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Shareholder votes on executive compensation at US firms have been judicious as well as effective, new research finds

Findings bode well for mandatory say-on-pay provisions of financial reform bill  

July 21 - When Robert I. Toll stepped down as CEO of luxury-home builder Toll Brothers last month, he could look back over a career replete not only with riches but with his industry's most coveted awards for excellence. But that didn't save him from a 73% pay cut three years ago, from $26 million to $7 million, after owners of one fourth of Toll Brothers' shares withheld their votes to re-elect the head of the firm's compensation committee. At the time, a proxy advisory firm concluded that Mr. Toll's average compensation over the previous three years had been 564% above the median paid to CEOs at peer companies.

While Mr. Toll's pay cut stands out as particularly severe, shareholder "vote-no" campaigns similar to the one at Toll Brothers have turned out to be a highly effective way of bringing stratospheric CEO paychecks closer to earth, according to new research. A study to be presented at the annual meeting of the American Accounting Association (San Francisco, Aug 1-4) finds that such campaigns resulted on average in a single-year CEO pay drop of about $7.3 million (about 38%) in firms where pay was excessive . Companies that sustained hefty CEO  pay reductions during the study's time span (1997-2007) included Yahoo, UnitedHealth, United Natural Foods, Sanmina-Sci, Saks Inc, Sprint, Qwest Communications, Legg Mason, Lennar, KB Home, Constellation Energy, and Apple.

In addition, the study finds that pay-design proposals by institutional investors resulted in average pay reductions of about $2.3 million in companies with excessive CEO pay. Excessive pay is an amount greater than what would be expected on the basis of a number of standard economic determinants, including firm size, return on assets, stock performance, and industry.

The findings would seem to bode well for the increase in shareholder say on pay likely to result from the major financial-reform bill that President Obama signs into law today. The new legislation requires shareholder advisory votes on executive pay at least once every three years (and, subject to the decision of the shareholders, possibly as often as every year) in all companies or categories of companies not specifically exempted by the SEC.

"This study casts doubt on the two most frequent criticisms of increased shareholder say on pay -- either that it will be largely ineffective or that it will lead to radical changes dictated by unions or other special-interest groups," comments Fabrizio Ferri of New York University, who carried out the new research with Yonca Ertimur of Duke University and Volkan Muslu of the University of Texas at Dallas.

In the words of the study, which analyzed 1,198 executive-pay-related shareholder proposals and 134 vote-no campaigns at S&P-1500 firms, "Shareholder votes and proxy advisor recommendations seem to reflect a sophisticated understanding of CEO pay levels and an ability to filter out the lack of sophistication or the social equity objectives of activists...There is no indication that special interest groups pushing for radical change or trying to micromanage executive pay have hijacked shareholder votes -- a concern expressed by critics of say on pay. By and large shareholders have judiciously used their voting power...selectively supporting proposals giving themselves power on extraordinary compensation items (e.g., large golden parachutes), while rejecting proposals dictating the level or structure of pay."

Based on these findings, Prof. Ferri views the new legislation as likely to promote discussion between shareholders and appropriate board members not only of the amount of executive compensation but of the way it is arrived at. "The great majority of pay-related proposals had to do with the pay-setting process (what we call 'rules of the game') or pay design, especially how to link pay with performance. I would expect that the new financial-reform bill will serve to encourage behind-the-scenes discussions that address such questions and not just compensation dollar amounts."

Noting that vote-no campaigns proved more potent than pay proposals in lowering excessive pay, the study's authors note that mandated say on pay "shares the advantages of vote-no campaigns over shareholder proposals, but at a lower cost...Unlike a vote-no campaign, a say-on-pay vote channels shareholders' dissatisfaction outside the context of a director election, allowing shareholders to press for changes in executive pay while retaining valuable directors."

Adds Prof Ferri: "Directors can be of value to companies in many ways. It is to the shareholders' benefit to avoid the possibility of voting them off the board over an issue -- executive compensation -- that may have little or nothing to do with the reason for their being on the board in the first place."

 One apparent major lapse of shareholder judgment did emerge in the analysis of pay activism -- namely that "activists target firms with high CEO pay, whether excessive or not, inconsistent with a sophisticated approach." The authors surmise that "many activists regard high levels of CEO pay as excessive from a social equity standpoint, even if justifiable based on economic determinants." At the same time, quite apart from the targeting issue, "voting shareholders support compensation changes only at firms with excess CEO pay, suggesting that, on average, shareholder votes reflect a sophisticated understanding of CEO pay figures. This speaks favorably about the potential ability of advisory say-on-pay votes to capture the quality of CEO pay practices, contrary to claims that shareholders lack the required specific knowledge or the incentives to acquire it." 

Is the targeting of companies in which pay is high but not excessive attributable to unions -- perhaps reflecting a proclivity on their part to exercise their muscle as pension-fund shareholders in firms where they also represent workers? The authors investigate this possibility but find  that "firms targeted by union pension funds are not more likely to be unionized than firms targeted by other activists, inconsistent with the conflicts-of-interest hypothesis." Further, "union-sponsored proposals suffer a penalty in terms of support from other shareholders and proxy voting services when the target firms' employees are affiliated to the union whose pension fund is sponsoring the proposal."

The study, entitled "Shareholder Activism and CEO Pay," will be among hundreds of studies being presented at the annual meeting of the American Accounting Association, a worldwide organization devoted to excellence in accounting education, research, and practice. More than 3,000 scholars and practitioners are expected to register for the meeting in San Francisco, Aug. 1-4.



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