The Implications of Say on Pay: The Next Generation Statutes (Part 4)

The US implemented say on pay in TARP companies in 2010 and in public companies in 2011.  In that regard, the US has been behind other countries, particularly Britain and Australia.  Both gave shareholders an advisory vote on compensation earlier in the decade (Britain did so in 2002).

As a result, these countries have had more experience with the consequences of the practice.  It is safe to say that both countries remain frustrated with the continued trends in executive compensation.  A recent report in Britain by the High Pay Commission noted the harms caused by escalating executive compensation and challenged the holy grail of CEO compensation:  The need for it to be performance based.  As the report observed:  

• The question of whether pay for performance works is a controversial one. Popular common sense suggests that people can and will work within a range of effort and through pay we can encourage them to work harder and towards certain defined goals. However, this is increasingly questioned and the interaction between financial incentives and performance is not simple.

What seems clear is that both countries (and presumably shareholders) have become concerned with the amount paid rather than the metrics used to determine the amount.  

Both countries have either adopted or are considering changes to the say on pay approach.  Australia has adopted a second generation say on pay statute, with the changes having become effective on July 1, 2011.  The draft of the statute is here; an explanatory memorandum here.  The provision has generated considerable commnetary,  some of it critical.  For the debate on the legislation, go here.  The law prohibited certain shareholders from voting (directors and executive officers) and imposed a two strike requirement. 

Under the provision, the first strike occurs when at least 25% of shareholders oppose the compensation report.  This triggers a duty by the company to explain any response (or non response).  Following the receipt of one strike, companies must include on the ballot for the next meeting a "spill" motion.  To the extent 25% of the shareholders again vote against the compensation report and the spill motion passes, all directors except the managing director must stand for reelection.  

As ISS has reported, twelve Australian companies have received first strike votes.  These companies have a year to address shareholder concerns.  Otherwise, they may face a recall election for the members of their board. 

Britain has not yet acted but has suggested that it may adopt a say on pay provision that makes shareholder approval mandatory. Reform proposals in Britain have recognized the closed nature of the compensation approval process.  The proposed reforms, therefore, include employee representation on the remuneration committee.  As the High Pay Commission explained: 

• The High Pay Commission has found remuneration committees to be a closed shop, made up largely of current and recently retired executives. This model has failed, leading to spiralling pay. We believe that greater engagement with employees may help restrain executive pay and help mitigate negative impacts on morale as well as encourage a greater engagement with the workforce. We therefore call for employees to be represented on remuneration committees as a first step to better engagement and accountability. 

In addition, the High Pay Commission recommended the strengthening of the shareholder vote on compensation.  Rather than provide shareholders with a veto over compensation already determined, the Commission indicated that shareholders should have the right to help shape compensation in the future.  As the Report recommended: 

• Shareholders should cast forward-looking advisory votes on remuneration reports  The High Pay Commission has considered recommending making shareholders’ advisory votes on remuneration reports binding, but it was felt that a preferred option at this stage would be to make the vote forward looking. We therefore recommend that shareholder votes on remuneration are cast on remuneration arrangements for three years following the date of the vote and that these arrangements include future salary increases, bonus packages and all hidden benefits, giving shareholders a genuine say in the remuneration of executives.

The government has indicated that it will make specific proposals next month.  They may include eliminating the advisory portion of the vote, allowing shareholders to veto compensation packages.

Whatever one thinks of these reforms, they have one thing in common.  They are what occurs when "say on pay" ultimately fails to adequately address concerns about executive compensation.  To the extent that say on pay likewise does not work in the US, similar pressure will build.

Primary materials from some the "say on pay" derivative suits can be found at the DU Corporate Governance web site.

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