Aurora Borealis
1 August 2015 CFA Institute Journal Review

Evidence on the Outcome of Say-On-Pay Votes: How Managers, Directors, and Shareholders Respond (Digest Summary)

  1. Imrith Ramtohul, CFA

The economic value of the say-on-pay (SOP) provision of the Dodd–Frank Act has been subject to study and debate. Overcompensated managers with low SOP support tend to increase dividends, reduce leverage, and increase corporate investment. Firms that obtain excessively high SOP support tend to fall in value. The SOP legislation does not seem to have improved executive contracting.

What’s Inside?

The authors find that overpaid managers with low say-on-pay (SOP) support tend to raise dividends, reduce leverage, and increase capital expenditure. Management’s response to the SOP vote, however, does not appear to affect future vote outcomes. No subsequent change in firm market value follows low SOP support. Furthermore, the authors note an increase in excess compensation subsequent to the SOP vote, even in the case of previously overpaid managers. Firms that receive unjustified high SOP support tend to decrease in value. The SOP legislation does not appear to have improved executive contracting in the short term. The authors, however, recognize that further study might be needed to assess the long-term impact of this legislation.

How Is This Research Useful to Practitioners?

The authors examine the economic impact of the SOP legislation, which provides shareholders with the opportunity to voice their opinion on managerial compensation. They test several hypotheses of managerial responses to low SOP approval. Executive decisions tend to be affected when the firm receives a low-support vote. Managers of low-support firms invest further in research and development, increase capital expenditures and dividends, and reduce leverage. But shareholders do not seem influenced by these changes, so there is no major impact on firm market value. Furthermore, these actions taken by management need not decrease the likelihood of low SOP support in the future.

The authors identify an increase in excess compensation subsequent to the SOP vote when management was previously overcompensated. Although excess compensation seems to be reduced in the first full year after the SOP vote, the decrease in excess compensation in the second year represents only 28% of the increase that occurred in the year of the first low-support vote. Boards of firms with low SOP support also persist in overcompensating CEOs, so there is no increase in firm value. Furthermore, firms with unjustified high SOP support tend to decrease in value. Economic losses arise when the shareholders fail to vote down managerial overcompensation. Again, the SOP legislation does not seem to have improved CEO contracting in the short term, although it could limit the increase in excess compensation. The authors, however, acknowledge that further study is needed to identify the long-term impact of the SOP legislation.

Portfolio managers and institutional investors will find the conclusions of this research useful. It seems that the legislation has not created sufficient incentives for boards to limit excessive managerial pay in the short term.

How Did the Authors Conduct This Research?

The authors test four hypotheses (self-interest, shareholder alignment, window dressing, and unjustified endorsement) to assess the response of management to SOP votes. They obtain their sample from the population of S&P 1500 Index firms in the Execucomp database with CEO and top executive compensation data available for fiscal year 2010. They then search the SEC’s EDGAR database to obtain the results for each firm’s first mandated shareholder SOP vote following the 2010 fiscal year as well as the date that the voting results were released. The sample is reduced to 1,250 firms with necessary data available on both Execucomp and EDGAR.

Firm-level accounting data are obtained from Compustat, stock returns are from CRSP, and governance data are from RiskMetrics. For models in which first-difference measures are used, all firms have data in both the preceding and subsequent fiscal year. The resulting sample ranges from 679 to 822 observations, depending on the model. Of the 822 firms, 749 (91.1%) receive more than 70% approval for SOP in 2011, and 742 firms (90.6%) of the 819 firms with available data receive more than 70% shareholder support in 2012.

The authors confirm the previously documented evidence that compensation is positively related to the S&P 500 Index return, firm’s sales, and firm’s stock return in the prior year. Compensation is negatively related to return on assets over the prior year and is unrelated to the CEO’s tenure. The authors find that 88% of shareholders support executive compensation and show that low SOP support in the first year of the vote results in higher dividends and lower leverage as well as an increase in both research and development and capital expenditures. Boards of firms with low SOP support continue to overpay CEOs. There is a net increase in CEO excess compensation over the first two years of the vote.

The authors test the robustness of their results and find no evidence that their findings are being influenced by multicollinearity.

Abstractor’s Viewpoint

There have been various studies carried out to assess the impact of the SOP legislation. In theory, the legislation could encourage a better alignment of shareholder and managerial interests. Boards and managers do not always take steps to enhance firm value, even after low SOP support. Similarly, firms with excessively high SOP support tend to fall in value. The results are interesting. Although I have concerns that the data used in the models relate only to 2010, which is relatively recent, the research suggests that the SOP legislation does not always induce management to act in the best interests of shareholders. Further research will be required to assess the long-term impact of the legislation.

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