ProfessorBainbridge.com

Using the financial crisis to justify regulating Main Street

Lucian Bebchuk is still trying to use the financial crisis of 2007-2008 to justify his sweeping regulations of executive compensation:

In fact, pay arrangements did provide substantial incentives for excessive risk-taking. Under the standard design of pay arrangements, executives were fully exposed to the upside of risks taken but enjoyed substantial insulation from part of the downside of such risks. As a result, executives had incentives to increase risk-taking beyond optimal levels.

The trouble with this rhetorical move should be obvious. Unfortunately, Bebchuk's not the only one peddling it. So I was forced to spell out the problem in my book Corporate Governance after the Financial Crisis:

Scholars are divided as to whether this incentive structure causally contributed to either the housing or credit crunch. Grant Kirkpatrick contends that incentive pay encouraged high levels of risk taking.  Richard Posner argues that the structure of executive compensation practices encouraged management to cling to the housing bubble and “hope for the best.”  In contrast, Peter Mulbert contends that the empirical evidence does not support treating compensation as a major causal factor.  What seems clear, however, is that the problem was localized to the financial sector. Whether or not financial institution executive compensation practices contributed to the crisis, there is no evidence that executive compensation at Main Street corporations did so.

Accordingly, using the financial crisis as a legitimate rationale for regulating Main Street executive compensation practices is a bogus argument.

"Is Any CEO Worth $189,000 Per Hour?"

Prompted by news of the $378 million new Apple CEO Tim Cook will make in his first year on the job, BusinessWeek posted an article headlined by the titular question. It's a fair article, which you ought to go read.

Qoheleth tells us that "What has been, that will be; what has been done, that will be done. Nothing is new under the sun! Even the thing of which we say, 'See, this is new!' has already existed in the ages that preceded us."

Just so.

Back in the 1930s, a lawsuit challenging executive bonuses as corporate waste gave rise to the aphorism “no man can be worth $1,000,000 per year.” One wonders what the anti-CEO pay campaigners of those days would make of a man supposedly worth $1 million per 5.3 hours?

I discuss these arguments in my new book Corporate Governance after the Financial Crisis, in which I argue that:

The rhetoric of class warfare makes a poor foundation for economic policy. As a justification for regulating executive compensation, however, it is particularly inapt. First, why single out public corporation executives? Many occupations today carry even larger rewards. The highest paid investment banker on Wall Street in 2006 was Lloyd Blankfein of Goldman Sachs, for example, who “earned $54.3 million in salary, cash, restricted stock and stock options,”[1] or about 4 times the median CEO salary from the year before. The pay of some private hedge fund managers dwarfed even that sum. Hedge fund manager James Simons earned $1.7 billion in 2006, for example, and two other hedge fund managers also cracked the billion-dollar level that year.[2] Not to mention, of course, the considerable sums earned by top athletes and entertainers.

Second, regulating executive compensation may scratch the public’s populist itch, but it does little to address inequalities of income and wealth. To be sure, as Brett McDonnell observes, fat cat “CEOs have become poster boys for” the dramatic increase in “inequality in income and wealth in this country.”[3] Even if one assumes that redressing such inequalities is appropriate social policy, however, capping or cutting CEO pay is not an effective means of doing so.

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[1] Jenny Anderson & Julie Creswell, Top Hedge Fund Managers Earn Over $240 Million, N.Y. Times, Apr. 24, 2007.

[2] Id.

[3] Brett H. McDonnell, Two Goals for Executive Compensation Reform, 52 N.Y.L. Sch. L. Rev. 586, 587 (2008).

 

UK Shareholders to get Binding Say on Pay Vote

The Corporate law and Governance Blog reports that:

Later this month the Government will publish proposals following its consultation on executive remuneration. However, ahead of this announcement, the Prime Minister had made clear that shareholders in the largest companies are to be given a binding vote on remuneration: see here.

I find this rather curious, given that nonbinding say on pay votes in the UK haven't proven all that impressive. As I wrote in Corporate Governance after the Financial Crisis:

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. 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 is 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 does not 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.”

