Let's Fix "Say on Pay"

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This article is part of an ongoing series about the Shareholder Bill of Rights currently in Congress. Together, we can ensure that this bill truly represents our interests as shareholders and individual investors.

It was one of the great shareholder heists of modern times: When Disney (NYSE: DIS  ) decided super-agent Michael Ovitz was unfit to rule the Magic Kingdom, the company soothed the upset with a $38 million cash severance payment -- on top of the multimillion-dollar "golden handshake" options package he got.

Ovitz had worked at Disney for 454 days.

At least Ovitz was (more or less) an innocuous presence at Disney, respecting the Hippocratic maxim to "first, do no harm." One can hardly say the same of Stan O'Neal, the former CEO of Merrill Lynch. Before being ousted in October 2007, he ratcheted up the company's risk-taking during the credit bubble, leading to catastrophic losses on subprime securities. The company was ultimately forced to seek out a white knight in Bank of America (NYSE: BAC  ) . O'Neal's parting gift? Securities and retirement benefits worth $161.5 million, much of which included deferred compensation for the legacy of leadership he left in his wake.

Needless to say, the problems addressed by the Shareholder Bill of Rights Act's "say-on-pay" provision have received a lot of attention. Many experts believe that incentive structures at a number of large companies specifically reward the sort of risk-taking that led up to the financial crisis. None other than Warren Buffett, CEO of Berkshire Hathaway (NYSE: BRK-A  ) , told us that "incentives are the most important things to change right now."

The current situation
In the wake of the credit crisis, the veil has been lifted on compensation structures that implicitly incentivize traders and executives to maximize short-term individual gain at the expense of the long-term health of their employers.

Financial institutions are under intense scrutiny for their pay practices, particularly companies that received government assistance to avoid toppling the financial system -- see the government-facilitated takeover of Bear Stearns by JPMorgan Chase (NYSE: JPM  ) , for example, or the conversion of Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) into bank holding companies so that they could borrow directly from the Federal Reserve.

The Shareholder Bill of Rights Act seeks to provide shareholders with a "say on pay" on two fronts:

  1. The bill would establish an annual shareholder vote to approve the compensation of executive management.
  2. The bill also provides for a separate vote to approve "golden parachutes" that are paid out to executives in the context of a company merger or acquisition.

Note that the results of the votes are "non-binding" -- if a majority of shareholders withhold their approval, this doesn't overrule the board's decision, nor does it force the board to review the compensation. The process simply allows shareholders to register their dissatisfaction by withholding their vote.

Regardless of what happens to the legislation in Congress, you might soon have the opportunity to vote on pay. Last month, Microsoft (Nasdaq: MSFT  ) -- which has become a model of good corporate governance -- announced that it will grant shareholders a "say-on-pay" vote. While the vote is only triennial, as opposed to annual, the company says that it would speak to shareholders in the event of a "significant negative say-on-pay vote." Coming from one of the highest-profile U.S. companies, that decision could prompt others to follow suit.

The pros and cons
You might think that a non-binding vote has no teeth, but it turns out that's not the case. There is evidence from the U.K., which adopted a non-binding "say-on-pay" vote in 2002, that boards do react to shareholder dissatisfaction expressed through the votes by curbing excessive compensation or forcing the CEO out of office. Public "shaming" can be effective.

However, while "say on pay" appears to curb excesses on the downside ("avoid paying for failure"), by tightening the relationship between pay and company performance when the latter is disappointing, it doesn't improve it where performance is good. That suggests that if "say-on-pay" legislation is universally applied, it could disrupt companies that are well-run for the sins of those that aren't.

In a detailed review of the U.K.'s experience with "say on pay" and its applicability to the U.S., professor Jeffrey N. Gordon of Columbia Law School proposes two alternatives.

In the first, "say on pay" is enacted at the discretion of each company's shareholders, who can opt in to the program. In the second, "say on pay" would be restricted to the largest U.S. companies, where it would have the largest economic and societal impact. (In the U.K., "say on pay" is restricted to companies quoted on the LSE's Main Market, which numbers approximately 1,080.)

Finally, Gordon concludes that the discussion regarding "say on pay" is separate from that about compensation at the systemically important financial institutions, because the latter raise concerns that "transcend shareholder objectives."

How reform will affect you
Owning a company's shares makes you a minority owner of that company. If a "say-on-pay" measure were to be enacted, you should use that privilege and vote (or consciously withhold your vote).

Given that the major shareholders at most publicly traded companies are institutional investors, individual investors are right to question whether their small voices will be heard. But remember: Not all institutional investors are created equal. You have a choice when you buy a mutual fund or select a fund manager in your 401(k). All other things being equal, you should certainly favor fund managers who have a straightforward proxy voting policy and who vote their proxies in a manner that proves they think like owners.

Shareholders, be heard!
We want the Shareholder Bill of Rights to come from all of us. So cast your vote in the online poll below or post your comments at the bottom of this article (or any other in this series). Or send us an email at Let's all tell Wall Street and Washington what rights we shareholders really need.

