The 'Say-on-Pay' Debate Heats Up

Following the lead of Aflac and Verizon, more pay proposals are expected to pass this proxy season. Is that a good thing?

In November, Verizon adopted "say on pay," becoming the second U.S. public company to do so after Aflac. The decision, which goes into effect next year, gives shareholders a nonbinding up-or-down vote on the future pay packages of senior executives. Also in November, a say-on-pay proxy resolution gained support from nearly half of shareholders (48 percent) at Cisco.

As Congress debates whether or not the rule should be implemented for all companies and CEO compensation issues continue to be a lightning rod, say on pay is likely to be one of the most controversial topics this coming proxy season. One reason for all of this attention is that the issue has become emblematic of the shareholder push for more influence on corporate decision making.

"It goes right to the heart of corporate governance in the sense that it examines the balance of power between the rights of shareholders and the rights of directors to control the corporation," says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. Elson recently assembled a panel of experts on all sides of the issue as part of the Weinberg Center's series on corporate governance topics.

"The real question shareholders have raised is whether we are overpaying, in effect, for failure," says Stephen Davis, program director at the Millstein Center for Corporate Governance and Performance at Yale School of Management, and editorial director of Global Proxy Watch. Davis studied companies in the United Kingdom, where rule makers mandated say on pay for public companies, five years ago. In most cases, Davis found that U.K. shareholders supported the pay packages they voted on. "There is a relatively low amount of opposition [to pay plans]," says Davis. "[Shareholders] only recommend against the plans they vote on about 10 to 13 percent of the time. So there is more scrutiny, but there isn't the sort of abuse of the system."

Shareholders Muscling In?

D. Craig Nordlund, general counsel and corporate secretary of Agilent Technologies, argues against adopting a say-on-pay law. "The solution that is being proposed is a legislative solution to give investors some direct say on pay, while in fact the solution really needs to be improving the quality of the directors on the compensation committee. It is a sort of one-size-fits-all attack on compensation systems that do not link to performance. And one of my fears, in addition to providing shareholders with this sort of direct access, is that there is going to be ongoing confusion between high compensation and high compensation that is linked to performance."

Nordlund says that he is also concerned that proxy advisory services, which review thousands of proxies, would be forced to come up with a formula on pay that would not take into consideration certain cases, such as when a company needed to pay a high price to lure an outside CEO. "It could look excessive and you could argue that it is not linked to performance since, in fact, the CEO has not performed yet," he maintains.

Indeed, many executives have lined up in opposition to say on pay. Frederic W. Cook, founding director of Frederic W. Cook & Co., says many executives do not support say on pay: "While there's a lot of good that can be said for the say-on-pay proposal, my client base is adamantly opposed to it."

Cook says putting pay to a vote shows a lack of confidence in the board, and is unnecessary and potentially harmful. "The feeling [among directors] is: 'Look, as directors, you elected us, and you are paying us to do this job, so let us do it, and don't second-guess us,' " Cook says. He is also concerned that say on pay could provide an opening to shareholders who want to muscle in on the corporate agenda and lead to shareholder "plebiscites" on other issues.

Elson points out that the idea of allowing shareholders to vote on pay is not a novel one, nor is it unprecedented. "In fact, now the New York Stock Exchange requires listed companies to get shareholder approval of new equity grants to executives, so there is a vote, and that is frankly a vote on pay that is out there."

Cook worries that if say on pay continues to gain momentum, especially if a law is passed, it could paint Corporate America with a broad brush, while shareholders are really only concerned with the pay practices at a minority of large companies. "What the investors who are mad about pay are focused on are the practices of the top 200 companies. But there are about 12,000 public companies who could be forced to put say-on-pay votes in their proxies," Cook says.

"Sins of a Few"

William Lauder, president and CEO of The Estée Lauder Cos., agrees that passing say on pay would require all companies to pay for the sins of a few: "I can only say that the cost to an organization for complying with the extraordinary rules and regulations that are largely driven from the unfortunate existence of bad actors is enormous to the private sector and to the public sector. Say on pay is yet another version of that."

Kenneth Bertsch, executive director in charge of corporate governance policy at Morgan Stanley Investment Management, thinks say on pay might provide a good way to manage potential conflicts of interest when it comes to executive pay, although he says views on the idea are mixed within his organization. "I think it is a classic area where shareholder ratification is a useful tool. I think there is a systemic problem in executive pay. It is a unique area in terms of conflicts of interest, given the management influence in the boardroom."

Many of the panelists argue that the real issue isn't giving shareholders more say on pay, it is doing a better job of linking pay to performance. "There's no debate in the pay-for-performance notion that if there is performance, the pay is fair because there has been meaningful shareholder value delivered," says Lauder. "And if the pay for performance is properly structured, management and shareholders are properly aligned. The question becomes, when something starts getting out of sync, what voice do the shareholders have in re-syncing that process."

At a time when many boards are clamoring for less regulation, the best practice for directors may be simply to better police themselves by linking pay to performance. They also need to do their best to avoid the type of high profile pay case that ignites the interests of shareholders, politicians, and reporters.

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