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Explaining the failure of say-on-pay

by Robert Teitelman | Published June 20, 2011 at 12:50 PM

It's really difficult to dislodge an orthodoxy once it has taken root. In its latest issue, Bloomberg Businessweek demonstrates that with a story on corporate governance and compensation, "Investor 'Say on Pay' is a Bust." On the level of news reporting, the story is fine, even if it does confirm a reality that has been the case for decades: Despite the new ability to vote on senior executive pay packages offered up by Dodd-Frank, shareholders (meaning large institutions) rejected comp plans at only 2% of public companies. Meanwhile, median pay jumped 35% to $8.4 million for Standard & Poor's top 500 CEOs. Institutional Shareholder Services recommended rejecting comp plans at 293 companies; instead, just 32 of 1,998 companies saw plans rejected. This is yet another failure of the corporate governance orthodoxy, and one would think it would inspire a fresh look at the simplistic alignment of interest that drives the theoretical mechanism of latter-day shareholder democracy. After all, institutions have never cared all that much about compensation for senior executives, which they view, at best, as not having much of an effect on share prices (and generally not caring about issues like unfairness or rising inequality), despite the labors of folks like Lucian Bebchuck. A million here or a million there doesn't matter to institutions if share prices are rising. And given the belief in the power of CEOs, institutions are loath to mess with pay. This is not just something that's happened; it's the reality of the situation since institutions became the major power bloc among shareholders 50 or so years ago. Indeed, the rise of compensation began with the ascension of power of the institutions, and the shift from stakeholder to shareholder governance.

Of course, that history is often buried beneath a more ahistorical argument that says shareholders are just dying to do the right thing -- on pay, on M&A, on monitoring companies generally -- but that they're blocked from doing so by entrenched managers and captive boards. The answer then to nearly every perceived corporate problem has been to open up the process and make it possible for shareholders to wield power, from easier nominations of board members to votes on matters like pay.

And yet institutions still won't toe the governance line. Given the power, they mostly ignore ISS recommendations and accept most pay packages. This raises the question: How should this be explained away, while still retaining the orthodoxy that suggests more power for shareholders will result in clearly beneficent outcomes? Businessweek offers up a fascinating variety. First comes the venerable Robert A.G. Monks, a corp gov pioneer and founder of ISS. He sputters, "Say-on-pay is at best a diversion and at worst a deception. You only have the appearance of reform, and it's a cruel hoax." Alas, Businessweek then drops Monks, who never explains why it's a diversion, a deception and a hoax. The charge hangs in the sky like a dark cloud without elaboration. It seems to be enough that Monks utters it.

Businessweek's second explanation focuses in on lobbying. "Some of the credit -- or blame -- goes to the Center on Executive Compensation," it writes. "The three-year-old center is an offshoot of the HR Policy Assn., a lobbyist on human resources issues for 300 of the largest companies, including Procter & Gamble and IBM." Businessweek says that the center "advised companies that received negative ISS recommendations to send rebuttals to shareholders and warned the nation's 100 biggest institutional investors about possible 'bias and errors' in proxy advisors' recommendations." Well, that is shocking. Some obscure but undoubtedly well-funded lobbyist outfit advises companies to -- defend themselves by sending rebuttals. Is that legal? How long is the reach of these dreaded lobbyists? Simply arguing that perhaps ISS is "biased" is enough to humble that powerful tribune of shareholder democracy. Moreover, the center also wrote a white paper recommending the Securities and Exchange Commission look into regulating the proxy advisers. A white paper!

Businessweek leaves the distinct impression that these actions are both sinister and somehow unfair to the sainted ISS, whose executive director, Patrick McGurn, gets to sputter like Monks about "K Street lobbyists." But consider this: If institutions are so prone to being gulled by "K Street lobbyists" (as CEOs are often presented as falling under the influence of malign investment bankers), why should they be fit to oversee corporate operations? Indeed, Lynn Turner, former chief accountant at the SEC and former managing director for research at Glass Lewis, ISS' major rival in proxy advisory, takes this a step forward and makes a charge that looks an awful lot like institutional self-interest verging on corruption: that mutual funds are afraid of voting against the companies for fear they'll lose their 401(k) business. Turner or Businessweek offer up no details to nail that charge. But you begin to get a sense of what the next step in governance will be: Institutions with "conflicts" need to be dealt with.

All this, of course, is crazy. This is not a defense of ultra-high and steadily rising CEO pay. It is exasperation at the refusal to acknowledge that "governance" is more complex than the ISS and Glass Lewis crowd presents it. Businessweek steadfastly ignores the long historical pattern of institutional passivity and, like the governance crowd itself (with its own large self-interest in these matters) reels off any number of excuses and explanations, each of which avoid the heart of the matter. Shareholder democracy deserves a more searching examination than this, from both the industry and the media. - Robert Teitelman

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