Say on Pay research

From the pens of Randall S. Thomas (Vanderbilt Law School; European Corporate Governance Institute), Alan R. Palmiter (Wake Forest University - School of Law), and James F. Cotter (Wake Forest University Calloway School), comes Dodd-Frank's Say on Pay: Will it Lead to a Greater Role for Shareholders in Corporate Governance?:

"Say on pay" gives shareholders an advisory vote on a company's pay practices for its top executives. Beginning in 2011, Dodd-Frank mandated such votes at public companies. The first year of "say on pay" under the new legislation may have changed the dialogue and give-and-take in the shareholder-management relationship at some companies, particularly on the question of executive pay. 

We study the evolution of shareholder voting on "say on pay" - beginning in 2006 as a fledgling shareholder movement to get "say on pay" on the corporate ballot, evolving as a handful of companies and later the financial firms receiving TARP funds conducted "say on pay" votes, and leading to Dodd-Frank’s extension of the process to all public companies. 

Using results from an empirical analysis of data from the pre-Dodd-Frank period, we project that the new mandatory management-sponsored “say on pay” proposals will attract strong shareholder support at most companies, while poorly performing companies with high pay levels can expect shareholder dissent. These projections are confirmed by early results in the first year of post-Dodd-Frank experience with “say on pay.” 

Our empirical analysis of the pre-Dodd-Frank data supports the potential importance of third party voting advisor recommendations, particularly by the ISS, on executive pay proposals. The raw data show 20 percent swing in shareholder support for management “say on pay” proposals associated with a negative ISS recommendation. However, once we take into account the different recommendations issued by management and ISS, the net effect of an ISS negative recommendation on the overall shareholder vote is relatively small at most companies. Nevertheless, the early Dodd-Frank results show that all 37 companies that failed to obtain majority support in these advisory votes had received negative ISS recommendations. 

The early results show that companies that initially received negative “say on pay” recommendations by the ISS often modified their disclosure filings or changed their pay practices. This may indicate to a growing role for shareholders in influencing executive pay practices and more generally corporate governance.

Nothing terribly surprising there, but it's very useful confirmation of what eyeball analysis of the results suggested. But I remain unconvinced that say on pay is a good idea. See my article: Remarks on Say on Pay: An Unjustified Incursion on Director Authority, in which I argued that:

Proponents of ... federal legislation entitling shareholders to vote on executive compensation must carry their burden of proving three distinct claims: First, that there is an executive compensation problem justifying legislative intervention. Second, say on pay is an effective solution to the problem. Third, that any such legislative intervention should be imposed at the federal level. 

If any of these claims fail, the case for a federal say on pay law collapses. In these remarks, I hope to demonstrate that none of the three holds up to close examination.

A Binding Say on Pay?

In the UK, the Institute of Directors is recommending that the government adopt a requirement for "a binding shareholder vote on remuneration policy ...." <SARCASM>What a good idea. After all, the nonbinding say on pay rules have worked so well.</SARCASM>

From my book Corporate Governance after the Financial Crisis:

Professor Jeffrey Gordon argues that the U.K. experience with say on pay makes a mandatory vote a “dubious choice.”[1] 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. 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 is 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.”[2] 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 does not work when it comes to holding management accountable.

Why not a Say on Say on Pay?

Larry Ribstein:

“Say on pay” seems like one of those “chicken soup” ideas — at best salutary and at worst unobjectionable.  Who could object to letting the shareholders vote on executive pay?

Minor Myers, for one, in The Perils of Shareholder Voting on Executive Compensation. He suggests that “the more involved shareholders are in a firm’s managerial decisions, the more difficult it is for directors to be held accountable for the outcome of those decisions.” The shareholder vote, he argues, will insulate directors’ compensation decisions from shareholder outrage, which might otherwise have served as an important discipline.  He “proposes amending the [say on pay] legislation to allow firms to opt-out of the say on pay regime by shareholder vote. This preserves the benefits of say on pay for those firms where shareholders wish to retain it and allows other firms to exit the regime at little cost.”

This proposal makes some sense. Myers cites evidence indicating that some firms gain and others lose from say on pay.  In other words, some firms find that they benefit more from holding directors solely responsible for managerial pay than by having the (mostly disengaged) shareholders take responsibility. Indeed, Myers’ theory suggests say on pay may be a boon to greedy managers.

