How Much Does Performance Count In a Say-on-Pay Vote?

How Much Does Performance Count In a Say-on-Pay Vote?Zoom inDownload PDF

Say-on-pay votes are a barometer of shareholder sentiment on executive compensation and performance. While the fraction of companies that fail say on pay—those that receive less than 50 percent support—is small, such feedback is a warning signal to directors that shareholders are deeply concerned and that action needs to be taken to regain their support. Semler Brossy’s latest study of vote results across the Russell 3000 examines the relationship between market performance and voting outcomes.

The data reveal that companies with negative shareholder returns during the previous year fail approximately three times as often as those with positive returns from year to year. Interestingly, shareholders respond differently to incremental changes in returns depending on whether performance is positive or negative. In the case of negative returns, the more negative the shareholder returns, the more likely a company is to fail. Should voting returns become positive, however, improved company performance does not lead to substantially better vote outcomes. In fact, companies that grow their stock price by leaps and bounds, defined here as achieving positive returns of 50 percent or more in a single year, do about as well as companies with only modest gains of 10 percent or less.

Here are three possible explanations for how poor market performance could impact say-on-pay votes:

  1. Shareholders are displeased with negative company performance and also think that CEO compensation is not properly aligned with that negative performance. However, given the similarity of voting results across a wide range of positive returns, shareholders appear to be primarily concerned with alignment when the company is underperforming.
  2. Negative total shareholder return (TSR) simply increases the likelihood that shareholders will carefully evaluate a company’s pay programs. Fewer than 4 percent of Russell 3000 companies fail say on pay in any given year, meaning that shareholder approval is the default. If a company stands out in the portfolio by declining in market value, that may be a cue to investors to reevaluate not only the business fundamentals but also pay and governance practices. In other words, negative performance drives the higher failure rates more than alignment.
  3. Shareholders use the say-on-pay vote as a means to voice their frustrations with lackluster performance, perhaps faulting the design of existing incentive plans for contributing to the company’s poor returns. In other words, even if pay and performance were aligned, the company is still more likely to fail say on pay.

But here’s another complication: pay decisions are typically made at the end of the fiscal year, based on performance throughout the preceding twelve months. However, what happens in the markets aftera company’s fiscal year but before the annual shareholder meeting when say-on-pay ballots are due also appears to impact vote results. Companies that have positive TSR throughout the fiscal year, but experience a sudden drop afterwards, fail 2.2 percent of the time, or 1.8 times more often than those with continued positive performance. An opposite effect applies to poor performers who experience major gains just prior to the shareholder meeting. Taken together, these observations suggest that shareholders continue to be swayed by market results up to the day they cast their proxy votes.

Negative TSR appears to indicate a heightened risk for failing say on pay. To prevent this, we recommend that our clients commit to shareholder engagement throughout the year, regardless of company performance. Based on our research, we see the following implications for boards:

For a full analysis of the 2014 say on pay voting results, click here to read the report on Semler Brossy’s site.

This article was originally published on NACD Directorship on January 7, 2015.