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Dodd-Frank’s Say on Pay: Will It Lead To A Greater Role for Shareholders in Corporate Governance?

Randall S. Thomas, Alan R. Palmiter and James F. Cotter

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Background

• Implementation of a mandatory say on pay

vote for shareholders was first enacted in the U.K. in 2002.

• Executive pay critics argued that it would

provide an important check on the observed upward movement in pay levels.

• Skeptics claimed that at best it would operate

as a check on pay arrangements that deviated far from the norm (Cheffins and Thomas 2001).

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Arguments in Favor of Say On Pay

• Make corporate management more

accountable to shareholders and shift balance of power in favor of shareholders.

• Encourage boards to align pay and

performance.

• Arrest the upward spiral of pay levels.
• Push boards to eliminate pay structures

that encourage excessive risk taking.

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Arguments Against Say On Pay

• Upset the traditional balance of power

between managers and shareholders.

• Shareholders are poor judges of proper pay

practices and levels.

• Increase power of ISS and voting advisors.
• Increase disclosure and voting costs,

especially for smaller companies.

• Push American companies to adopt one-size-

fits-all pay programs.

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Dodd Frank’s “Say On Pay” Mandate

• Section 951 of the Dodd-Frank bill requires

public companies to give their shareholders an advisory vote to approve or disapprove the compensation paid to named executives during the prior fiscal year.

• SEC rules implemented this requirement with

detailed specifications on the form of the proposal and the particular officers whose compensation will be subject to the vote.

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Data– Shareholder Proposals On Executive Compensation

• For many years prior to the enactment of

Dodd-Frank, shareholders had submitted advisory proposals related to executive compensation matters using Rule 14a-8. These included proposals to approve certain features of executive pay, including SERP payments and Golden Parachutes.

• Voting support for these proposals ranged

from around 10% for less popular categories to 50+% for the most popular ones.

Pre-Dodd Frank: Shareholder Executive Compensation Proposals (2003-2010)

Table 1: Shareholder Proposals on Executive Compensation (Number and % Support) 2003 2004 2005 2006 2007 2008 2009 2010 Majority Support Report 16 5 25 3 4 3 3 9 11.2% 10.3% 8.4% 9.0% 6.9% 7.6% 10.2% 6.2% Disclose 1 9 3 4 3 2 5.5% 27.4% 8.0% 8.3% 10.8% 10.2% Approve 16 23 14 15 7 3 5 4 43 56.6% 48.9% 55.4% 41.4% 45.8% 57.3% 31.9% 58.3% Cap 1 9 6 8 7 1 2 5.1% 10.2% 10.7% 5.2% 5.4% 9.2% 5.1% Link 48 7 35 37 73 27 8 12 14 16.6% 34.6% 29.6% 32.5% 29.8% 32.3% 26.0% 32.5% Reduce 47 33 7 11 16 15 6 10 14 32.6% 13.2% 12.0% 23.2% 23.0% 20.2% 23.9% 29.1% Restrict 3 7 25 38 30.1% 23.1% 29.1% 25.8%

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Shareholder Proposals -- Overview

• f Voting Results
• Report, cap and disclose proposals attract

little support (<10%).

• Link, reduce and restrict attract moderate

levels of support (15% to 25%).

• Approve proposals, asking a board to

institute an advisory shareholder vote on particular pay practices such as SERPs, attract the highest average levels of support (49.6%) and the most “majority support” proposals.

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Shareholder and Management Proposals on “Say on Pay”

• Shareholders began submitting “say on

pay” proposals in 2006, recommending to boards that they give shareholders an advisory vote on executive pay.

• Shortly thereafter, management

sponsored say on pay proposals began to appear – a few on a voluntarily basis but largely because TARP-funded firms were required to do so.

