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The success of say-on-pay is an endorsement of the executive pay model at a preponderance of American companies—even the global ones, said Ira T. Kay, managing partner at Pay Governance LLC in New York. 

With 98 percent of companies passing their annual say-on-pay votes during the past four years, it's clear that proxy advisers have had an impact on reducing “shareholder irritants,” Kay said. He cited tax gross-up, excessive severance payments and other problematic pay practices that companies have abandoned in response to criticism from proxy advisers, primarily Institutional Shareholder Services Inc.

The question, Kay said, is whether say-on-pay votes create additional shareholder value.

Institutional shareholders should expect that proxy adviser voting recommendations will improve the company's subsequent total shareholder return (TSR) as companies make changes to their pay programs to conform to proxy adviser policies, Kay said.

However, his research indicates that this isn't the case. A proxy adviser “against” recommendation on say-on-pay is associated with lower subsequent two-year company TSR, Kay said.

Kay spoke during a March 31 panel discussion on executive compensation at the Council of Institutional Investors Spring 2015 Conference.

Of the possible explanations for the gap in subsequent TSR performance, two principal theories derived from Kay's research are:  

• the proxy adviser “against” recommendation that triggers substantial changes in incentive pay programs makes the programs worse and therefore the stock price goes down, or

• the “against” recommendation serves as a bearish signal from ISS that it is a bad plan or has bad pay-for-performance alignment and that is a good enough reason for investors to stay away.

Yes Means No

With respect to the near-universal support for company pay programs, panelist Stephen O'Byrne, president of Shareholder Value Advisors Inc., Larchmont, N.Y., said that “investors frequently vote ‘yes' despite misgivings.”

“High approval rates reflect the perception that negative votes are costly and ineffective,” O'Byrne said, citing a 2015 investor survey   that found “only 21 percent of respondents agreed that CEO compensation is appropriate in both size and structure.”

In a show of hands, about one-third of the panel discussion audience agreed with an attendee's comment that there are too many “for” recommendations from proxy advisers that, after finding significant deficiencies, nevertheless recommend voting for the pay program.

If, instead of a 2 percent failure rate, 20 percent of companies had failed say-on-pay, Kay said there would been “chaos in the boardroom.” The compensation programs of “hundreds, maybe thousands of companies would have changed” as companies scrambled to make changes even if they believed their plans were working, he said. These changes “would have been for the worse” and a lot of damage would have been done, he said.

Excerpted from a story that ran in Pension & Benefits Daily (04/01/2015).

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