Larry goes on to analyze whether the rule should be opt out or opt in. 

In any case, the SEC and Congress' refusal to make say on pay optional is one of the com plaints that I register about the rule in my forthcoming book Corporate Governance after the Financial Crisis:

[Professor Jeffrey] 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. Gordon’s proposal finds support in a recent behavioral economics laboratory experiment finding that say on pay has a more positive impact on investors when it is voluntarily effected by companies than when it is mandated.  As we have seen, however, Congress went in a different direction, despite the considerable uncertainty as to whether say on pay will be effective.

Strict liability clawbacks

Kevin LaCroix reports on the SEC's latest use of Sarbanes-Oxley Section 304 to clawback compensation from a CEO who was not charged with personal wrongdoing in connection with securities fraud issues at his company:

... the SEC reached a settlement with the former CFO of Beazer Homes to return more than $1.4 million in bonus compensation he earned during a period when the company was committing accounting fraud. As is contemplated under Section 304, the former CFO, James O’Leary, was obligated to return the bonus compensation even though he was himself not charged with any wrongdoing in connection with the accounting fraud. The SEC’s August 30, 2011 press release about the settlement can be found here. ...

These SOX Section 304 clawback actions against Beazer Homes CEO and CFO follow prior Section 304 clawback actions in which the SEC has sought reimbursement of compensation paid to corporate officials they had earned during periods in which their companies had made financial misstatements, as I discussed in an earlier post. As was the case in the actions against Beazer’s CFO and CEO, in the prior actions the officials involved were not alleged to have been involved in or aware of the financial misreporting. At least one court (refer here) has affirmed the SEC’s authority to pursue the compensation clawback under these circumstances, under SOX Section 304.

LaCroix seems uncertain of section 304's merits:

Though statutorily authorized, the implementation of a forfeiture without culpability or fault raises troubling questions, including even basic questions of fairness. On the other hand, it might also fairly be asked whether the CEO or CFO ought to be able to retain benefits accumulated at a time when the investing public was being misled, by financial statements that the CEO and CFO certified, about the company’s financial condition. As an SEC official was quoted as saying in the press release about the SEC’s settlement with O’Leary, “Section 304 of the Sarbanes-Oxley Act encourages senior management to take affirmative steps to prevent fraudulent accounting schemes from occurring on their watch.”

I'm likewise of two minds on this issue. On the one hand, as I've argued here before: During the 1990s, restating financials became commonplace. Some firms were notorious for taking incredibly aggressive accounting positions. When they were called out for it, they simply restated their financials and claimed the SEC and/or private claim was moot.

As illustrated by other provisions of SOX, such as the CEO and CFO certification rules, Congress concluded that too many CEOs and CFOs had simply turned a blind eye to misconduct by subordinates. A claw-back rule that essentially imposes strict liability on CEOs and CFOs for subordinate misconduct arguably provides a powerful incentive for CEOs and CFOs to ensure that the company's internal controls work.

A related argument is that much corporate financial statement shenanigans during the 1990s appears to have been motivated by efforts to maximize the value of top manager's stock options and other forms of equity and incentive compensation. Or, at least, so Congress concluded. It's precisely those forms of compensation that section 304 targets. The CEO and CFO, one might argue, should not be allowed to benefit from misconduct by subordinates, whether or not the CEO or CFO was aware of the misconduct. Any other rule would perpetuate the incentive to turn a blind eye.

On the other hand, I am troubled by the fairness issues LaCroix notes. I'm also concerned that a strict liability approach to section 304 would tend to encourage CEOs and CFOs to resist restating flawed financial statements and/or to game the timing of their compensation and stock transactions relative to any such restatements.

We also now know that section 304 prompted companies to increase "non-forfeitable, fixed-salary compensation and decreased incentive compensation, thereby providing insurance to managers for increased risk." Sanjai Bhagat & Roberta Romano, Reforming Executive Compensation: Focusing and Committing to the Long-Term, 26 Yale J. Reg. 359, 366 (2009).

