By Ralph A. Walkling
general, say on pay gives shareholders an advisory vote on CEO compensation.
Heated arguments have been made on both sides of the issue, yet to date
there is little actual evidence about the market’s reaction to say on pay.
You can imagine three possible outcomes of say on pay legislation:
• First, it’s possible that the initiative could create
value by better aligning the interest of owner and managers.
• Second, since the vote is advisory only, it could have
little impact on firm value. Firms need not take any action regardless of
the outcome. Academic research generally finds little market reaction to
advisory vote initiatives.
• Third, the legislation could be disruptive. A strong
case can be made that the authority for executive compensation must remain
inside the boardroom and that attempts to alter this authority will destroy
value. The chairman of Directors and Boards, Robert Rock, has written
eloquently about say on pay, making this very point: “Should shareholders
have the right to an advisory vote on executive compensation? With the
exception of where pay is egregious, I don’t think so.” [“Say on Pay Is a
Populist, but Misguided, Notion,” Directors & Boards, Third Quarter
In a Drexel University working paper, “Shareholders’ Say
on Pay: Does It Create Value?” [see link below]
my co-author, Jie Cai, and I examine the market’s reaction to say on pay
legislation and related shareholder-sponsored initiatives. Here are some of
The First Legislative Volley
On April 20, 2007, the House passed the Shareholder Vote
on Executive Compensation Act (H.R. 1257) by a two-to-one margin. The same
day, then-Senator Barack Obama introduced a companion bill in the Senate.
Neither bill limits CEO pay but requires a nonbinding shareholder vote on
executive compensation. John McCain, while campaigning for President, also
expressed general agreement with say on pay.
To examine the market’s reaction to the say on pay
legislation we calculated risk-adjusted rates of return for over 1,200 firms
ranked by level of “abnormal” CEO compensation.
Our results indicate that, after controlling for market
movements and other confounding factors, firms with the highest level of
unexplained CEO compensation and lowest pay for performance experienced
significantly positive returns when the bill passed the House.
This result is consistent with the market believing that
say on pay legislation improves value for these firms. It is also consistent
with Robert Rock’s suggestion that say on pay would be useful only where pay
is egregious. Presumably firms with the lowest level of unexplained
compensation (underpaid executives, if you prefer) don’t need say on pay.
Indeed, these firms experienced small (statistically insignificant)
The Highest Returns
We also found that the highest market returns were earned
by firms responsive to shareholder proposals in the past and by firms with
higher levels of activist shareholdings.
All of these results may understate the impact of say on
pay legislation. We again note that the vote is advisory. But the results
indicate gains to firms that could benefit if say on pay were to be
One argument against say on pay is that if it were
beneficial, firms could adopt it voluntarily. Blockbuster, Apple, and Aflac
are among the companies that have done just that, and activists have
pressured many other companies on say on pay. We found about 50 companies in
the 2005-2006 period that were individually targeted by shareholder
proposals related to say on pay.
When Value Was Destroyed
However, our results indicate that the firms targeted by
these proposals appear unlikely to benefit from say on pay. In general,
their market performance was superior, their CEOs did not have higher levels
of unexplained compensation, and their corporate governance was not
abnormal. At the announcement of say on pay proposals for these firms, value
was destroyed. On average, these firms experienced significantly negative
abnormal returns when the proposals were announced. Interestingly, unions
sponsored most of these say on pay proposals.
The subject of executive compensation is certain to remain
a hot topic. Our results provide objective evidence for the current debate
on say on pay. Say on pay can create value in firms with egregious pay, but
blanket application to all firms can destroy value. As with much
legislation, one size does not fit all.
Dr. Ralph A. Walkling is Stratakis
Chair and executive director of the Center for Corporate Governance
http://www.lebow.drexel.edu/Centers/CorpGov/index.php at Drexel
University’s LeBow College of Business. He is a regular contributor to
Directors & Boards.
He can be
contacted at email@example.com.
This article originally appeared in the Fourth Quarter 2008