Why Say on Pay Doesn't Matter

A series of posts on Race to the Bottom this week has made much about the likely prospect of “Say on Pay” becoming the law of the land if the Dodd bill addressing financial reform passes in the coming weeks, which it is likely to do. However, the practical effect of this provision of the Dodd bill on executive pay seems negligible.

For those unfamiliar with “Say on Pay,” this is a concept first put forth by shareholders that calls on companies to submit all executive pay decisions to a vote of the company’s shareholders prior to going into effect. Like the provision in the Dodd bill, this shareholder approval ritual is advisory. Thus, directors can ignore the wishes of shareholders if they so choose.

In the short-term, it is unlikely that this provision will have any impact on the vast majority of public companies. Race to the Bottom notes that only a few companies that have submitted pay plans to shareholder approval have experienced any blow back from their investors. Citing the situation at Occidental Petroleum, shareholders voted down a compensation plan for the company’s CEO Ray Irani, a perennially overpaid executive who has been a lightening rod for investors for many years. Undoubtedly, when Say on Pay becomes the law of the land, there will be a few more of these votes getting majority status.

While shareholder approval of executive compensation is a good thing for some obvious as well as less obvious reasons, as a practical matter, very little will change in the short-term. What remains unchanged is the fact that institutional investors largely give companies a pass when it comes to pay practices. Despite the railing of pitchfork capitalists that things must change, those major investors “pulling the lever” at proxy voting time have no incentives to change their voting practices. There are several reasons for this.

First, a substantial percentage of institutional investors – investment managers, corporate pension funds, insurance companies and some pension funds – have policies when it comes to executive pay that I would characterize as “but for the grace of God go I.” By tackling the executive pay head-on as large investors, these institutions risk impacting their very own pay practices. While most of these investors would not admit to this practice, as a practical matter, this is the consequence

Second, institutional investors defer to their professional proxy voting advisors – ISS/Risk Metrics, Glass Lewis, et al. – in order to untangle the complicated mess that is designed to obfuscate the executive pay setting process. A quick glance at any company proxy statement will confirm the fact that 60 to 80 percent of proxy statements are devoted to executive pay discussions.

The proxy advisors have responded in an equally complicated fashion both to analyze these complicated pay setting processes as well as justify their own existence to their paying clients by demonstrating their intellectual prowess on the subject. For instance, ISS/Risk Metrics employs multiple regression analysis and a two stage assessment of just one aspect of company executive pay setting. While this approach gets the job done, the entire process from both the issuer and investor perspectives only obscures the problem.

The good news in all of this is that the question of executive pay will now be addressed head on by shareholders. A procedural barrier preventing meaningful discussion about pay practices has been removed. What now must be done is to address excessive corporate pay practices and their underlying causes in a meaningful manner. This will require a better informed corporate electorate that can decipher the the arcane data that currently obscures greater understanding of the matter.

The 2011 proxy season should be an interesting test of shareholder mettle on this subject. While some executives may fear a firing squad of sorts from shareholders, as a practical matter, their investors will most likely miss their targets. However, in time, investors may become better shots.

About John Richardson

John Richardson is the CEO of JMR Portfolio Intelligence, a Washington DC based human rights consultancy.
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