Once you’re done, remember to check out "It's Time for a Shareholder Revolution" for more on the Shareholder Bill of Rights.

Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Berkshire Hathaway and Walt Disney are Motley Fool Stock Advisor selections. Berkshire Hathaway, Walt Disney, and Microsoft are Motley Fool Inside Value recommendations. The Fool owns shares of Berkshire Hathaway. The Motley Fool is investors writing for investors.

Read/Post Comments (15) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 02, 2009, at 6:47 PM, 102971 wrote:

    Executive compensation (in total) should be tied to a % of the company's profit and bonuses should be tied to a % (not more than 10%) of the INCREASE in profits over the previous year. No increase - no bonuses.

  • Report this Comment On October 02, 2009, at 7:50 PM, standandcounted wrote:

    shareholders vote should not be based on how many shares they own but on the how many share holders there are total,000 individual share holds,mutual fund companies should count how many holders they have and have them vote for the mutual fund companies and same for other big firms, so everyone has an equal say , not the major share holders like CEO etc. and only those who have held a holding of at lest 3- months

  • Report this Comment On October 02, 2009, at 8:08 PM, vegastar wrote:

    Interesting idea, but we might have trouble finding CEO's if the company is yet to make a profit or even a loss where the CEO pays the company to work there ,i.e. 10% of -$200,000 is -$20,000. Maybe this would be an incentive for the CEO to make a profit... The bonus part sounds good as it is but the limit should be less than 10% maybe 5% or less tied to a sliding scale of total profit.

  • Report this Comment On October 03, 2009, at 10:43 AM, ripantuck wrote:

    This whole discussion reminds me of the the children's story about the Emperor who has no clothes. Executive Compensation is absolutely ridiculous. How can anyone be motivated when they can't possibly lose unless they violate the Law to such an extent that they go to jail.

    Executive compensation should be no more than 10 times the lowest paid person in the company, maybe only 5 times. If an executive wants to live an opulent lifestyle, it is easy. He/she simply buys stock or starts the company like Gates or Buffet and gets rich by making the company successful. No stock options for publicly traded companies' executives either.

    Executive compensation beyond a modest living salary merely invites, not mediocrity, but incompetency. Until this is understood by enough people, our corporations will continue to be run by incompetents. The banking crisis, I am afraid, is just the tip of the iceberg.

    I see absolutely no difference between non-owner corporate executives and lottery winners, except there is no lottery in the world that guarantees the amount of money and financial security, regardless of performance, to the extent that the average medium to large size corporation grants to top executives


    Don Clark

  • Report this Comment On October 03, 2009, at 12:23 PM, BWharam wrote:

    I believe that an “Opt-out” would be a better option than “Opt-in”, this would bring visibility to companies that do not want this information in the public view. Additionally; change the way that amendments are displayed on proxy statement, numerous time I have voted against amendments to “Adopt the new compensation policy for the board and executives” because other than digging through 200+ pages I have no way of knowing what that really means.

    Barry Wharam

  • Report this Comment On October 03, 2009, at 3:12 PM, dymty wrote:

    As the ratio between executive pay and labor has sky-rocketed, it's no wonder that the consumer has been slowly drowning in debt. If wages for honest working people had risen proportionately in the last 20 years, there may not have even been a need to reduce interest rates and create all the financing schemes that were cooked up just to get more people into homes. The consumer has been roundly blamed for this financial fiasco, but place blame where it's due: on the disparity between real wages for the working class and executive compensation. It should not be 525:1, as it was in 2000, nor should it be 319:1 as it was in 2008. The "Say on Pay" needs to bring some equity back to the working class so the consumer can actually consume AND have something left over to invest. Interest rates needn't have dropped to such rediculously low levels and the sub-prime lending practices needn't have been created because people would have been able to SAVE for a down payment and AFFORD their monthly mortgage payments. This is not rocket science. Executive pay has to be moved from the top of the balance sheet from 'Fixed Costs' to accurately reflect its influence on profits. 'Labor' is not the sole reason why a company can't post a profit. One can only squeeze so much from the bottom line until you end up in a recession or depression and double-digit unemployment.

    Phillip M. Zeuner

  • Report this Comment On October 03, 2009, at 9:10 PM, peters46 wrote:


    Thirty years ago I read that the ratio (until the 60's) used to be about 25 to one. Lowering the ratio back to 25-1 would not have solved/prevented the problems. In high school (over 40 yrs ago) someone asked our social studies teacher why there were poor people. Why not just give everyone a million? What would they do with the million? Outbid each other for the best cut of meat. Buy a brand new vehicle. A new house. New clothes. Except, who would sell them anything? Over 90% would think they could retire. Who would work in retail establishments? Who would work in factories? Who would fix your vehicle? Even at inflated prices, one would be hard put to find any of that. And for those who found that they could not afford steaks at $500/pound, and decided to go back to work, the inflation would remain. Their wages would be higher, but so would their expenses, providing no net increase in value. I do think it should be 25-30%. But the IRS tried to do something similar years ago - they decided that the company could only deduct the first million as expense (I'm relying on memory which hasn't been terribly good lately) except under certain circumstances (I believe goals had to be set and met - even if they were not real goals - and they were not real goals - read some of them).