The merits of section 304's strict liability approach thus remain highly debatable.

A caustic take on say on pay litigation

TK Kersetter lets loose with both barrels on a phenomenon we've been tracking here at PB.com for a while:

... companies that failed the say-on-pay shareholder vote (that is, they did not garner a majority of shareholder support) that are now being sued have fallen into the black regulatory hole known as: UNINTENDED CONSEQUENCES. I equate this to the modern-day expression: “My Bad!” In other words, it’s the creators of the regulation saying, “Oh, sorry companies… This wasn’t our intention, but now it is what it is.” Who couldn’t see this coming? Even I (fully admitting I’m not the sharpest tool in the shed at times), knew that the plaintiff’s bar would capitalize on this newly formed soft underbelly of American companies. And it sure didn’t take long.

You'll recall from our earlier discussion that aggressive plaintiff lawyers are suing companies with failed say on pay votes, despite the undisputable fact that "Dodd-Frank and the legislative history make clear that while both the say on pay and say when on pay votes must be tabulated and disclosed, neither is binding on the board of directors. The act and its legislative history further make clear that the votes shall not be deemed either to effect or affect the fiduciary duties of directors. S. Rep. No. 111-176, at 134 (2010)."

Anyway, back to Kersetter:

The sad part is, every expert I have been able to talk to believes these cases (eight filed so far) are frivolous and cannot be won if they to go to trial. And that’s OK for the law firms that filed the suits because more often than not they would prefer to settle than fight it in court. Two of the cases, one of which was clearly in the “egregious abuse of comp” category, have been settled. The other targeted companies are going through that frustrating exercise of, “Should we spend the time, energy, and money to fight a frivolous lawsuit that we are pretty sure to win?”… or “Do we settle, pay our blood money for not getting shareholder support, and get our company and board out of the negative limelight?” I wish that decision was as easy as it sounds and that all companies would stand their ground. But the facts are, sometimes settling is the best business decision… no matter how bad it ticks you off.

That's what the plaintiff's bar is counting on. As I've said before, "Sharks got to eat. Until Rule 11 has real teeth and we adopt loser pays with respect to class action legal fees, lawyers are going to bring these sorts of cases."

Kersetter continues:

As I’ve said before, many of these lawsuits aren’t developed based on mass shareholder discontent and unfortunately they don’t have to be. All it takes is one volunteer or malcontent shareholder (or sometimes a recruited shareholder) for the plaintiffs’ bar to file the suit. Then they hope for what all these chasers hope for: a company eager to settle. Well I’m here to support those companies, because what’s right sometimes overrides what’s prudent ,and I hope that some companies will fight the battle and clear up this mess for the rest of us.

Maybe more important, though, is to make sure your congressmen and the SEC see how ridiculous some of these lawsuits are and ensure they understand that nonbinding shareholder votes—even those won but where the percentages of votes were close—are not incidental, and often there is nothing “nonbinding” about them. I promised in my last blog that after this rant I would turn to some positive issues. Honestly, it might take me a while because with all that facing today’s American businesses, this is an unintended consequence that we could have predicted and we shouldn’t be dealing with.

And the Washington idiots that passed Dodd-Frank wonder why the economy is struggling.

Say on Pay Proves Ineffective, but Still Problematic

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.

Repealing Dodd-Frank piecemeal

BNA reports (sub. req'd) that the House Financial Services Capital Markets Subcommittee has passed several bills that would repeal or revise several of Dodd-Frank's more onerous provisions. Among them are:

The Burdensome Data Collection Relief Act (H.R. 1062), sponsored by Nan Hayworth (R-N.Y.), would repeal Section 953(b) of the Dodd-Frank act. The provision requires public issuers to disclose the median annual total income for all employees except the CEO and the annual total income of the CEO, and to calculate the ratio comparing the two figures.

