Is Say on Pay All About Pay? The Impact of Firm Performance

Jill E. Fisch is Perry Golkin Professor of Law at the University of Pennsylvania Law School; Darius Palia is Professor of Finance at Rutgers University; and Steven Davidoff Solomon is Professor of Law at UC Berkeley School of Law. This post is based on a article authored by Professor Fisch, Professor Palia, and Professor Davidoff Solomon, forthcoming in the Harvard Business Law Review.

In Is Say on Pay All About Pay? The Impact of Firm Performance, we seek to answer the question whether “say on pay” votes really focus on executive compensation. As policymakers evaluate the decision whether to retain say on pay, it is worth examining more carefully the information that shareholders convey through their vote on executive compensation, a question we examine in this article. We find that, although pay plays a role in voting results, the say on pay vote is largely a means for shareholders to express dissatisfaction with firm performance.

U.S. issuers have now been required to provide shareholders with the opportunity to cast an advisory vote on executive compensation—say on pay—for five years. The effect of say on pay remains heavily debated. Shareholders rarely reject compensation plans; they fail to receive majority support at fewer than 2% of issuers. Rather, shareholders at the overwhelming majority of issuers vote to approve executive compensation, and the average percentage of votes in favor exceeds 90%. The link between say on pay and CEO compensation is unclear—CEO pay continued to rise for the first several years after Dodd-Frank, declined in 2015 and, most recently, in 2016, rose to record levels.

Even in cases in which compensation packages fail to receive substantial support, the effect of a low say on pay vote is unclear. Academic studies have reached inconsistent results but have generally failed to find conclusive evidence that issuers reduce executive pay packages in response to lower approval rates. Studies suggest, however, that issuers modified the structure of executive pay packages in response to the say on pay mandate, in particular, concentrating a greater component of pay in restricted stock and stock options. It is not clear, however, that this higher concentration of equity-based pay makes it truly performance-based or that the modifications are increasing shareholder value.

We analyze say on pay votes of S&P 1500 companies between 2010 and 2015. As might be predicted, we find that both excess compensation and pay-performance sensitivity affect the level of shareholder support for executive compensation packages. More surprisingly, however, we find that, even after controlling for these variables, a critical additional driver of low shareholder support for executive compensation packages is the issuer’s economic performance. Say on pay votes reflect, to a large degree, dissatisfaction with firm performance, and not solely pay.

We further test the role of Institutional Shareholder Services (ISS) voting recommendations. We identify two important results. First, as with voting outcomes, ISS recommendations are driven by an issuer’s economic performance, independent of pay-related variables. Second, we show that ISS’s evaluation of the CEO’s pay-performance sensitivity uses an ex post measure of sensitivity and, as such, appears to differ from shareholder preferences.

Our findings have important implications. First they suggest that shareholder voting may be a poor tool to address public concerns about the size and structure of executive compensation. Because of the key role of economic performance in explaining say on pay voting outcomes, the say on pay vote operates as a signal of investor dissatisfaction with executive pay only in poorly-performing companies. So long as the issuer is performing well, even if executive pay is too high or insufficiently tied to performance, these concerns will not lead investors to vote against the pay package. To the extent that say on pay is about curbing problematic compensation, it seems to be a rough and inadequate tool.

Second, and perhaps more importantly, shareholder support for executive pay seems to be highly correlated with an issuer’s short term stock performance. Shareholders appear to focus substantially on performance and to be punishing executives, through say on pay, for poor performance rather than excessive pay. To the extent that the say on pay vote heightens executives’ incentives to focus on short term stock price at the potential cost of working to enhance long term firm value, it may be counterproductive.

The complete article is available here.

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