  • Report this Comment On October 03, 2009, at 9:10 PM, matunos wrote:

    I say make "say on pay" votes binding... after all, the shareholders are the owners, right? You shouldn't need to amass 30% of a company's float before the board has to start listening to you. If the shareholders (most of whom will be represented by institutional investors) vote for bad executive pay policies, then the company will suffer. But that's what *ownership* is about.

    It's high time shareholders were allowed (indeed, *obligated*) to take an interest in the dealings of the companies they invest in, rather than hoping for a get-rich-quick passive investments in the stock market.

    I would support even more heavy-handed polices as well. For instance, disallow business deductions for any executive's compensation that goes over a certain multiple of the median employee's compensation.

  • Report this Comment On October 03, 2009, at 9:22 PM, peters46 wrote:

    Sorry, I meant it should be a ratio of 25-30. I kind of give up on any hope for use of say-on-pay if it passes. From over 90% of all comments I've seen on executive pay, most MF investors never vote on company elections - they never realized that most companies had REAL (not advisory) say on pay until the advisory thing was passed. As one non-MF investor told me, he didn't even have time to read it when it came in the mail, so he put it in File 13. And he is retired, doing a few volunteer hours a week for a charity, and putzing around the house. He had time - he just didn't want to tax his brain. Many others don't invest in stocks directly - they use mutual funds.

  • Report this Comment On October 07, 2009, at 9:11 PM, gayledon wrote:

    fastest way possible to get beauracrat quality ceo's. period!


    redondo beach CA

  • Report this Comment On October 08, 2009, at 12:46 PM, sbhesc5 wrote:

    Executives should not earn more than 20-1 ratio of the lowest paid employee's annual salary. J.P. Morgan said this years ago. I could see a 25-1 ratio but not the ridiculous amounts of today.

    Annual bonuses need to be tied to a specific measurement if the measurements are not met then the bonus is reduced just like my bonus in the company I work for is tied to a set of goals and measurements. Bonuses should be no higher than 20%.

    Golden parachutes should be abolished. Executives who are fired get no money other than unused vacation just like their employees.

    If all companies were required to do this then there would not be a need to give more than another company to retain a CEO.

    Anyone earning more than $750,000 has to pay social security again. Only this does not go to them it goes into the FICA fund to be used to offset the deficit coming. This will help limit pay and help to fix the Social Security fund.

    Shareholders should be limited to one vote for every 50 shares held; up to a max of 20 votes. This the funds get only 20 votes, the same as the person who has 1,000 shares.

  • Report this Comment On October 09, 2009, at 2:32 PM, megaroid wrote:

    The first issue is really determining exec pay. We read about pay/payouts that do not really reflect the pay - mainly the stocks and the silly methods they use to determine it's value. I think that stock awards (ISO or RSA etc.) should be reworked totally. Of course for exiting CEO's the payout may be known.

    In any case these final payouts should be scaled to the company and stock performance, and they should have a cap. How many CEO's sign an expense contract for their business that is open ended? They cannot, and pay should be done the same way. It would be pretty easy to publish some generic guidelines for different businesses and company size.

    Executives should have a severance arrangement, and not an overly crazy one. But this should not be allowed to be reworked under the guise of "not working for competitors etc.". The standard severance should exclude that - if they go to work for a competitor the severance goes away. Green and black mail must go. The severance should be agreed on hire and not allowed to change.

    The other item that I did not hear much on but needs to go is poison pills. With these in place companies remove competitive threats, thus allowing their pay to go where they want it. Outside firms/people cannot get on a board and change pay with takeover threats when these posion pills are in place.

  • Report this Comment On October 09, 2009, at 3:51 PM, atclmel wrote:

    I believe the Internal Revenue Code has (or had) a excessive compensation statute for small corporations with a cap on salary at $1 million. However the corporation could circumvent the statute by using comparable salaries of other similar size corporations.

    I suggest that all corporate executives salary be capped at a certain level, (say1 million) reviewed by Congress annually. The only way an executive could earn more than the capped amount would be if the corporation earned positive net income. They could then get a percent of the Net income on a laddered basis, eg. 1% of first $10 million, .05% of next $20 million etd.

    The compensation should include everything including salaries, deferred compensation, options, golden parachute, etc.

  • Report this Comment On October 09, 2009, at 8:14 PM, fromunder wrote:

    i would like to see the individual investor win a larger role in decisions,such as executive compensation.

    we may want to consider a method in which mutual fund participants would have a say as to how the managers of said funds vote.

  • Report this Comment On October 12, 2009, at 7:19 PM, moonbandito wrote:

    the unholy alliance between the board of directors, the compensation committee of the board of directors, and the executives HIRED to manage a corporation needs to be broken.

    The cozy relationship of interlocking 'compensation committees' and 'board members' must also be ended.

    Congress passed a constitutional amendment to insure that the members couldn't vote themselves a pay raise. Wonder why?

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