What lessons can be learned from the Uk's advisory vote on executive as US companies prepare for say on pay
In 2002 the British built and test-drove the original say-on-pay concept. Now the US is building its own version, spurred by public outrage over executive pay and reckless corporate risk-taking. Firms that took money from the Troubled Asset Relief Program had to submit to say-on-pay votes in 2009, while a mandatory vote for all listed companies is under consideration by US lawmakers.
So what lessons does the UK’s say-on-pay experiment have for the US? Is say on pay a sufficiently powerful rebuke to prevent senior management members from over-indulging? Certain parties fear difficult decision-making will be passed to proxy advisory companies, some carrying possible conflict-of-interest issues. Simple solutions, you won’t be surprised to learn, are not on the table.
So just how effective has the British say-on-pay experience been? Bess Joffe, director of shareholder engagement at Hermes, which manages the UK’s biggest pension fund, has knowledge of shareholder engagement on both sides of the Atlantic. She believes the UK’s experience has meant increased dialogue between companies and investors.
‘The main lesson is how valuable the dialogue is on the advisory vote,’ she notes. ‘It’s created an opportunity to develop a dialogue with directors on remuneration committees. In the UK, best company practice is about putting together consultation documents and distributing them to big institutional investors, well before amendments to compensation plans. It’s a very free-flowing discussion with no hard feelings.
‘It also gives us another view into the boardroom. It’s common in the UK to have dialogues with executive and non-executive directors. It’s not about market-sensitive information; it’s about reassurance and accountability.’
Governance specialist Carol Bowie from RiskMetrics Group agrees the UK experience has been constructive. ‘The latest study from Harvard’s Professor Fabrizio Ferri shows the advisory vote has definitely been an effective tool in the link between pay and performance,’ she notes. ‘It hasn’t affected the actual levels of pay per se, but it has had an impact on pay for failure.’
Bowie also says that if the US government makes a real go of say on pay, investors need to really believe the rule means business – which means companies need to take it seriously. ‘Most will, but I think it’s too early to be sure,’ she adds.
Toothless tiger
Some feel say on pay in the UK has lacked the teeth to bring about real change, however. ‘Has say on pay got the issue into the press? Certainly. Has it constricted executive pay? No,’ says Sarah Wilson, managing director of UK proxy governance and voting service Manifest. ‘If companies were doing the right thing and the shareholders agreed, then votes on the remuneration report would be low, less than 2 percent of votes. Clearly there’s a lot of communication going on, but whether it’s going to be acted upon has yet to be seen. Given the level of aggressive voting recently, I think we will know within the next three years.’
Peter Walker from London-based governance specialist Pielle Consulting seems to share Wilson’s ambivalence about the effect of the non-binding vote on executive compensation in the UK. ‘I like the concept of say on pay as a means of increasing disclosure but the idea seems to generate more heat than light,’ he says.
Even if a non-binding vote lacks real bite, giving shareholders a say on pay has generated positive headlines and airtime for early adopters. In 2007 insurer Aflac became one of the first US companies to hand shareholders a UK-style vote. Despite the heady $11.96 mn package paid to Aflac’s CEO Daniel Amos, just 2.5 percent of shareholders voted against it.
But one major issue for US companies adapting to say on pay is proxy voting guidance. In the UK, organizations like the Association of British Insurers and the National Association of Pension Funds help establish guidelines on compensation for UK companies. In the US, many institutional investors outsource that job to a proxy voting and governance entity like RiskMetrics. And that, says Professor Jeffrey Gordon from Columbia Law School, looks problematic.
‘RiskMetrics both rates firms on their proprietary corporate governance index and, through a purportedly separate arm, provides proxy voting advice,’ he points out. ‘It charges firms for consulting services on how to improve corporate governance scores.’
Gordon says a recent empirical paper was generally skeptical about the value of commercial corporate governance ratings. ‘It is easy to imagine that a single entity could create guidelines, establish rating systems for good compensation, consult with firms on how to improve their compensation ratings in light of their particular circumstances, and then, behind purported ethical and physical barriers, provide proxy voting advice to shareholders,’ he notes.
Delegation or abdication?
Anne Simpson, senior portfolio manager for corporate governance at US pension fund CalPERS, shares Gordon’s unease on the issue, saying it’s a short road from delegation to abdication. ‘It’s essential these agencies are treated as sources of useful advice and information, but the decision and responsibility for the decision must remain with the owner,’ she suggests. ‘There’s a naked conflict of interest. Chinese walls are easily breached – as the Mongols knew. Conflict-of-interest issues are a big concern for us and we take a wide variety of advice, externally and internally. But there’s no substitute for doing your homework and talking direct to the company.’
It’s too early to predict accurately how say on pay will translate to the US. In the UK, compensation packages haven’t been visibly slashed. But what is increasing on both sides of the Atlantic is genuine dialogue about pay for failure, as well as pay for long-term performance – even the ability to claw back bonuses if performance backfires. ‘Some companies now have three-year rolling contracts where 12 months used to be the norm,’ Simpson points out. Performance-target time periods are definitely increasing. Fears that some activist shareholders would attempt to use say on pay for their own special interests have also largely fallen away, at least in the UK.
Foot in the door
Say on pay may actually turn out to be a more useful tool in the US where accountability and shareholder empowerment is more of a struggle for investors, and it remains hard for most US investors to oppose directors and boot out poorly performing ones.
But implementation will have limited effect unless pay incentives and accompanying strictures are applied right across a company. It’s not just an executive problem: this is a problem for just about everyone.
Same model, different road map
The UK’s say-on-pay model is an awkward fit for the US. As yet it’s not clear where the cut-off would be in any mandatory regime: the largest 500 companies, for example? In the US there are around 10,000 public companies compared with 1,100 or so in the UK.
In addition, British institutional investors tend to operate out of London and Edinburgh, which makes investor communication and coordination relatively easy. Although the US has many more institutional investors, they are historically much less coordinated en masse; it’s a much more diffuse set-up generally.
The British have also traditionally given shareholders more power than their US counterparts, resulting in less opposition to campaigns like say on pay.
