A recent paper [Miriam Schwartz-Ziv and Russ Wermers, Do Small and Large Shareholders Have a Say-on-Pay? (October 15, 2014) available at SSRN] investigates the voting patterns of shareholders on Say-On-Pay and finds that ‘small’ shareholders are more likely than large shareholders to use the non-binding Say-On-Pay vote to govern their companies, are more likely to vote for an annual Say-On-Pay vote, and are more likely to vote “against” Say-On-Pay (i.e., to vote against the pay package).
A low Say-On-Pay vote is more likely to be followed by a decrease in excess compensation, a more reasonable selection of peer companies for determining compensation, and CEO turnover. Therefore, while the non-binding Say-On-Pay vote gives all shareholders voice, especially small investors, larger shareholders (5% blockholders) are generally needed to compel Board action.
Researchers interpret these results to mean that large shareholders prefer to confront management directly and in private, even when compensation is large and excessive. This approach may be driven by a desire to avoid a negative vote outcome, which could be followed by a share price decrease — since, presumably, large blockholders have established a toehold for a longer-term purpose. A more recent example of this behavior is that of Warren Buffett at the Coca Cola Company (Shareholder Pressure Pops at Coke).
The researchers reviewed Say-On-Pay votes by mutual funds from 2009 and 2013. Their literature review found:
- Voting ‘actively’ (inconsistently with ISS) is most likely when mutual funds have a relatively large stake in the company and/or investors are locked in for the long-term.
- Mutual funds are less likely to vote against management if they manage the company’s pension fund.
- Proxy votes are significantly impacted by media coverage.
- Funds vote like lemmings (influenced by other funds). I attribute that to the prudent man standard, which requires fiduciaries to act like other fiduciaries, even where that it doesn’t make sense. At bottom, this reflects the myth of efficient markets, and the fact that indexing has become the ultimate defense of lemmings. (See Review: The Shareholder Value Myth)
Not surprisingly, in addition to the findings noted above, the data showed funds were more reluctant to follow ISS advice against Say-On-Pay than when ISS recommended in favor. The vote failed 15.5% of the time with a negative recommendation but only 0.6% of the time when ISS recommended in favor.
Mutual funds were more likely to enforce stricter governance standards than shareholders as a whole. Perhaps, because individual investors generally don’t have proxy advisory services and are more likely to vote with management. They can also exit more easily.
In the vast majority of cases, all funds within a management company vote in the same direction. Researchers attribute that to economies-of-scale in analyzing the details of executive pay.
Factors Effecting Say-On-Pay Outcomes
- The larger the compensation awarded to the CEO, the larger the vote against.
- Strong profitability is associated with lower votes against pay packages.
- When 5% holders own a high fraction of stock, a favorable vote is more likely.
- When ownership is dispersed, the vote is “particularly beneficial in coordinating a large number of small shareholders, by offering them a relatively simple and cheap way to communicate their (dis-)satisfaction with the executive’s compensation awarded and/or the company’s performance.”
- Funds with low returns “are particularly likely to vote in support of management.” Are they afraid to confront management in public or too lazy to monitor? They lack the incentive per next bullet.
- A negative ISS recommendation increases the likelihood that shareholders vote against Say-On-Pay by approximately 30% but among mutual funds it is 44%. They cite Gilson and Gordon‘s argument that institutional investors in a competitive environment have little incentive to monitor. Readers are left to draw their own conclusion that pension funds are more likely to do their own monitoring and retail investors don’t subscribe to ISS.
- Shareholders were more likely to vote against the compensation awarded when companies held a golden parachute Say-On-Pay vote in the same year.
Although I’ve provided highlights from the study that stood out for me, there’s plenty of additional findings and discussion that should be interesting to members of the corporate governance industrial complex. I predict this study is going to get dog-eared.
How different would study results be if all mutual funds did at least some of their own monitoring, voted based on a policy that didn’t default to either ISS or management and knew shareowners would consider their voting history when investing? If you want to take voting history into account when choosing your funds, especially index funds, see the mutual fund profiles at ProxyDemocracy.org.
If announcing votes in advance became a recognized ‘best practice,’ mutual fund votes would get a lot more press, making their votes even more powerful, and investors would be more likely to determine if fund votes align with their own values before investing. (See Will Corporate Elites Attack Public Opinion Next?)
As we have seen in The Rise and Fall of Homo Economicus: The Myth of the Rational Human and the Chaotic Reality and the Economics of Good and Evil: The Quest for Economic Meaning from Gilgamesh to Wall Street, people are not rational entirely profit-seeking robots. Our decisions make a real difference in creating the world of our future.