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Comments of
Deborah Gilshan
February 4, 2009
Response
to Gordon paper: alternatives to federal, mandatory Say on Pay
1)
Federal
provision of shareholder right to decide whether a public firm should
OPT IN to
an advisory shareholder vote regime:
This
alternative option seems to be somewhat driven from the belief that not all
firms ‘deserve’ the regime of Say on Pay forced upon them, where a
shareholder vote on compensation is, somehow, a sort of punishment on
companies. We do not consider it in such punitive terms; instead, we see Say
on Pay as an opportunity for companies to demonstrate how they are
using compensation structures to provide alignment of the interests of
directors with shareholders. Furthermore, we expect that a further outcome
of the vote would be improved, and more transparent, disclosure within the
Compensation Disclosure and Analysis section of annual reports, which would
put shareholders in a more informed position to make the voting decisions.
A further
observation is that most firms do not have egregious pay practices and so
would be discriminated against in a different way, in that they have a good
story to tell, and would be denied the opportunity to gain shareholder
endorsement of their pay practices. The value of the goodwill created in
such cases should not be underestimated and often serves the Company well,
especially when they are proposing changes or there is on issue of concern
on compensation in subsequent years. By necessity, governance activists
already focus on the companies with the most material concerns. Furthermore,
this sort of structure would put too much onus on shareholders to decide to
which companies a vote on pay should apply, and may give them too much undue
power in this regard. As a consequence, it may increase the risk that the
interests of minority shareholders may be oppressed, especially if there is
a major shareholder on the share register, where their interests are not
always the same.
2)
Application of Say on Pay to the very largest firms, perhaps the top 500
companies by market cap:
I do not
think that such a discriminatory model would work; I think the discipline of
going through the annual vote process, from the perspective of both
companies and investors, is a valuable one. It enriches the understanding
that investors have of companies due to the importance of remuneration
within corporate governance risk analysis. It has required investors to
develop expertise on pay structures, which I think enhances both the quality
of corporate governance evaluation undertaken and the overall engagement
with companies. It has also made the consequences of pay decisions more
acute for companies.
The size of
a company does not necessarily imply egregious practices, which this
proposition appears to be based upon. It would also concentrate the debate
almost exclusively on quantum, which would not be a bad outcome per se, but
which is not the main focus of ‘solving’ the pay phenomenon. The focus
should be on improving performance linkage, which is necessary across all
companies, regardless of size and market cap. Smaller firms can learn from
the experience and as they grow, they will be aware of the process; instead
under this regime, Say on Pay becomes a consequence of market cap and size,
and less about egregious pay practices that cause concern.
I also
disagree with the general proposition that for smaller firms, corporate
governance is so inherently different. By its very nature, corporate
governance is not discriminatory on size of the company or the sector that
it is in, unlike social, environment and ethical risk analysis, which tends
to be more material in certain sectors. In the UK, smaller companies do have
some leeway on certain of the Combined Code provisions; for example, the
minimum number of independent directors is stipulated at two for smaller
companies (Principle A.3.2 of The Combined Code of Corporate Governance,
June 2008: “Except
for smaller companies, at least half the board, excluding the chairman,
should comprise non-executive directors determined by the board to be
independent. A smaller company should have at least two independent
non-executive directors.”).
However,
when the Code was reviewed in 2007, there was little
support for widespread derogations from the full Code to apply to smaller
companies as the majority of respondents considered that
“the same
governance standards should be applied to all companies regardless of size
and that ‘comply or explain’ allowed small companies the flexibility not to
follow particular provisions where they felt it appropriate” (2007 Review of
the Combined Code: Summary of Responses to Consultation, November 2007, pg.
12, www.frc.org.uk). Quality
corporate governance structures, including well aligned remuneration
structures, are factors relevant to minimise corporate governance risk in
any company, regardless of size. Considering this, I do not agree that
smaller firms would be ‘ill-served’ by a narrower set of compensation best
practices. In my experience, smaller firms are often most fertile in terms
of sensitivity to shareholder engagement and often a higher degree of
positive governance momentum is observed at these firms. The ‘intervention
experience’ for shareholders at smaller firms is often the most productive
and constructive. Smaller firms also tend to be most open to guidance to all
governance matters, not exclusively compensation issues. Furthermore, the
requirement to adopt good governance structures and follow corporate
governance best practice is a consequence of listing on a main market and is
the quid pro quo for the privilege of access to public capital, and is no
less important, especially in terms of alignment of interest between owners
and management, for smaller firms.