Pre-Dodd Frank: Management and Shareholder Say On Pay Proposals

Table 2: Say-On-Pay Proposals Pre-Dodd Frank (Number, Support and Majority Support) Panel A – Shareholder Sponsored Proposals Year Number of "say on pay" 14a-8 proposals Shareholder support (% For) # receiving majority support 2006 5 42.5% 2007 52 37.5%*** 7 2008 71 38.1%*** 8 2009 61 41.1%*** 21 2010 48 40.3%*** 9 Panel B – Management Sponsored Proposals Year Number of "say on pay" proposals Shareholder support (% For) # receiving majority support 2006 2007 2 98.2%*** 2 2008 8 89.2%*** 8 2009 152 87.6%*** 152 2010 146 88.7%*** 143

*** represent a test of the difference of the mean of the percentage of shares voted in favor of “Say-On-Pay” vote by year between shareholder and

management proposals at the 1% level in a two tailed test.

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Say On Pay Proposals– Overview

• f Results
• Shareholder say on pay proposals ask the

board to institute an advisory say on pay

• vote. They average 42% support and 16%

receive majority support.

• Management say on pay proposals ask

shareholders to approve the top 5 executives

• pay. They average 88%, and only 1% failed

to attract majority support. These are

• verwhelmingly for financial institutions.

Pre-Dodd Frank: Impact of ISS Voting Recommendations (2003-2010)

Table 4: Pre-Dodd Frank Management and ISS Recommendations (Number and Support) ISS and Management “For” Recommendation Management Only “For” Recommendation ISS Only “For” Recommendation ISS and Management “Against” Recommendation Report 1 1 66 24.5% 15.5% 8.6% Disclose 5 17 41.7% 9.0% Approve 2 79 6 84.4% 50.3% 28.2% Cap 1 33 24.7% 7.1% Link 1 156 89 91.3% 35.5% 14.1% Reduce 53 88 43.1% 10.4% Restrict 70 3 27.6% 8.3% S’holder Say

• n Pay

1 273 2 51.8% 42.0% 12.7% M’gment Say

• n Pay

234 69 92.4% 73.4

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Interpreting the Results

• Management rarely recommends in favor of a

shareholder proposal on executive pay issues.

• ISS generally recommended against shareholder

proposals to report, disclose, cap and reduce pay.

• ISS recommended in favor of management say on

pay proposals 77% of the time.

• A negative ISS recommendation on a

management say on pay proposal is associated with approximately 20% lower “for” votes.

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Post-Dodd Frank: First Year’s Experience (I)

• Commentators on first season’s results

have made several observations, including:

• Management garnered 91.2% average

support from shareholders on these mandatory votes.

• Say on pay proposals were defeated only

1.6% of the time = 37 firms from Russell 3000.

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Post-Dodd Frank: First Year’s Experience (II)

• Low stock returns and high CEO pay resulted

in lower support for say on pay proposals.

• Pay for performance issues were raised at

almost all companies with failed votes: half of them had double digit negative three year total share returns (TSR).

• Firms with CEO pay in the top quartile and

TSR in the bottom quartile received the weakest average shareholder support levels (73.9%).

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Post-Dodd Frank: First Year’s Experience (III)

• ISS issued negative say on pay

recommendations at 285 firms, but 86% of them still obtained majority approval of their executives’ pay packages.

• Negative recommendations were associated

with a 25% average decline in voting support.

• ISS negative recommendations largely

focused on pay for performance issues (ex: high pay and negative TSR).

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Impact of Say On Pay

• Even before say on pay votes, many

companies made changes to the substance and disclosures of their pay programs.

• Some companies receiving negative ISS

recommendations filed supplemental proxy disclosures and engaged shareholders actively.

• Some companies with failed votes are named

in derivative law suits alleging breach of fiduciary duties.

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Open Questions

• Has Dodd Frank opened new lines of

communication between management and shareholders on executive pay issues?

• Is there evidence of a change in corporate

governance practices at firms experiencing low shareholder approval levels?

• Will there be substantive changes to pay

practices as a result of say on pay?