Pay Versus Performance and Investor Voting Decisions

The U.S. Securities and Exchange Commission (SEC) recently adopted the Pay Versus Performance disclosure rule to enhance transparency and assist shareholders in evaluating executive compensation. The rule requires public companies to disclose a new measure of compensation actually paid (CAP) alongside traditional measures of pay and firm performance indicators, such as stock returns and net income, in a standardized proxy statement table. While much of the information repackages existing data, the goal is to reduce information processing costs and enable more informed voting on executive pay and director elections.

Mandated by the 2010 Dodd-Frank Act, the rule took 12 years to finalize. Initially proposed in 2015, it was paused for seven years before being finalized in August 2022. The rule garnered support from institutional investors and advocacy groups, who argue that it clarifies compensation strategies and highlights misaligned incentives that contributed to past financial crises. Proponents believe the simplified presentation of pay and performance data will help investors assess directors’ effectiveness in linking executive pay with firm outcomes. Critics, however, contend that the disclosures are redundant and risk creating information overload without adding meaningful insights.

Our study, Pay Versus Performance and Investor Voting Decisions, examines whether the new rule improves the decision-usefulness of pay disclosures by simplifying compensation analysis. Previously, the complexity and length of SEC disclosures may have hindered investors’ ability to assess and vote on executive pay. By consolidating key data, the rule aims to streamline this process and reduce information processing costs. To test its impact, we analyze data from over 2,500 firms that disclosed CAP for the first time in their 2023 proxy statements.

New Measure of Executive Pay

The Pay Versus Performance rule introduces CAP as a performance-sensitive adjustment to summary compensation table (SCT) pay. CAP reflects year-end changes in the value of unvested equity awards, pensions, and dividends. Unlike pay reported in the SCT, which is based on grant-date fair values of equity and is never negative, CAP provides a more dynamic measure of executive pay and can be positive or negative. While investors could theoretically compute a CAP-like measure using existing SEC disclosures, doing so involves significant time, complexity, and assumptions, making the process costly. CAP aims to simplify this process. To analyze its impact, we compute a CAP/SCT ratio to quantify the divergence between the measures, hypothesizing that a significant association between this ratio and changes in investor support for Say-On-Pay or compensation committee members would indicate that investors use the new disclosure.

Changes in Investor Voting

Our findings reveal that a larger CAP-to-SCT gap is significantly associated with changes in voting support for Say-On-Pay proposals and compensation committee members, suggesting that investors use the new disclosure to inform their decisions. These results hold after controlling for a variety of factors, such as firm performance and proxy advisor recommendations. Importantly, CAP disclosures do not appear to influence voting for board members who are not on the compensation committee. Additional tests support the notion that these changes stem from the new CAP disclosures, as investors began incorporating the information only after it was made available in the proxy.

Information Processing Costs

If the new rule reduces information processing costs, its impact should be more pronounced for firms with pay structures that were previously harder to interpret. Using proxies for pay complexity and disclosure length, we find that firms with higher ex-ante information costs exhibit greater shifts in voting behavior, particularly for compensation committee members, following the disclosure of a CAP value that diverges from SCT. This suggests the rule reduces information processing costs where they are highest.

Firm Performance

Investor reactions to CAP disclosures also depend on firm performance, as pay-performance alignment likely becomes clearer when CAP is shown alongside stock returns. We find that firms reporting a higher CAP/SCT ratio with strong stock returns retain or increase investor support for executive pay and compensation committee members. Conversely, a higher CAP/SCT ratio paired with poor stock performance leads to significant declines in Say-On-Pay approval and support for compensation committee members. These results suggest that juxtaposing performance-adjusted pay with stock returns reduces the effort required for shareholders to assess whether compensation strategies align with value creation.

Proxy Advisors

The PVP rule could also reduce processing costs for sophisticated market participants like proxy advisors, who heavily influence investor voting decisions but face time constraints during busy proxy seasons. In fact, the largest proxy advisors—Institutional Shareholder Services (ISS) and Glass Lewis—updated their 2023 voting guidelines stating they would incorporate the new disclosures into their qualitative assessments of pay packages.

Our findings show that ISS reduces its support for Say-On-Pay proposals and compensation committee elections when firms report a higher CAP/SCT ratio paired with poor stock performance, but increases support when a higher CAP/SCT ratio is disclosed alongside strong stock returns. Glass Lewis reduces support for Say-On-Pay in firms with higher CAP/SCT ratios and poor performance but does not appear to adjust recommendations for compensation committee members. These results indicate that even sophisticated market participants appear to benefit from streamlined pay-performance information.

Implications

Our key finding is that the SEC’s new Pay Versus Performance rule makes executive compensation information easier to understand and process, which influences their voting decisions. For academics, the study contributes to the literature on disclosure processing costs and shareholder voting by showing how streamlined disclosures can shape investor behavior. Practitioners, such as compensation consultants and proxy advisors, may also find the evidence useful in understanding how investors adjust voting decisions based on perceptions of pay-performance alignment. For regulators, the results highlight the benefits of standardized and transparent disclosures in promoting informed investor voting. While we do not evaluate whether CAP is a superior measure of pay-performance alignment, the evidence shows the new disclosures facilitate greater scrutiny of executive compensation practices.