What Should Shareowners Say on Pay?
By Holly Testa, Director, Shareowner Engagement
As income inequality continues to rise, outsized executive pay packages linked to short-term performance are being called into question. This was discussed at length during the recent Investing for Impact event First Affirmative hosted in San Francisco.
In 2011, the SEC (Securities and Exchange Commission) mandated that shareowners have a "say on pay"-the right to vote on executive compensation pay packages. What have we collectively done with this vote? Overwhelmingly shareholders have voted in favor of ever-increasing pay packages for the Chief Executive Officers of public companies, while average worker pay and market returns languish in comparison.
How Did We Get Here?
According to First Affirmative's Chief Economist, Mel Miller, disclosure of executive compensation has caused unintended consequences: "Nobody wants to be considered below average, and disclosure of peer pay has led to the 'Lake Woebegon effect'-a human tendency of overestimating our own abilities, achievements, and performance."
The Lake Wobegon effect is not limited to executives. The boards of directors responsible for crafting and approving CEO pay packages tend to think they have chosen well-that their CEO is above average! But, statistics clearly show that only a handful of companies have this coveted above average leadership in any given year. And higher pay at the top does not mean better returns for shareowners. In fact, research indicates that the CEO pay at high-paying companies may be negatively related to the company's future stock returns.
Shareowners and boards have a responsibility to determine the real value received by the company in exchange for the pay, as well as the unacceptable trade-offs that may result from getting this value proposition wrong. Excess pay at the top may mean inadequate compensation for other key employees, or it may mean underfunding of capital improvements and research.
Carol Bowie from Institutional Shareholder Services noted that while "Say on Pay" has not reigned in executive compensation, it would probably have been worse without the mandated disclosures, as the growth in the rate of pay increases in the last five years has slowed. She also noted a promising trend: "We have seen a tremendous rise in engagement between directors and investors, and this has spilled over to other issues of concern to investors."
Just Say No!
Danielle Fugere from As You Sow shared the results of the organization's second 100 Top Overpaid CEO publication which highlights the worst offenders and pay practices. Her response to the question of what should shareowners say on pay is very straightforward: "Shareholders should say NO, often and vigorously! We don't believe it's good for the economy or for economic growth to keep putting more and more money into the pockets of a very few people. It raises the cost of capital and reduces competitiveness."
Many asset managers working with responsible investors have stringent policies in place and vote against bloated pay packages. First Affirmative, for example, voted against 45% of pay packages at portfolio companies in 2015. But this is in stark contrast to the voting records of many institutional investors. In fact, as Fugere points out, "Some mutual funds have never met a compensation plan they did not like."
It is clear that how we value our "human capital" is broken across the whole spectrum, from the top paid executive to the lowest paid worker. While we collectively work on a solution, we will take Danielle's advice. We will say no, often and vigorously!
Posted: April 20, 2016