In my article Dodd-Frank: Quack Federal Corporate Governance Round II (September 7, 2010).  Available at SSRN: http://ssrn.com/abstract=1673575, I explain that:

Section 953 requires that each reporting company’s annual proxy statement must contain a clear exposition of the relationship between executive compensation and the issuer’s financial performance.[1] It further requires disclosure of “the median of the annual total compensation of all employees of the issuer,” except the CEO, the CEO’s annual total compensation, and the ratio of the two amounts.[2] This requirement is expected to be hugely burdensome:

[It] means that for every employee, the company would have to calculate his or her salary, bonus, stock awards, option awards, nonequity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings, and all other compensation (e.g., perquisites). This information would undoubtedly be extremely time-consuming to collect and analyze, making it virtually impossible for a company with thousands of employees to comply with this section of the Act.[3]

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[1] Id.

[2] Dodd-Frank § 953.

[3] Warren J. Casey & Richard Leu, United States: New Executive Compensation Disclosures Under Dodd-Frank (August 3, 2010), Mondaq.com, http://www.mondaq.com/unitedstates/ article.asp?articleid=106962. See also Jean Eaglesham & Francesco Guerrera, Pay Law Sparks “Nightmare” on Wall St, Fin. Times, Aug. 31, 2010, at 1 (“The rules’ complexity means multinationals face a "logistical nightmare" in calculating the ratio, which has to be based on the median annual total compensation for all employees, warned Richard Susko, partner at law firm Cleary Gottlieb. "It's just not do-able for a large company with tens of thousands of employees worldwide.”).

The other reform bills include:

Say on pay spawned lawsuits

Reuters:

Shareholders upset with ever-higher executive compensation packages are using new "say-on-pay" votes to challenge the payouts in court, a tactic raising eyebrows among legal experts.

The lawsuits are zeroing in on companies that lose these advisory votes by shareholders on top management compensation. The plaintiffs accuse the companies of waste or excessive pay and in some cases cite "no" votes as confirmation boards violated their duties to shareholders. ...

Stephen Bainbridge, a law professor at UCLA in Los Angeles, is among those who warned say-on-pay would trigger costly litigation. "I think they (plaintiffs' lawyers) are aggressively trying to use this as an opportunity to make new law on executive compensation," he said. The suits are unlikely to be successful, he said.

I blogged about why these suits are likely losers a couple of weeks ago.

Say on Pay developments

UCLA graduate and prominent executive compensation/tax lawyer Jim Barrall sent along a reprint of his latest Daily Journal article on say on pay. Highlights:

• First, with respect to the frequency for future say-on-pay votes, based on the 2,200 Dodd-Frank proxy filings to date, company recommendations of annual say-on-pay advisory votes have now overtaken triennial recommendations (approximately 52 percent to 41 percent), with the balance being either biennial recommendations or no recommendations. The annual vote recommendation trend is an apparent capitulation to ISS' policy of universally recommending annual votes to its investor clients and the now well-documented voting preferences of most institutional shareholders.

• Based on the 300-plus reported meetings held to date, pluralities of shareholders at approximately two- thirds of the reporting companies have favored annual votes and one- third have favored triennial votes.

• Second, of the 300-plus companies that have reported their Dodd- Frank shareholder votes, (i) say-on- pay general advisory votes have failed to receive majority approval at only eight companies, (ii) several companies in well-publicized cases have changed various pay plans and policies in order to obtain support for their say-on-pay votes from proxy advisers and share- holders, (iii) approximately two- thirds of the companies' votes have passed with approval rates of more than 90 percent and (iv) approximately 90 percent of the votes have passed with approval rates of more than 70 percent.

• SEC filing data collected by Latham & Watkins show that public companies in record numbers are challenging negative proxy adviser recommendations in letters to their shareholders and in supple- mental proxy filings with the SEC. ...  Many of the company filings have made cogent attacks on factual errors made by the advisers and accused the one-size-fits-all computer models of not properly accounting for appropriate peer groups, measuring a company's performance and CEO pay, or considering individual facts and circumstances, especially for companies in troubled or changing industries.

Say on pay litigation

In state law, executive compensation decisions by the board of directors is subject to the business judgment rule, making shareholder pay lawsuits extremely hard to win.

When the federal government decided to stick its nose into the pay imbroglio (at the behest of unions and some academics with time on their hands), the Congress decided to let the shareholders vote on executive compensation--so-called say on pay.

