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:
- The bill would establish an annual shareholder vote to approve the compensation of executive management.
- 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 [email protected]. 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.
