History and Context of Advisory Votes on CEO Pay
As we prepare for As You Sow’s release of its eighth report on Overpaid CEOs (February 24th webinar, sign up here), I wanted to provide a brief history and context for the Say on Pay vote.
A Quick Say on Pay History Review
When President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into federal law on July 21, 2010 it included a provision that required companies to include a shareholder vote on the compensation of the top executives in its annual proxy statement. This vote opportunity was new to shareholders of U.S. companies and followed shareholders of United Kingdom companies winning the right to a similar vote in 2002.
Between 2002 and 2010 many U.S. institutional shareholders filed shareholder resolutions calling for the same rights. These shareholder provisions calling for a “say on pay” gained traction through years of advocacy, with more than 50 of the proposals gaining majority support. Ultimately, over 70 companies voluntarily adopted the proposal. Around the same time, it became increasingly apparent that poorly chosen incentives had played a role in the 2008 financial meltdown. The vote on pay was only one aspect of compensation addressed by Dodd-Frank and rulemaking is on-going on other elements of Dodd-Frank.
Although average support in the S&P 500 pay votes has always been high, it is down slightly over the past few years. In fact, Semler Brossy, a leading independent executive compensation consulting firm, provides statistics that indicate that the average vote against the CEO pay package at S&P 500 companies increased by 1.3 percentage points, from 10.4 percent in 2020 to 11.7 percent in 2021, i.e. a 12.5 percent increase in the number of votes against the CEO pay package, “on average.” As our report shows and we will discuss more on Thursday, the number of companies that receive high opposition votes has shown marked growth.
Early Voting Rationale and Company Response
ISS has also reported on increase in high votes against advisory votes noting that, “The percentage of companies with failed say-on-pay votes . . . is tied with 2012 as the highest failure rate since mandated votes began.”[i].
Why were opposition votes high in early years, and why did they subsequently flatten before rising again recently? I believe part of that answer is that some of the worst practices in executive compensation have become obsolete, or at least rare.
I have a copy of “Say-on-Pay at U.S. Companies: Update of Evaluation and Voting Trends.” Published by ISS on March 19, 2011, written by Carol Bowie, Head of Compensation Policy Development at the time. She lists what she calls the key questions:
· What is the link between executive pay and performance?
· Are the performance criteria and target thresholds appropriate?
· How does the company use employment agreements?
· Are severance and/or change-in-control provisions reasonable?
· What perquisites are provided?
· Is the company’s compensation peer group appropriate?
· Is disclosure clear and complete?
· Is the board responsive?
One of the severance provisions that led to votes against were gross-ups. This was the clearly questionable practice of the company, rather than the rewarded executive, paying the executives’ tax on particularly generous severance packages. That simply sounds bad: why would shareholders pay for taxes for someone who was no longer at the company? Clearly there was no retention or motivation involved in this practice. Like many things in compensation it is slightly more complicated than that, but this explanation suffices for our purposes. This and other questionable practices triggered opposition recommendations against many companies that first year.
Companies (with the help of consultants) quickly responded, particularly to practices highlighted by the leading proxy advisory services. Boards swiftly removed offensive language and now many highlight in boastful tones on their proxy statements that they do not have gross-ups. The worst corporate governance practices almost disappeared (or seemed to; gross-ups occasionally sneak back into packages when actual change of controls take place, but that’s another story – to be featured perhaps in an upcoming blog.)
Investors Begin a More Nuanced Evaluation
Over time, pay practices evolved and there were a few years with lower levels of opposition. Some defenders of excessive pay even noted that what they saw as high support for pay suggested that shareholders were generally satisfied with pay practices when that was far from the truth. Over the years there has been growing awareness of the economic and political consequences of high income inequality, and the truly excessive nature of pay.
Guidelines began to evolve, becoming much more nuanced and considered, particularly among large investors. In 2018, for example, CalPERS sharply increased the level of scrutiny in its pay and performance evaluation. This identified many more companies where increases in pay far outpaced change in performance on many key measures. Their opposition level has sharply increased over the eight years we have authored this report.
Pay for performance remains a key factor, but investors are diving more deeply into complex questions of correlation and causation. The idea, implied in thousands of proxy statements, that executives will work harder and better if they are incentivized to do so, has been under more sophisticated criticism. In fact, HIP Investor’s analysis completed for As You Sow has found that there is in fact a negative correlation between overpay and subsequent performance.
Did Say on Pay Work?
I’m sometimes asked my opinion regarding whether the advisory vote on pay has “worked”. I believe it has, but it is difficult to prove. Has it dramatically reduced compensation? No. Anyone who thought that it would was naïve. There are no quick fixed for intractable human characteristics such as greed.
However, it has dramatically improved disclosure and communication. I would contend that it has ended some of the worst pay practices. My theory is that after some initial high opposition votes the low hanging fruit – the worst of the worst practices – were abandoned.
Guidelines gradually became more specific, analyzing performance more closely. By 2021, when COVID-19 decisions first appeared in proxy statements, shareholders were poised to do a critique and used their votes accordingly. With stronger guideliens in place more shareholders voted against companies that made inappropriate adjustments to metrics or took other actions that insulated executives from the effects of COVID 19.
I am convinced that if those same changes actions had happened earlier investors might not even have noticed, much less voted against them. There is no way to measure this, but I think it intuitively makes sense. Those who shrug off the pay vote to me are the equivalent of a parent concluding that, “Time out didn’t work on my toddler because he did it again.” Or, “He went and misbehaved in a different way.” We don’t know how many CEOs made suggestions to the consultants only to have the consultants counter with, “That got a negative vote at . . .” I believe it has happened often.
While the low hanging rotten compensation fruit may be gone, more sophisticated investors are now evaluating the health of the tree and all the branches. Now is the time for pruning.
[i] Rachel Hendrick, David Kokell, Kevan Marvasi, Chris Scoular, Galen Spielman, Mete Tepe, Juliana Vaughn, Liz Williams, “2021 Proxy Review – United States Compensation,” Institutional Shareholder Services