As I will explain in my forthcoming book Corporate Governance After the Crises:

Dodd-Frank § 951 creates a new § 14A of the Securities Exchange Act, pursuant to which reporting companies must conduct a shareholder advisory vote on specified executive compensation not less frequently than every three years. At least once every six years, shareholders must vote on how frequently to hold such an advisory vote (i.e., annually, biannually, or triannually). The compensation arrangements subject to the shareholder vote are those set out in Item 402 of Regulation S-K, which includes all compensation paid to the CEO, CFO, and the three other highest paid executive officers. In addition, a shareholder advisory is required of golden parachutes.

Now here's the kicker. Dodd-Frank and the legislative history make clear that while both the say on pay and say when on pay votes must be tabulated and disclosed, neither is binding on the board of directors. The act and its legislative history further make clear that the votes shall not be deemed either to effect or affect the fiduciary duties of directors. S. Rep. No. 111-176, at 134 (2010).

Despite all this, Broc Romanek reports that:

Mike Melbinger in his blog on CompensationStandards.com ... blogged about how some of the first companies to fail to receive majority support on their SOP have been sued (as well as their compensation committee members and even their compensation consultants) in shareholder derivative suits. Not only have the early failures of this proxy season been sued, but two of the companies that failed last year were sued (one case has been settled and one is still pending, as noted in this Schulte Roth memo).

It'll be interesting to see what legal theories these plaintiffs lawyers come up with. My guess is a waste claim that will go nowhere and a securities fraud claim attacking the company's CD&A disclosures. Surely they won't have the brass balls to claim that say on pay is binding, will they?

I don't blame the plaintiffs' lawyers who brought these suits. Bringing suits even though it is clear the legislature intended for a statute to to give rise to a cause of action is what plaintiff lawyers do. And why not? Sharks got to eat. Until Rule 11 has real teeth and we adopt loser pays with respect to class action legal fees, lawyers are going to bring these sorts of cases.

I blame Congress for having passed this asinine law in the first place, even though folks like yours truly had repeatedly warned Congress that say on pay would be abused and turned from a supposed non-binding voting exercise into a club to beat directors with. As that Schulte Ross memo makes clear, that's exactly what's happening:

In 2010, out of approximately 290 SOP votes held, a majority of votes cast were voted against NEO compensation in only 3 instances. Given the number of SOP votes still to come in 2011, now that SOP is mandatory for a much larger group of companies, it is safe to assume that there will be more negative SOP votes than in 2010. Although the vote is advisory in nature, a negative SOP vote can have serious repercussions. The vote may translate into votes against directors. It also is likely to result in significant unfavorable publicity, which was the case at all 3 of the companies that received negative votes on SOP in 2010. In addition, lawsuits alleging breach of fiduciary duty and corporate waste were filed against directors at 2 of the companies that received a negative SOP vote in 2010. In one case, the lawsuit was settled, while it is still pending at the other company. At both of these companies, there also were changes to executive compensation policies and/or leadership.

At the 2 companies that have thus far had negative outcomes on SOP resolutions in 2011, in preparation for a possible lawsuit, plaintiffs’ firms already have announced investigations on behalf of shareholders concerning breaches of fiduciary duty relating to historical and potential NEO compensation.

SEC Investor Bulletin re Say on Pay

The SEC has issued an investor bulletin explaining how the new say on pay rules work. Here's the executive summary:

• Say-on-Pay Votes. The new rule requires public companies subject to the proxy rules to provide their shareholders with an advisory vote on the compensation of the most highly compensated executives. Say- on-Pay votes must be held at least once every three years.
• Frequency Votes. These companies also are required to provide their shareholders with an advisory vote on how often they would like to be presented with the Say- on-Pay votes - every year, every second year, or every third year.
• Golden Parachute Disclosures and Votes. These companies are required to disclose compensation arrangements and understandings with those executive officers in connection with an acquisition or merger. In certain circumstances, these companies also are required to conduct a shareholder advisory vote to approve the golden parachute compensation arrangements.

I still think this is a lousy idea. See Say on Pay: An Unjustified Incursion on Director Authority.