A further
consideration is that executive compensation is often taken as a proxy for
good governance generally and can be used as a kind of ‘litmus test’ for the
governance structures of an investee company. If the compensation policies
and practices demonstrate a strong alignment of the interests between
shareholders and directors, it can be generally inferred that other
corporate governance structures support this alignment and facilitate the
protection of the long term interests of shareholders. It is also important
to observe that many financial analysts do focus on remuneration – it is
often the key corporate governance issue that even the most traditional
analysts recognise should be part of the investment evaluation process or be
part of the fundamental analysis and evaluation of companies. In this way,
remuneration analysis can enhance stock selection.
Other
areas of comments
Linkage
of pay to performance:
Based on
the UK experience, there has been a greater linkage of performance and pay,
as Professor Gordon does admit in his paper. His criticism of the UK
experience in that it has led to a narrow range of approaches to the
inherently difficult problem of executive compensation, is somewhat
overstated. It has made performance linkage better and improved engagement
and dialogue systems between companies and their owners. Companies do try to
be innovative, and will often propose criteria for performance measures
other than earnings per share and total shareholder return targets for
longer term incentive plans. Companies will never be able to meet all the
preferences of investors in terms of performance measures, but that is a
problem in all markets, and it is worth observing that this
‘standardisation’ of performance criteria may serve companies better. Whilst
this may not be something that we as investors encourage and is perhaps a
challenge to the corporate governance community more than anything else, it
has been a consequence of the remuneration resolution arena.
Proxy
advisory firms:
I think the
concern around proxy advisory firms is valid to an extent but somewhat
understates the talent and skill set within institutional investors
governance teams and presumes an ‘absentee landlord’ approach to corporate
governance which is not an accurate observation on the corporate governance
community, certainly in the UK.
Regarding
the “gatekeeper role” of proxy advisory firms: this criticism is not unique
to ‘Say on Pay’ and is a criticism generally of proxy advisory firms and the
role that institutional investors allow them to play in voting decision
making processes and all that extends from this. Institutional investors
have a responsibility to limit the power of proxy advisory firms and
routinely do. I think this is a responsibility that most institutional
investors take seriously and execute effectively. After all, it is not proxy
advisory firms that own shares in companies. However, these firms do have a
role to play in highlighting issues and can act as a filter to allow
institutional investors to devote their time on the egregious practices or
companies that demand more attention or detailed analysis.
“Big
bang” of compensation engagement not likely in the
US:
I think
assuming this will not happen in the US slightly underestimates what effect
Say on Pay could potentially have. It has the potential to revolutionalise
the shareholder experience of investing in US companies, especially if it is
accompanied with proxy access and majority voting. It would also have the
affect of reducing shareholder proposals on the issue. Given this, it has
the potential to engender better relations with companies precisely because
it would not be a shareholder proposal but instead would be part of the
management driven agenda at general meetings.
Shareholder proposal process in the US:
Whilst it
may be easier, from a procedural viewpoint, for a shareholder to propose a
resolution at a US company as compared to the UK, it may be somewhat
overstating the case that this is favourable for US investors. The
comparison between the UK and the US in this area needs to be qualified by
also considering the structures inherent in the UK system which foster a
better way for shareholders to hold boards to account, as explained in
Professor Gordon’s paper. I think the point is that whilst it might be
easier, technically, to propose a shareholder resolution in the US, their
effects are diluted somewhat precisely because of their prevalence. The
effect is more concentrated in the UK because it is a unique, last resort
technique which can have powerful outcomes. Shareholder proposals may be
more common in the US, but can sometimes be less effective precisely because
there is so few ways in which shareholders can hold boards to account.
Deborah
Gilshan
4th
February 2009 |