Management Influence on Investors: Evidence from Shareholder Votes on the Frequency of Say on Pay

Fabrizio Ferri is Associate Professor of Accounting at Columbia Business School. This post is based on an article authored by Professor Ferri and David Oesch, Associate Professor of Financial Accounting at the University of Zurich.

In our paper, Management Influence on Investors: Evidence from Shareholder Votes on the Frequency of Say on Pay, forthcoming in the Contemporary Accounting Research, we try to quantify the influence of management recommendations on shareholder votes. In the post-Enron world, firms have become increasingly responsive to shareholder votes, even when non-binding. A key driver of voting outcomes is the recommendations issued by proxy advisors. For example, various studies estimate that ISS recommendations “move” about 25% of the votes, raising legitimate concerns about the quality of these recommendations, the degree of transparency and competition in the proxy advisory industry, potential conflicts of interest, etc. In contrast, we know very little about the influence of management recommendations on shareholder votes. The challenge in empirically evaluating this influence is that management recommendations are typically the same across firms and over time (i.e., in favor of management proposal and against shareholder), making it impossible to estimate their association with shareholder votes.

In this study we identify two settings offering variation in management recommendations. The first one is Section 951 of the Dodd-Frank Act. In addition to mandating a non-binding shareholder vote in 2011 on executive pay, known as “say on pay” (SOP), Section 951 mandated a non-binding vote on the frequency of future SOP votes (known as “say when on pay” vote), offering a choice between an annual, biennial or triennial frequency. In our sample of S&P 1500 firms, management recommended an annual SOP vote in about 60% of the cases, and a biennial or triennial vote in the rest of the cases. This unique case of cross-sectional variation in management recommendations allows us to estimate their influence on shareholder votes, which we quantify at 25.9% of the votes (after controlling for standard determinants of shareholder votes). We also find that the extent of management influence depends on management credibility with shareholders (as revealed by past shareholder votes).

The second setting is the case of shareholder proposals to declassify the board. Over the last decade, such proposals have been among the most frequent and successful in terms of voting outcome and firms’ subsequent adoption, reflecting the belief that classified boards hurt firm value. Declassifying the board requires an amendment of the certificate of incorporation, which, in turn, requires a shareholder vote. Hence, to declassify the board in response to a shareholder proposal winning a majority vote, the subsequent year the board must submit a management proposal to amend the certificate of incorporation to a shareholder vote. Between 2001 and 2012 we identify 129 firms where a shareholder proposal to declassify the board won a majority vote and was then followed by an analogous management proposal. Effectively, this means we can observe a time-series variation in management recommendations, from ‘against’ to ‘for’. Controlling for other determinants of votes, the difference in voting outcomes between the two subsequent proposals should capture the effect of the change in management recommendations and, thus, management influence on shareholder votes. Using this setting, we estimate management influence at about 24.4%.

Remarkably, our cross-sectional and time-series estimates of management influence, based on two different settings (frequency of SOP votes and board declassification), are quite close, at around 25%. The magnitude is large and may actually be understated, since we examine two settings where many institutional investors have strong predetermined preferences (in favor of annual SOP votes and in favor of declassifying board). Hence, the percentage of votes “in play” (and thus potentially subject to management influence) may be lower than in other voting settings.

Our estimates are based on associations between shareholder votes and management recommendations and thus are subject to the usual endogeneity concerns. In particular, an important concern is reverse causality. If management align their recommendations with expected voting outcomes, then the association would not reflect a causal effect of recommendations on votes, but, rather, the opposite. However, by construction, our board declassification test rules out this possibility. If management simply changed its recommendation to align it with shareholders’ preference after observing the voting outcome in favor of the shareholder proposal, there should be no association between the management recommendation and shareholder votes in the subsequent year (i.e. the voting outcome should be about the same in both years). Instead, we observe a 24.4% increase in votes for the proposal. Another concern is that maybe some shareholders who voted against declassification in the first year decided to vote in favor next year because they observed a majority vote (rather than because of the change in management recommendation). However, when we examine a subset of majority-vote shareholder proposals re-submitted the subsequent year (and opposed by management in both years), there is little change in voting outcomes. Hence, our estimate is likely to capture the change in management recommendation.

In addition to estimating management influence on shareholder votes, the study sheds some light on the consequences of such influence. In particular, we find that firms adopting a triennial frequency  in 2011—and, thus, facing the next SOP vote in 2014—were less likely to make changes to their compensation practices in response to negative SOP votes compared to firms adopting an annual frequency (and thus facing the next SOP vote in 2012). Our evidence of lower responsiveness by companies adopting triennial SOP votes is consistent with the view that a less frequent vote reduces management accountability. Furthermore, it may suggest that management used its significant influence over shareholder votes to institute a less frequent SOP vote and thus reduce scrutiny over executive compensation.

Overall, the key message from our study is that, while concerns’ with the role of proxy advisors are legitimate, policy-makers and academics should be equally concerned with management influence on shareholder votes and, more generally, on the voting process.

The full paper is available for download here.

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