Do Compensation Disclosures Matter for Say-on-Pay Voting?

Lakshmanan Shivakumar is Professor of Accounting at London Business School. This post is based on an article authored by Professor Shivakumar and Tathagat Mukhopadhyay, Doctoral Candidate in Accounting at London Business School. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, by Lucian Bebchuk and Jesse Fried.


Concerns about executive pay packages have been raised by market participants and media for nearly the last three decades and, more recently, executive pay structures incentivizing risk-taking have been pointed out as a major cause for the 2008 financial crisis. In response to these concerns, the Securities and Exchange Commission (SEC) adopted a two pronged approach to both better inform investors about executive compensation decisions as well as to give shareholders a say on executives’ pay. While the former was implemented in 2006 by requiring firms to provide detailed executive compensation-related disclosures in definitive proxy materials, the latter approach was introduced through the mandatory “Say on Pay” (SoP) voting requirement introduced in 2011. Many prior studies examine the effectiveness of SoP, but so far we know very little about the usefulness of compensation-related proxy disclosures. In our paper, Do Compensation Disclosures Matter for Say-on-Pay Voting?, which was recently made public via SSRN, we directly examine the influence of such disclosures on the SoP voting decisions of stock market participants.

Market participants are known to respond to a variety of firm disclosures (see Healy and Palepu, 2001), raising the possibility that greater clarity and more information on compensation could help shareholders understand the reasoning behind a firm’s remuneration decision. A recent survey of institutional investors by Larcker and Tayan (2015), finds that most investors want corporations to provide more explanations of their compensation package in their proxy statements. However, critics contend that myopic shareholders cast their SoP votes without a proper understanding of labor-market demands or apathetically relying on proxy advisors’ recommendations (e.g., Bainbridge, 2009). Firms could also obfuscate information by potentially including irrelevant information in proxy statements, thereby diluting the usefulness of compensation-related disclosures to shareholders. Thus, ex-ante it is unclear whether compensation-related disclosures in proxy statements are useful to investors. We evaluate this empirically by examining whether compensation-related disclosures in proxy statements influence investors’ decisions in SoP votes. Specifically, we investigate whether greater textual disclosures about performance measures in proxy statements affect the outcome of SoP vote and, if so, whether firms make more use of this disclosure mechanism when there is a greater demand from market participants for such information.

Since disclosures of performance are expected to be driven by the vision and strategy of a firm, we rely on the Balanced Scorecard (BSC) literature to identify major dimensions of corporate strategy and typical key performance indicators that boards use to ensure alignment of managerial incentives and link rewards to performance (Kaplan and Norton, 1992). Using a list of the most common yet potentially relevant performance indicators identified from the BSC literature, we parse discussions of these performance measures from all proxy materials filed by US listed firms since January 2007. We first evaluate whether firms that provide more textual disclosures of performance are more likely to get SoP approval voting. Controlling for the level of pay, other known economic determinants of compensation and the voting recommendation of Institutional Shareholder Services (ISS), we find that firms are more likely to obtain SoP approval when they provide greater textual disclosures of performance. Hence, greater disclosures allow investors to independently evaluate compensation packages, without necessarily relying on ISS’ views.

In order to account for differences in compensation structure across firms and other omitted correlated variables, we repeat the above analysis on the subsample of firms that receive an “Against” recommendation from ISS. Firms in this subsample are relatively homogenous in that they do not meet the standards of ISS in terms of the level or structure of compensation or the rationale provided for the compensation, including information available from sources outside of proxy statements. We continue to find that the likelihood of receiving SoP approval increases with the extent of disclosures regarding compensation-relevant performance measures. We also study whether firms take advantage of this disclosure mechanism to increase their chances of obtaining SoP approval and find that, relative to firms that passed their previous SoP votes, failed firms increase their disclosures ahead of subsequent SoP vote. Next, we examine whether increased disclosures in response to a failed SoP vote is related to the likelihood of obtaining shareholders’ approval in the subsequent period. We find that firms that increase their disclosures are more likely to get SoP approval next time, suggesting that changes in disclosure practices are relevant to investors and significantly influence SoP voting outcomes. Finally, consistent with firms providing more information on performance measures when their executive pay is greater than that of their peers, we find a significantly positive relationship between peer-adjusted pay and text-based scores.

Overall, we report novel evidence that firms can credibly respond to shareholder demands for information by providing textual disclosures in proxy statements to justify executive remuneration decisions. Such disclosures increase the likelihood of firms getting shareholder approval, even after accounting for proxy advisor’s recommendations. Furthermore, firms are shown to utilize this channel when they offer higher compensation to managers relative to peer firms and when shareholders voice their disapproval of such compensation. In summary, our analyses suggest that the quality of compensation-related disclosures affects voting outcomes. Thus, these results speak to the importance of firms providing more narrative discussions of performance measures in their proxy materials.

Our paper contributes to both the executive compensation and disclosure literatures as well as to the growing literature on the determinants and consequences of mandatory SoP voting. Our findings also have broader implications for practitioners and regulators. Over time, SEC has mandated more extensive and comprehensive disclosures of information on executive compensation. However, increased disclosures are costly and increase compliance risks for businesses. Thus, while there are real costs to imposing greater disclosures, very little empirical evidence exists on the benefits of such increased disclosures. Our findings show that companies can effectively use disclosure mechanisms as one tool to address shareholders’ concerns on executive pay.

The full paper is available for download here.

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