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Say-on-Pay: Wrong Solution, Wrong Problem


It is hard to imagine the benefit that can be derived from shareholders’ voting, on a non-binding basis, “to approve the compensation of executives” as is proposed in the recently-adopted Senate bill.(1)  For the most part, average shareholders, including institutional shareholders, have neither the access to the necessary information nor the skills to second-guess the decisions made by a compensation committee.  Moreover, it is a one-size-fits-all solution that would be imposed upon all 13,000 public companies and not just the few hundred where excessive compensation may be a serious problem.

But the real problem is not that executives are widely overpaid, and the solution is not a shareholder vote on compensation.  Rather, the real problem is that shareholders have no practical ability to voice their disapproval regarding company performance – other than voting with their feet – and say-on-pay proposals have evolved as a proxy for a more fundamental complaint on company performance.  It is not just a coincidence that low say-on-pay votes, and several recent outright disapprovals, correlate with well-recognized shareholder disappointment in company performance.  Similarly, it is no coincidence that there are few limits on what successful companies can pay their executives without encountering any significant objections.

What if companies, rather than including in their proxy statements say-on-pay proposals, instead addressed the underlying concern more directly?  What if, for instance, companies included in their proxy statements the straight-forward question:  “Do you think that the company’s board of directors is doing a good job?”  Would the votes be roughly the same as for say-on-pay proposals?  Might they be more meaningful?  Through providing a more direct alternative, could companies eliminate the unintended consequence of shareholder criticism of compensation when, in fact, the compensation system was not significantly broken in the first place?

Could companies establish consequences for a losing vote that would have just enough teeth to satisfy shareholders but not so many teeth as to destabilize or endanger efficient board functioning?  For example, what if upon the receipt of a negative vote the two directors with the most tenure were required to resign?(2)  This would assure some level of board turnover, and would, if shareholder dissatisfaction continued for more than a year or two, assure substantial rotation of the entire board.

Proxy access – the next likely misstep by the SEC – is a similarly misguided solution.  It too is a proxy intended to address the difficulty that shareholders have in expressing their dissatisfaction with company performance.  It comes, however, with the cost of providing activist and single issue investors with the same access to a company’s proxy statement that longer-term, serious investors would be provided.  Again, a one-size-fits-all solution imposed on 13,000 companies when only a few hundred have a serious problem.

We do not know whether forced board rotation is the right solution, but we know that neither say-on-pay nor proxy access is either.  We encourage companies and investors alike to consider alternatives that permit shareholders to express their views in the most constructive, and least destructive, ways possible.  We also encourage Congress and the SEC not to legislate corporate governance in a free-market economy. 

(1) Restoring American Financial Stability Act of 2010, Sec 951.
(2) A possible alternative would be for two of the three most tenured directors to resign, thereby providing the flexibility to retain someone with special expertise or a large shareholding.