Corporate Governance and the Problem of Executive Compensation: The Role of Say on Pay

The other place where matters have been federalized is with respect to say on pay.  Say on pay gives shareholders of every public company (defined as those traded on a stock exchange or registered under Section 12(g) of the Exchange Act) the right to an advisory vote on the amount paid to the top five executive officers (two of whom are the CEO and CFO).  See Rule 14a-21, 17 CFR 240.14a-21. 

Shareholders have taken advantage of the authority and proved very willing to vote against a pay package.  More than 50 companies this proxy season have received a negative vote on their compensation.  According to the WSJ, four of the companies in 2012 were repeat offenders, receiving negative votes in 2011 and 2012. 

Negative votes have generated derivative claims against the board.  They have not, for the most part, been successful.  Most recently,  the court in Iron Workers Local No. 25 Pension Fund v. Bogart, N.D. Cal., No. 11-4604, June 13, 2012 (a copy of the decision is here), dismissed a derivative suit based upon a negative say on pay vote.  Relying on Aronson, the court found that the allegations were not sufficient to show reasonable doubt as to the applicability of the business judgment rule. 

The Fund does not even claim that the MPS Board was not adequately informed when it made its decision to increase executive compensation. Instead, the Fund primarily relies upon the negative 'say-on-pay' vote to cast doubt on the honesty and good faith of MPS’s board in making its decision to increase executive compensation. The Fund argues that the negative 'say-on-pay' shareholder vote is evidence showing that directors failed to act in the shareholders' best interests and rebuts the presumption that the MPS Board’s decision regarding compensation is entitled to business judgment deference.

Allegations based only upon a negative say on pay vote were not, however, enough.

The Fund’s allegations here regarding the challenged compensation decision are not sufficient to overcome the presumption that the MPS Board reasonably exercised its business judgment. The fact that the Fund’s interpretation of the 'pay-for-performance' policy does not match the MPS Board’s executive decision is not the equivalent of an allegation that the MPS Board intentionally misled shareholders. Additionally, the 64% negative vote by shareholders does not, on its own, rebut the business judgment presumption.

While litigation has not succeeded, anecdotal evidence suggests that companies receiving a negative vote have responded to shareholder unhappiness.  Nonetheless, the impact of advisory votes is likely to be modest.  It will probably cause compensation to become more performance based.  Certain types of abusive practices will be less common.  With respect to amount, however, the experience in Britain suggests that say on pay is not likely to prevent the continued escalation of compensation. 

J Robert Brown Jr.