Say-on-Pay Frequency results depend more on who the shareholders are than market cap of company

Dodd-Frank contemplates a shareholder vote on executive pay (say on pay) and a separate vote on how often to hold the say on pay vote (say when on pay):

Most issuers are recommending triennial votes. ISS and many institutional investor activists are arguing for annual votes. Preliminary results suggest that investor composition rather than market capitalization is critical:

It is still not possible to draw any firm conclusions as to whether smaller issuers will enjoy a higher probability of success recommending a triennial vote than larger issuers.  The reasons is issuers reporting in this segment still seem to be subject to controlling shareholders.

Recently, Biodel Inc., with a market cap of $53 million recommended, and had approved, a triennial frequency.  Officers and directors control about 20% of the stock with 15% held by institutions.

Alico Inc. recommended a triennial vote but their shareholders expressed an interest for an annual vote.  It looks like Alico forgot to check with its 50%+ controlling shareholder before making a recommendation.

Tellular (market cap $102.8 million, institutional ownership of 39%, insider ownership of 16%) and Daily Journal (market cap $100.1 million, institutional ownership of 7% and insider control of 29%) have succeeded in having triennial frequency votes approved.

On the other side of the ledger, Insteel Industries (market cap of $220.1 million, institutional ownership 74% and insider control of 9%) saw its shareholders express an interest for an annual frequency even though the board recommended triennial.

(HT: Nell Minow) Interesting. But it would be more interesting to break down the institutional investor vote into sub-categories. Are mutual funds voting differently than state and local employee pension funds, for example.

In my paper, Remarks on Say on Pay: An Unjustified Incursion on Director Authority, which argues say on pay is bad policy, I argued that only a subset of institutions are likely to be pay activists:

A rational shareholder will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs.[1] Given the length and complexity of corporate disclosure documents, especially in a proxy contest where the shareholder is receiving multiple communications from the contending parties, the opportunity cost entailed in becoming informed before voting is quite high and very apparent. In addition, most shareholders’ holdings are too small to have any significant effect on the vote’s outcome. Accordingly, shareholders can be expected to assign a relatively low value to the expected benefits of careful consideration. Shareholders are thus rationally apathetic. For the average shareholder, the necessary investment of time and effort in making informed voting decisions simply is not worthwhile.[2]

Most shareholders recognize that they are better off pursuing a policy of rational apathy rather than an activist agenda. They know that directors have better information and better incentives than do the shareholders.

Instead, activist shareholders—the type likely to make use of the powers say on pay and its ilk would empower—have tended to come from a distinct sub-set of institutional investors; namely, union and public employee pension funds.[3] As I have observed elsewhere:

The interests of large and small investors often differ. As management becomes more beholden to the interests of large shareholders, it may become less concerned with the welfare of smaller investors. If the large shareholders with the most influence are unions or state pensions, however, the problem is exacerbated.

The interests of unions as investors differ radically from those of ordinary investors. The pension fund of the union representing Safeway workers, for example, is trying to oust directors who stood up to the union in collective bargaining negotiations. Union pension funds have used shareholder proposals to obtain employee benefits they couldn’t get through bargaining (although the SEC usually doesn’t allow these proposals onto the proxy statement). AFSCME’s involvement especially worries me; the public sector employee union is highly politicized and seems especially likely to use its pension funds as a vehicle for advancing political/social goals unrelated to shareholder interests generally.

Public pension funds are even more likely to do so. Indeed, the LA Times recently reported that CalPERS’ renewed activism is being “fueled partly by the political ambitions of Phil Angelides, California’s state treasurer and a CalPERS board member, who is considering running for governor of California in 2006.” In other words, Angelides is using the retirement savings of California’s public employees to further his own political ends.[4]

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[1] Robert C. Clark, Corporate Law 391 (1986).

[2] See id. at 390-92.

[3] As I have noted elsewhere, “activism is principally the province of a very limited group of institutions. Almost exclusively, the activists are union and state employee pension funds. They are the ones using shareholder proposals to pressure management. They are the ones most likely to seek board representation.” Stephen M. Bainbridge, Pension Funds Play Politics, Tech Central Station, April 21, 2004.

[4] Id.