This year marks a tipping point in activists' battle to rein in high-flying executive pay.
More than 100 companies face resolutions at their annual meeting this spring that would give shareholders a chance to vote on executives' pay packages. These "say on pay" votes would be nonbinding. But with the public and Congress livid about bonuses paid to executives at AIG and other government-supported companies, boards of directors would do well to pay attention, shareholder activists say.
"By having more transparency [in executive recruitment and pay negotiations], it's more likely that you'll get a compensation system that will benefit or be in the interest of shareholders," says Brad Barber, director of the Center for Investor Welfare and Corporate Responsibility at the University of California, Davis. "That would lead to a stronger relationship between pay and performance."
But whether say on pay will actually restrict executive compensation remains an open question, say Mr. Barber and other experts.
Momentum seems to be in the reformers' corner. At least five companies in recent weeks have announced plans to hold say-on-pay votes. Mary Schapiro, chair of the Securities and Exchange Commission, has expressed support for shareholders to have an advisory vote on executive pay packages. Congress, through the recent economic stimulus bill, has made say on pay a standard of sorts by requiring it of public companies that receive bailout money through the Troubled Asset Relief Program (TARP). Even President Obama spoke out in favor of it when he served in the Senate.
Support in Washington marks "a fundamental change in the conditions for the adoption of say on pay," says Richard Ferlauto, director of corporate governance and pension investment at the American Federation of State, County, and Municipal Employees. "This will create an overwhelming momentum for say on pay to become the US market standard.... By 2010, it will be a market requirement for all US-based companies."
For many socially minded activists, say on pay represents a milestone in a long-term quest to empower shareholders and improve corporate governance.
"The say-on-pay movement shows what concerned investors can do when they put their financial clout to work together," says Lisa Woll, CEO of the Social Investment Forum, a network of institutional investors with an interest in social responsibility.
But some scholars aren't persuaded that say on pay is a meaningful win for investors. Investors' ultimate goal – a stronger link between executive pay and company performance – isn't likely to result, since 60 to 90 percent of pay already comes in the form of stock, says Wayne Guay, an executive compensation expert at the University of Pennsylvania's Wharton School of Business. Such ratios mean companies already tie pay to performance to a large degree and may not have much room for improvement.
Although say on pay is required by law for public companies in Britain, that rule hasn't prevented compensation trends from mirroring those in the United States, he notes. "The root of the problem has to be that the board of directors is not doing its job" in cases of overcompensation, Professor Guay says. "If we want to get rights in the hands of shareholders, I would rather see our efforts go toward seeing that we get good directors in place."
Others go even further with their critiques. Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, warns of "misplaced optimism" surrounding say on pay. He says activists are celebrating a "Pyrrhic victory" for investors because, while say on pay may make shareholders feel more authoritative, it won't give board members the independence from management that they must have to fix the problem.
Say on pay "has some harm to it because it dilutes the authority of the board," Professor Elson says. "The protector of the shareholder is a good board. And if you approve say on pay, why not approve shareholder votes on capital allocations or on strategic moves? Once you go down that road, shareholders end up voting on everything and nothing gets done."
Activists have tried targeting boards in years past, but they've encountered obstacles. The SEC ruled in 2008 that companies don't have to consider initiatives to give shareholders a channel to directly nominate directors. (Directors, often with input from management, routinely rely on a nominating committee to find new directors.) Hence, investors this year are focusing on more doable board reforms. More than 30 resolutions, for instance, call for chairs to be independent, i.e., not CEOs.
As proxy season heats up, analysts are watching a few other social issues with particular interest. For example, nearly half of the 36 companies being urged in resolutions to adopt sexual orientation nondiscrimination practices have already taken steps to change their policies. Also, 57 companies are facing resolution pressure to report or review where they make political contributions.
Still, say on pay may be the issue with the furthest repercussions. That's because there's more on the line than governance policies at several dozen companies. Congress and the Obama administration may also be watching, observers say, to see if investors (who are also likely voters) seem to relish the opportunity to vote up or down on pay packages. If they do, then this proxy season could turn into a bellwether for new laws or regulations on the near horizon.
"The average vote in favor of say on pay in the past few years has been right above 40 percent," says Carol Bowie, head of the Governance Institute at RiskMetrics, a Washington, D.C.-based firm that tracks shareholder resolutions. "As long as it's [40 percent] or above, that will present a convincing case to any Congress folk who are listening that a significant portion of investors support this."