August 11, 2010
Lisa Fairfax on Lund's Say on Pay
Posted by Lisa Fairfax

In light of Dodd-Frank's requirement that all public corporations must offer their shareholder's a Say on Pay, Lund's article is both extremely timely and valuable since it examines how and to what extent Say on Pay will impact compensation practices in the US.  Moreover, Lund's paper does not take on the debate about the propriety of enhancing shareholder power over compensation decisions more generally--presumably because in many ways that train has left the station.  Instead, Lund's paper seeks to ascertain whether Say on Pay represents an ideal mechanism for shareholders to impact pay practices or otherwise enhance their power over corporate affairs.  To that end, Lund argues that Say on Pay is a "relatively unattractive structure" for enhancing shareholder power in this area largely because its ex post nature generates significant bundling issues that distort shareholder decision-making and results in too little discipline of high-performing firms.  As an alternative, Lund proposes an ex ante structure--a shareholder advisory vote on CEO compensation plans applicable to future CEO compensation arrangements.  While I am not completely convinced of the propriety of his proposal, I did find it intriguing.   Then too, as I mentioned at the outset, Lund's paper is certainly timely and a valuable contribution to this critical debate.  Perhaps more importantly, his analysis was both engaging and thoughtful, offering novel insights regarding Say on Pay both in the US and the UK as well as the issue of shareholder power more generally. 

As an initial matter, while it was not the focus of his paper, Lund does a very nice job of grappling with some of the criticisms of Say on Pay.  He also does a very nice job of discussing the perceived benefits of Say on Pay in disciplining compensation decisions.  Specifically, he notes that the threat of a no vote inherent in a Say on Pay regime potentially impacts corporate decision-making at two critical junctures.  Thus, not only does it have an impact around the time of the vote for those seeking to avoid the largely reputational harm associated with a negative vote, but the threat of a no vote also may encourage increased consultation with shareholders prior to adoption of pay packages.   And to this latter point, evidence from the UK (which has mandated Say on Pay since 2002) suggest a substantial increase in dialogue with shareholders around compensation matters as a result of Say on Pay.

Nevertheless, Lund concludes that Say on Pay falls short of its goal, and asserts that the reason for this failing stems largely from the ex post nature of the Say on Pay vote.  Indeed, Lund notes that shareholders who are upset with a corporation's pay practices may nevertheless accede to such practices due to their fear of offending a seemingly valuable CEO.  In other words, because the CEO may perceive a rejection of his or her pay package as a personal rejection, shareholders must weigh the cost of that rejection against any benefits to be gained.  This bundling problem is most acute at high-performing firms where shareholders may perceive that the cost of offending a CEO who would be particularly high.  Seeming to confirm this problem is evidence from the UK revealing that Say on Pay has only had an impact on pay practices at poorly performing firms, and has had no impact on the CEO pay at above-median performing firms even when such firms have had controversial pay practices.  In Lund's view, this kind of result is inevitable in light of the bundling problems posed by an ex post Say on Pay vote.  To mitigate this problem, Lund offers an ex ante solution.

On the one hand, this solution seems ideal.  As he notes, we have had some experience with ex ante votes in the form of the shareholder vote on equity compensation plans.  Then too, such a vote is likely to alleviate bundling concerns since it applies to future CEOs--though Lund notes that it does not completely alleviate such concerns in circumstances where the future CEO is known or predictable.  Also, to the extent one of the primary purposes of the Say on Pay vote is to encourage more dialogue around compensation decisions, it is arguable that a vote on a Compensation Plan more directly achieves that result.

And yet this solution does raise some questions.  First, one has to wonder if Say on Pay votes in the US will have the same impact as such votes have had in the UK.  According to Lund, in the 8 years since the UK has adopted Say on Pay, there have only been 8 adverse votes.  By comparison, thus far this year there have already been three negative say on pay votes in the US at Motorola, Occidental Petroleum, and KeyCorp.  Moreover, at least with respect to Occidental, it is arguable that the vote reflects outrage over the pay package itself, as opposed to outrage about the link between the package and company performance.  This albeit anecdotal evidence not only suggest that US shareholders may be more willing to exercise their authority under a Say on Pay regime, but also suggest that such shareholders may not experience the same sort of bundling problems as UK shareholders, making the Say on Pay threat more credible and hence its potential to impact pay practices at all firms more likely.

Second, it is not clear that shareholders would actually view an ex ante Say on Compensation Plan regime as preferable to an ex post Say on Pay regime.  Hence, although Lund's Say on Compensation Plan regime would encompass more than just an advisory vote on equity compensation plans, it may nevertheless be telling that shareholders have insisted on Say on Pay notwithstanding the fact that they already have a vote on equity compensation plans.  Indeed, it may be that an ex ante vote will not provide shareholders with sufficient information to judge the adequacy of a company's compensation practices.  This may be because the flaws in a plan may not be clear unless and until an equity or compensation plan is applied to a particular executive in a particular setting--which may explain why shareholders express outrage about compensation that in some cases stems from equity plans they already have approved. 

Third, one has to wonder if the apparent fact that the UK version of Say on Pay has only managed to discipline poorly performing firms just reflects shareholders' discipline preferences.  That is, do shareholders only really care about paying for failure?  To be sure, Lund anticipates and grapples with this issue, but ultimately concludes that the more plausible explanation for the inability of Say on Pay to impact high-performing firms lies with the timing of the vote.  However, it seems possible that both of these explanations play a factor.  Indeed, while it may be true that participants in the Say on Pay debate appear to be concerned about so-called excessive pay across firms, shareholders may be less concerned with high performing companies not only because it may be too difficult and costly to assess whether such pay should be viewed as excessive when a corporation performs at a high level, but also because it appears to be less of a zero sum game at high performing companies.  The notion that shareholders are more concerned about pay for failure seems to be supported at least anecdotally in the kind of outrage that pay for failure sparks.   For example, the firestorm about AIG seemed to stem from the fact that AIG paid bonuses despite being "bailed out" by taxpayer dollars.  Similarly, people appeared to be outraged by Nardelli's exit pay package at Home Depot because the company was not doing well. And, in the midst of the Home Depot saga, when Barney Frank began thinking about holding hearings about excessive pay, his concern appeared to revolve around what he termed payment for "bad performance."  From this perspective, it could be that Say on Pay only disciplines poor firms because shareholders care most about the pay practices at those firms.  And while Lund certainly anticipates and addresses this point,one is still left wondering if this point is not one of the primary explanations for the empircal evidence.  Of course, it does not have to be the only explanation, nor does it mean that shareholders do not also care about excessive pay practices more generally.  Hence, it does not negate the benefit of a rule, like that proposed by Lund, that would enable shareholders to better address pay practices at all firms.

In the end, Lund's article represents a thought-provoking analysis of a truly critical topic that pushes us to think beyond the debate about Say on Pay, and towards examining the more fundamental question about how shareholders can exercise increased power in a responsible and efficient manner. 

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