous systematic evidence of such an effect. In this paper, we provide direct evidence on this issue by examining the effect of shareholder votes for, and the outright rejection of, equity pay plans on firms’ executive compensation policies.

We first examine the determinants of shareholder support for proposed equity pay plans. In contrast to prior research that examines votes for individual directors (e.g., Cai et al., 2009; Fischer et al., 2009), shareholder sentiment regarding firms’ executive compensation policies should be more directly reflected in their votes for equity pay plans. We find evidence that measures of “excess” compensation and shareholder dilution that are similar to those used by proxy advisors (e.g., ISS and Glass Lewis) and institutional investors (e.g., Fidelity Investments) are negatively related to shareholder support for equity compensation plans. However, these same measures have no association with shareholder support in director elections that occur at the same annual meeting. These findings suggest that shareholder voting on equity pay plans is a more likely channel than director voting for shareholders to express their sentiment about firms’ executive compensation policies.

We then examine whether shareholder support for equity pay plans has an impact on firms’ future compensation policies. This analysis is complicated because it is difficult to determine a priori the precise timing or elements of future compensation that should be affected by shareholder voting. Accordingly, we examine a variety of compensation measures over different horizons. In general, we find little evidence that shareholder voting support for equity pay plans affects future CEO compensation. Moreover, although not the primary focus of our paper, we do not observe a positive association between shareholder support in director elections and future compensation.

Given the endogenous nature of the relationship between shareholder voting support and CEO compensation, we supplement our cross-sectional regressions with two alternative research designs. First we employ instrumental variable (IV) regressions using ISS voting recommendations as an instrument for shareholder support. Given ISS’s expressed policy of formulating its recommendation from a limited information set based on proxy filings made before shareholders vote, we argue that these recommendations provide a plausible source of exogenous variation in shareholder votes. Consistent with the results of our cross-sectional regression analysis, the IV estimates also indicate that there is no relation between shareholder voting on compensation proposals and subsequent changes in CEO compensation.

Our second approach for addressing endogeneity is regression discontinuity design (RDD), which exploits the discrete nature of the level of voting support required for approval of an equity compensation plan (typically 50%). With relatively minor assumptions, RDD allows us to estimate an unbiased treatment effect, even when the shareholder voting is jointly determined with future compensation outcomes. Since these proposals are formally binding, they provide a more powerful setting for observing the effects, if any, of shareholder rejection of company-sponsored proposals. However, consistent with our earlier findings, the results from our RDD analysis provide virtually no evidence that failing to receive shareholder approval for an equity pay plan has an effect on subsequent executive compensation.

Given that shareholder votes on equity pay plans are binding in the sense that a failed vote deprives boards of the ability to grant the requested shares for compensation purposes, the lack of an effect on future equity-based compensation is puzzling. One possible explanation is that management responds to the rejection of a proposed equity pay plan by requesting additional shares in the subsequent year. To the extent that shareholders approve such requests, the total effect of shareholder rejection on equity-based compensation may be negligible. We examine this possibility and find that firms whose plans are rejected by shareholders are significantly more likely to request shares in the subsequent year. However, we find that the level of shareholder approval for these follow-up requests is not related to whether the original request was approved. This finding highlights the need to examine executive compensation and shareholder voting over multiple periods, as even if shareholder voting had an immediate effect, it might have little or no long-term effect.

Collectively, our findings are at odds with those of prior research, as they suggest that shareholder sentiment expressed through voting support does not affect firms’ executive compensation policies. Our findings also suggest that recent regulatory efforts, which focus on strengthening shareholders’ ability to affect corporate policy through shareholder voting, particularly in the context of executive compensation, may not have the desired effect on firm policies.

The full paper is available for download here.

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