The say on pay provision in the Dodd financial reform bill purports to create a purely advisory shareholder vote on executive compensation. (See prior post.) In fact, however, the legislation could turn out to have real teeth that will shift power over compensation from boards of directors to Risk Metrics (formerly ISS).
Eric Hilfers explains:
Those who have followed the NYSE Rule 452 changes will be familiar with the issues. Here is a quick summary for those who haven’t. Retail investors generally hold their investments through brokers. The broker is typically the “legal” owner of the stock, and the client is the “beneficial” owner. As a result, the issuer’s shareholder registry will reflect the ownership position of the broker, but not the individuals who hold through that broker (the issuer might not even know (or be able to find out) the true owners’ identities). Under state corporate law, only legal owners of shares may vote which means that brokers (rather than their clients) are the ones that in form vote retail shares. Brokers, however, are generally required to ask their clients for voting instructions. ... However, as it turns out, very few retail investors actually go to the trouble of instructing their broker how to vote. This leaves the shares “uninstructed”. NYSE rules permit brokers to vote uninstructed shares as the broker sees fit, but only in the case of “routine” matters. As it turns out, brokers tend to vote in favor of the positions recommended by management and the retail float of a typical public company can be anywhere from a few percentage points to 20+%. In other words, the retail shares are in practice a significant and reliable pro-management voting block.
The action in this area revolves around what is or isn’t a “routine” matter. If something is routine, then brokers can vote uninstructed shares; if it is not routine, then brokers can’t vote them, and the shares effectively don’t exist (quorum is a different discussion). ...
The latest addition to the Dodd bill takes the recent NYSE rule change a step farther. It essentially deems all votes regarding executive compensation to be non-routine. ...
An important related consequence of this is that it puts relatively greater voting power in the hands of institutional investors and that leads us to consider ISS.
What is ISS? It's a proxy advisory service that is now owned by RiskMetrics Group. It tells institutional investors how to vote their shares. Many institutional investors have effectively delegated proxy voting to RiskMetrics by blindly following its recommendations.
Back to Hilfers:ISS has been revising its voting guidelines based on the assumption that, one way or another, say on pay will become widespread (if not universal). At the moment, they have said that violations of their compensation policies will initially be channeled through the say on pay process (as opposed to immediately recommending withhold votes against directors). If a company gets a majority no vote on say on pay and fails to remedy the situation (whatever that means), then ISS will consider recommending withhold votes on directors. So putting it all together, the Dodd bill may create a situation where companies will face much greater pressure to bow to ISS’s compensation policies, or else risk losing a say on pay vote (thanks to the new broker voting rules) and then risk losing their director elections thanks to majority voting.
So here's the question: Proponents of shareholder empowerment measures like say on pay claim it will help make management more accountable. What those proponents want you to ignore, however, is the fact that what their proposal really do is to shift power from boards of directors not to shareholders but to Risk Metrics. Who holds Risk Metrics accountable?
Proxy advisory firms wield significant influence in shareholder elections, as their institutional clients --primarily mutual funds and pension plans-- have large stock holdings compared to other investors. Unfortunately, these firms are not subject to any required disclosures or oversight regarding their ability to control or influence the outcome of a vote. Some advisory services also have an inherent conflict of interest in the voting process because they also provide related consulting services, such as corporate governance ratings, corporate governance advice, and other research services, in addition to providing voting recommendations on proposals submitted in shareholder elections. (LINK)
Ironically, the only thing holding RiskMetrics accountable is market forces -- the very forces most shareholder power proponents claim don't work when it comes to holding management accountable. It's just one more reason to think proponents of shareholder empowerment are either disingenuous or misinformed.
