The efficiency effects of the UK system are potentially a matter of concern.  …the workings of the system seem ill-suited for a dynamic environment.  For example, immediately upon adoption of the DRR regime, the ABI and the NAPF adopted “best practices” of compensation guidance.  Because of the dominance of those two actors, whose institution investor members own 30% of the shares of large UK public firms, the annual shareholder vote is often a test of “comply or explain” with those guidelines.  Indeed, an alternative approach, in which shareholders would annually evaluate firm compensation practices in light of the firm’s performance and prospects as a whole, would be very costly.^[55]  The tendency for firms to “herd” in their compensation practices is very strong:   Follow the guidelines, stay in the middle of the pack and avoid change from a prior year, when the firm received a favorable vote. Yet what is the normative basis for giving authoritative weight to the guidelines, whose conventional wisdom has not itself been tested for performance-inducing effect?

…The guidelines may be “correct” in their outcome in particular instances of compensation form, but it is hard to believe that they will persistently produce a result similar to arms’ length bargaining, if that is the ultimate comparator.  More concerning, the implementation of the guidelines may transmit a particular form of compensation practice across an entire economy.

Deviations from the guidelines require, as a practical matter, a consultation with the proxy adviser of one of the institutional groups, either RREV or IVIS. To do otherwise may be to risk a negative recommendation on the advisory vote.  There are no studies on the bureaucratic capabilities or expertise of either proxy advisor.  The system as a whole seems to tilt toward stasis rather than innovation in compensation practices.  Perhaps this is wise.  In light of the generally greater shareholder power in the UK, it does, however, seem ironic that the implementation practicalities of “say on pay” may reduce the freedom-in-fact of the shareholders’ bargaining agent.

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55 See Kristin Gribben, U.K. Investors Warn U.S. About Say on Pay, Agenda (Nov. 12, 2007) (citing experience of UK fund managers, who nevertheless want to retain the advisory vote).

Only a relative handful of the large public pension funds have independent corporate governance expertise to guide their share voting, and even the largest and most experienced of these, CalPERS and TIAA-CREF, depend on guidelines that they fashion with only limited company-specific accommodation.  Most of the rest simply delegate most of the substantive decisionmaking in the governance area to a proxy services firm, in particular Institutional Shareholder Services (ISS), now part of RiskMetrics.^[58]

Like ABI and NAPF, ISS will establish guidelines on compensation; indeed, such guidelines already exist.  As in the UK, firms that do not want to stir trouble will herd. Or firms with alternative ideas will engage ISS in negotiation – but the numbers of firms and the time for serious engagement could easily make the situation untenable.  The propensity of many U.S. institutional investors to delegate such decisions could well give power to a handful of proxy service firms to make substantively very important decisions with potentially economy-wide ramifications.  Indeed, the economy-wide embrace of stock options in the 1990s resulted in part from institutional investor pressure on firms to adopt this “best practice” way to enhance managerial incentives.^[59] Then favored accounting treatment established “plain vanilla” options as the “best practice” implementation. In other words, much of what we now regret was the result of prior standardized practice that guidelines epitomize.^[60] It is clear that legislated “say on pay” in the U.S. is one way to catch and stop the bad-behaving outliers. But there are costs and risks that cannot be ignored.  

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58 See Stephen J. Choi & Jill E. Fisch, On Beyond CalPERS: Survey Evidence on the Developing Role of Public Pension Funds in Corporate Governance, 61 Vand. L. Rev. 315 (2008).

59 Gordon, Independent Directors, supra note 1, at 1529 n. 257.   

60 It is only now, with adoption of FAS 123R, that firms may feel free to experiment with alternative stock option forms, such as performance triggers for grant or vesting, possibly using industry indices to measure performance.  Yet the concerns about valuation of tailored instruments for accounting purposes may have its own uniformity pressure.

…In a 2005 article I said that the regime launched by the SEC’s CD&A regulation deserved a five year trial before we undertook significant change.^[67] Having looked more closely at the UK “say on pay” regime, I am prepared to reaffirm my prior view.  We need more information about the consequences of the UK system.  And we need more experience about the possible success of present compensation-reform efforts by shareholder activists at particular firms.  If this is not a satisfactory result from a social responsibility perspective, then the tax code would be a better place to look than adjustment with corporate governance.  

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67 See Gordon, Executive Compensation, supra note 20, at 701.