Say-on-Pay: A Bird’s Eye View

The TakeAway: New SEC rules on executive compensation advisory votes take steps toward broader board-shareholder engagement.

On Monday afternoon, the SEC proposed rules for Say-on-Pay (shareholder advisory votes on executive compensation) and golden parachutes (big payouts to executives dismissed after mergers or acquisitions).  The move continues a series of reforms from the 2010 Dodd-Frank Act, with rulemakings and comment periods unfolding through next year (the public comment period for Say-on-Pay ends November 18.)  A closer look at Say-on-Pay shows how the move fits into a broader context of board – shareholder engagement—perhaps the most important reform of all.

On the surface, Say-on-Pay appears quite toothless in the face of shareholder and public anger over salary excesses.  Most importantly, these votes – as with most proxy votes – are “precatory,” or nonbinding, so companies still can do pretty much what they want.  Digging deeper, however, Say-on-Pay’s impact comes more from process than outcome.  Say-on-Pay requires board to communicate with shareholders, which creates opportunities to change behavior, norms, and culture.  Many shareholder activists pursued Say-on-Pay not so much as an end goal, but more a stepping-stone toward deeper engagement with corporate boards, which traditionally maintain a power imbalance by stonewalling requests for dialogue.

“For boards and their companies, engagement means more than just disclosure,” Schapiro said SEC Chair Mary Schapiro yesterday at the National Association of Corporate Directors (NACD) Annual Corporate Governance Conference.  “It means clear conversations with investors about how the company is governed — and why and how decisions are made… Technology, investor attitudes and the way financial markets work have all changed dramatically during the past decade,” she continued, while making reference to the SEC’s efforts to engage more with boards and shareholders, too.  “[The SEC is] interested in breaking down barriers that may prevent effective engagement, and affect investor confidence and, ultimately, financial performance.  As the SEC works to encourage engagement between shareholders and boards, we want very much to engage with you, as well.”

On the outcome front, disagreements exist over whether, and how, compensation relates to a firm’s overall value.  Harvard Law School governance expert Lucian Bebchuk has extensively researched and written on compensation problems and solutions, and asserts that the causal link between performance and pay remains unproven.  He favors reworking compensation incentive systems, not cash salary amounts.  Others build on Bebchuk’s theories, and argue for more comprehensive structural reform to address the evolution of the CEO’s role and pay system, particularly the 1993 introduction of non-salary forms (such as stock options) to better align CEO interests with shareholders.  (We now know this solution became part of the problem.)

Meanwhile, the University of Delaware’s Charles Elson, another corporate governance expert who runs the Weinberg Center for Corporate Governance, disagrees.  He believes that as shareholder value falls, so should the value of the executive pay package—that pay should reflect company performance and align with shareholder interests.  However, Elson also believes that boards should oversee pay and pay cuts, not shareholders; he recently noted that boards are “much more responsive to [shareholder] pressure than they traditionally were.”

As for specifics, Dodd-Frank requires Say-on-Pay votes at annual general meetings (AGMs) at least once every three years, starting on 21 January 2011.  The proposed SEC rules, which govern shareholder and institutional investment managers, also allow for votes on how often to hold  a say-on-pay vote (every one, two, or three years); this “frequency” vote would occur at least once every six years.

Shapiro stressed how these measures fit into a larger framework.  “Dodd-Frank also required exchanges to amend their rules governing circumstances in which brokers vote proxies without instruction from beneficial holders, to prohibit voting on compensation matters, such as the say-on-pay votes,” she told NACD conference attendees.

Additional reforms will address other pay issues such as “clawback” provisions and proxy disclosure of the ratio of CEO pay to median employee pay.  Next up for rulemaking:  compensation committee independence and conflicts of interest when retaining compensation consultants.  In a nod to critics of the new median pay ratio disclosure, Schapiro announced that the SEC will devote time between now and next summer to considering views and comments before proposing rules to implement the requirement.

Edited by Bill Baue.

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