Is Say on Pay An Effective Governance Tool ?

Analysis and Recommendations

This report examines whether Say on Pay is a useful tool to ensure that executive compensation plans are designed in a way that is consistent with the firm’s best interests. It addresses five related questions:

• What is Say on Pay?
• What does Say on Pay imply about governance?
• What means are available to provide shareholders with Say on Pay?
• What is the impact (the impact on whom or what?) of providing shareholders with Say on Pay?
• Should Canada consider Say on Pay?

What is Say on Pay? Say on Pay is a commonly used expression to reflect the concept that shareholders have an opportunity once a year to hold a vote on the pay of a firm’s executives. The vote can either be non-binding (Australia, U.K., Canada and the U.S.) or binding to directors (Netherlands, Sweden).

What does Say on Pay imply about governance? Say on Pay implicitly implies that the underlying governance, most notably the board of directors, is ineffective. Say on Pay may then be useful if one assumes that shareholders are more adept than the board of directors in dealing with executive pay issues, and have less conflict of interests then the directors in doing so. However, if shareholders make worse decisions than directors and/or have more conflicts of interests than directors, then Say on Pay may undermine the effectiveness of the pay decision-making process. However, Say on Pay does raise several legal and economic concerns regarding its impact on directors’ role and duties.

What means are available to provide shareholders with Say on Pay? Say on Pay can be implemented in two forms: either it is adopted voluntarily following a shareholder proposal to that effect, or it is required by law, with government mandating that firms adopt Say on Pay and specifying its terms. There are very few instances of voluntary adoption of Say on Pay through successful shareholder proposals to that effect. Say on Pay is mandatory in the U.K., Australia, the Netherlands and Sweden. The U.S. House of Representatives has just adopted a similar measure, but it has yet to pass the Senate.

What is the impact of providing shareholders with Say on Pay? The U.K. and U.S. experience with shareholder voting on executive pay suggests the following four conclusions. First, shareholders rarely disagree with the executive pay plans proposed by boards of directors. Second, shareholder dissent with proposed executive pay plans is strongest when shareholders are initially given the opportunity to vote on executive pay plans, and then declines over time. Third, Say on Pay has the largest impact on firms with poor performance, and on firms where executive compensation is high compared to their peers’ executive pay. Fourth, Say on Pay leads to lower compensation growth for these firms and less rewards for failure, i.e., compensation becomes more sensitive to poor performance. While Say on Pay may lead to more pre-Annual General Meeting dialogue between institutional investors and directors as the latter attempt to enhance the potential for a vote that supports the executive compensation plan proposed in the executive compensation report, it may be also translate into more homogenization of executive compensation into perceived best compensation practices.

Should Canada consider Say on Pay? We conclude that mandated Say on Pay does not seem to bring many benefits and that it may actually be costly from a societal perspective. However, voluntary Say on Pay may have merits, assuming that its implications on the fiduciary duty of directors are well defined and that shareholders have the ability and incentives to make decisions that are in the firm’s best interests.