Manan Shah is a partner in the employee benefits and executive compensation practice at Jones Day in New York.
The new “say on pay†rules enacted as part of the Dodd-Frank Act were put in place to try to make executive compensation more accountable and transparent to investors. However, as we enter this year’s proxy season, it appears as though corporate advisers rather than corporate shareholders are reaping the benefits of the new rules.
It has been a full two years since the “say on pay†rules went into effect. But according to a recent report by the Semler Brossy Consulting Group, a vast majority of companies are not facing any challenges to their pay packages. Of the 2,215 companies in the Russell 3000 index that were surveyed in 2012, only 2.6 percent had a vote that failed on “say on pay†while more than 91 percent had a vote pass with at least 70 percent shareholder approval./p>
Despite this overwhelming shareholder support, corporations are going to increasingly greater lengths to ensure they pass the vote and avoid the negative consequences of a failure.
If a “say on pay†vote fails, the resulting fallout of negative media attention and frivolous shareholder litigation can cause significant damage to a company’s image and even its share price. Therefore, companies are facing extreme pressure to use significant financial resources and manpower to guarantee passage of the vote.
An even more alarming consequence is that mandatory “say on pay†votes may be forcing boards and compensation committees to substitute their knowledge of the company for the perceived wisdom of proxy advisers’ guidelines. Even among companies facing little risk of opposition, boards are acting cautiously to ensure proxy guideline support of pay packages. The result is that companies feel increasing pressure to make executive compensation changes to appease proxy advisers ! regardless of whether those changes are really in the best long-term interests of the company.
The problem is even worse for companies facing shareholder opposition to its pay policies. These corporations tend to incur even greater costs to proxy advisers, compensation consultants, lawyers and other advisers â€" and even more costs should the vote fail. This is likely to cause financial damage to the company through wasted assets and potential reputational harm, which could far outweigh the costs of the perceived “excessive†executive pay.
It is also unclear if the compensation changes recommended by proxy advisers are in the best interests of shareholders. A July 2012 working paper by the Rock Center for Corporate Governance found that revisions made by companies to their compensation programs in an attempt to conform to guidelines issued by proxy advisory firms actually produced a net cost to shareholders. As a result, thepaper concluded, proxy adviser policies and influence had induced the companies to make compensation decisions that actually decreased shareholder value.
In light of this, every institutional shareholder investing in companies subject to mandatory “say on pay†votes should be asking themselves whether the perceived benefits of the mandatory “say on pay†voting system truly outweigh the costs of efforts to ensure vote passage, which are incurred by both institutional shareholders and the companies in which they’ve invested If not, are we as institutional investors breaching duties to our own stakeholders as a result of the “say on pay†voting process
As asset managers, institutional shareholders have duties to ensure that their stakeholders’ assets are properly protected. Since it is difficult to perform an in-depth independent analysis on the thousands of shareholder issues up for vote, many such investors rely heavily on the recommendations of shareholder advisory fir! ms like I! nstitutional Shareholder Services and Glass, Lewis & Company.
These proxy advisers are for-profit firms that do not have the same vested interest in the financial success of the company as its shareholders. These firms make money by selling a product in the most cost-effective manner possible. With respect to executive compensation, this often means a “one size fits all†report that is not tailored to a company’s industry, location or other competitive factors.
Institutional shareholders debating whether to vote for or against a company’s “say on pay†proposal, therefore, cannot rely solely on the proxy adviser’s report. Rather, they should carefully consider whether the potential benefits of that vote clearly outweigh the negative implications that are likely to result.
At the very least, this should involve a careful review of the board’s recommendations on the shareholder proposals; after all, by investing in the company, they have already placed their faith in the compay’s board.
If concerns persist, institutional shareholders should hold discussions with the company’s board and executives before making a decision that could cause monetary and reputational harm.
The end result of mandatory “say on pay†rules cannot be a system that serves to potentially harm companies and their shareholders, while wasting manpower and needlessly funneling crucial resources to shareholder advisory firms and the myriad other advisers.
As proxy season kicks off, institutional shareholders should evaluate who really benefits from the “say on pay†rules: Is it the companies and their shareholders Or is it really the shareholder advisory firms The answer is crucial in determining whether to vote against a pay proposal.
Mr. Shah’s views do not necessarily reflect those of Jones Day or any of the law firm’s clients.
