I Think I am Probably Absolutely Sure, Perhaps

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expert perspective telescopeExpert Perspective from Grahall’s OmniMedia Editorial Board

In her June 21, 2009 article for Investment News titled “Directors’ role at center of ‘say on pay’ debate“ Sara Hansard says: “ The long-running debate over “say on pay” is heating up in Washington, with a group representing executives saying that the proposal undermines the role of directors while an investors’ group counters that it makes boards more accountable to shareholders.”

Ms. Hansard quotes Timothy Bartl, vice president and general counsel of the Center on Executive Compensation: “Allowing shareholders to vote on compensation may encourage boards to abdicate their responsibility to make decisions about executive pay packages and instead turn to outside consultants, …that could force directors to take a cookie-cutter approach to setting compensation rather than adopting policies that are best suited to their particular companies”.  And Hansard notes that: “The Washington-based Council of Institutional Investors, which represents pension funds and other big investors, supports the say-on-pay proposal.”

In the face of this great debate we must keep in mind that these shareholder “say on pay” votes are non-binding.  Sure, directors would be wise to consider an overwhelming shareholder vote for or against pay in the development of their executive pay packages. But unless there is a lawsuit, demonstrable fraud or other event as in the case of Worldcom case where “the settlement [was] a rarity in that the board of directors of a major corporation were being held personally and financially responsible by the company’s shareholders for the company’s failures”, it’s not likely that directors will be at much personal risk (except perhaps for their jobs since they are nominally elected by shareholders.)

So will “say on pay” cause abdication or increase accountability? It is hard to tell since for far too long Boards of Directors have been concerned with what “everyone else” is doing as opposed to what is in the best interest of their own company and shareholders. 

A better question might be “Do shareholders understand the compensation sufficiently to make an ‘informed’ vote?”  No doubt shareholders (whether individual or institutional) have their own agendas, as does each member of these groups.   Here are two possible scenarios:

>Where the “say on pay” votes are overwhelmingly pro or con (likely the vast majority of cases) the message is clear and seemingly shared, but hold no guarantee of its validity. 

>Where shareholders differ, the “averaging effect” may dampen the noise at the extremes and leave the board without any real information, valid or not.

Perhaps “say on pay” will make some shareholders “feel good”, some politicians “claim good”, some Boards of Directors “act good”, some executives “be good”, but ultimately very little “good” will come from the effort. Not because it’s a “good intention” gone bad, but because the vast majority of Board of Directors are already acting in the best interests of shareholders.

And, by the way, the Boards that aren’t acting in the best interests of shareholders, aren’t going to be swayed by a group of dissident shareholders who make a non-binding vote against a pay program. The only way these “bad guy Boards” will see the error of their ways is through the following series of events:

1) investors sell company stock driving down the price
2) company is acquired
3) management is tossed out
4) a new Board of Directors is elected

(Perhaps that is what is meant by “creative destruction”.)

We have been searching for an analogy that might bring greater clarity to “say on pay” rules. Try these on for size:

1) A storm warning advisory – This one doesn’t quite work because here the advisor really understands what he or she is talking about (unlike the shareholders voting on executive compensation).
2) A terrorist threat advisory – This one doesn’t work either since it is only a warning, and doesn’t (like say on pay votes) provide advice on actions to take
3) The Survivor television series – Survivor participants, each with their own agenda, gets to vote on who gets kicked off the island, but the “say on pay” voters are submitting an advisory vote, not a determining vote.

For the life of me I can’t find an analogy where anything like this advisory vote has been tried and showed success or failure. I wonder why that is?

If say on pay gives investors more comfort, then it is a probably a practice worth trying, but let us warn you that the worst bonus plan we have ever come across — where a CEO was rewarded for beating the same performance goal from prior years – was contained in a formulaic provision of an employment agreement that was shareholder approved.   When we suggested that the provision be changed, the uniform response from the Board and CEO was “Why? The shareholders are fine with it.”

The shareholders didn’t really understand the implications of the provision which illustrates a major conundrum regarding “say on pay”: shareholders don’t (and probably can’t ever) have access to adequate information to make bona fide decisions regarding compensation but as the owners of the company they should have that right to make sure executives are not overpaid.

We hope the unintended consequence will be an increase in shareholders’ understanding of executive compensation beyond the media hype, rather than a redirection of board efforts from governance to justifying their decisions. 

Email Grahall’s Editorial Director at edie.Kingston@grahall.com


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