In my article, Dodd-Frank: Quack Federal Corporate Governance Round II, I argued that say on pay was likely to prove ineffective:
The effectiveness of say on pay is highly contested. The Senate committee report argued that:
The UK has implemented ‘‘say on pay’’ policy. Professor John Coates in testimony for the Senate Banking Committee stated that the UK’s experience has been positive; ‘‘different researchers have conducted several investigations of this kind . . . These findings suggest that say-on-pay legislation would have a positive impact on corporate governance in the U.S. While the two legal contexts are not identical, there is no evidence in the existing literature to suggest that the differences would turn what would be a good idea in the UK into a bad one in the U.S.’’
In contrast, Professor Jeffrey Gordon argues that the U.K. experience with say on pay makes a mandatory vote a “dubious choice.” First, because individualized review of compensation schemes at the 10,000-odd U.S. reporting companies will be prohibitively expensive, activist institutional investors will probably insist on a narrow range of compensation programs that will force companies into something close to a one size fits all model. Second, because many institutional investors rely on proxy advisory firms, a very small number of gatekeepers will wield undue influence over compensation. This likely outcome seriously undercuts the case for say on pay. As we have seen, proponents of say on pay claim it will help make management more accountable, but they ignore the probability that say on pay really will shift power from boards of directors not to shareholders but to advisory firms like RiskMetrics. There’s good reason to think that boards are more accountable than those firms. “The most important proxy advisor, RiskMetrics, already faces conflict issues in its dual role of both advising and rating firms on corporate governance that will be greatly magnified when it begins to rate firms on their compensation plans.” Ironically, the only constraint on RiskMetrics’ conflict is the market—i.e., the possibility that they will lose credibility and therefore customers—the very force most shareholder power proponents claim doesn’t work when it comes to holding management accountable.
As for the U.K. experience, Gordon’s review of the empirical evidence finds that shareholders almost invariably approve the compensation packages put to a vote. He further finds that while there is some evidence that pay for performance sensitivity has increased in the U.K., executive compensation has continued to rise “significantly” in the U.K. Indeed, the growth rate for long-term incentive plans has been “higher” than in the U.S.
Gordon concludes “that ‘say on pay’ has some downsides even in the United Kingdom, downsides that would be exacerbated by a simple transplant into the United States.” He recommended that any federal rule be limited to an opt-in regime or, if some form of mandatory regime was politically necessary, that it be limited to the very largest firms. As we have seen, Congress went in a different direction, despite the considerable uncertainty as to whether say on pay will be effective.
With the first proxy season since say on pay became law behind us, we now see that it has indeed proved ineffective. Broc Romanek reports:
Last month, Premiere Global Services became the 40th company to file a Form 8-K reflecting a failure to get majority support for it's say-on-pay agenda item (47%). ... 40 failures is less than 2% of all companies that had say-on-pay on their ballot this season.
So what can we conclude? First, I must confess to be surprised how little influence ISS had on the process. ISS recommended no votes at about 12% of listed companies it analyzed. Pay packages at companies that got a negative ISS recommendation received a lower percentage of favorable votes than those at companies where ISS made a positive recommendation, but the vast majority still passed with room to spare. This assuages concerns that ISS would prove to be the proverbial 800 pound gorilla, but it does not eliminate the conflict of interest ISS has. Government regulators still need to take a hard look at ISS and other proxy advisory firms.
Second, I come away persuaded activist investors remain rare. The data suggest that shareholder governance activism is still concentrated among state and local government pension funds, union pension funds, and individual gadflies. It's good news that they remain a minority, but their activism remains troubling since they are often the investors most likely to use governance activism to advance a private agenda.
Third, and back to surprises, I must admit to being surprised at the number of lawsuits filed against firms at which there was a no vote. What part of advisory and nonbinding do the plaintiffs and their lawyers fail to understand?
If I were the czar of corporate governance, I'd throw out the Dodd-Frank say on pay rules and replace them with an opt-in regime.
