Say on pay in the Dodd-Frank Act: implications of the results in the United Kingdom.

• Published date: 22 March 2012
• Author: Huddleston, Tyler
• Date: 22 March 2012

I. INTRODUCTION

The financial crisis in the United States that began in 2008 (1) spurred public outcry over what was perceived to be excessive executive compensation at a time when the economy was performing poorly. (2) Special interest was paid to the poor performance of firms in the banking and financial services industries that were believed to be largely responsible for the crisis. (3) In response, Congress drafted legislation to heighten regulation of the financial services industry and increase reporting requirements for public corporations. The product of their work, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"), was signed into law by President Obama on July 21, 2010. (4) In addition to heightened regulation of the finance industry, (5) the Dodd-Frank Act included corporate governance provisions requiting all public companies to adopt so-called "say on pay" provisions. (6) These say on pay provisions require public corporations listed on U.S. stock exchanges to allow shareholders to cast a nonbinding vote indicating their approval or disapproval of the executive compensation plan at least once every three years. (7)

Corporate governance issues within the United States, especially regarding executive compensation, have long been subjects of interest for scholars, the media, and the public at large. (8) Advocates for say on pay around the world have historically argued that it would help curb excessive executive compensation during times of poor company performance and increase dialogue between shareholders and the board of directors. In particular, it would suggest the appropriate level of executive compensation from a shareholder's perspective given company performance. (9) Say on pay provisions are growing in popularity internationally and types of say on pay provisions similar to the Dodd-Frank Act have been instituted in a number of countries around the globe. (10) In the United Kingdom, similar say on pay provisions have been in place since 2002. (11)

This Note analyzes the say on pay provisions in the Dodd-Frank Act and offers opinions as to whether it will be effective. Part II lays out the history of say on pay in the United Kingdom, the specific terms of the regulations, and the effect of the U.K. regulatory scheme following its enactment. Part III discusses the say on pay regulations enacted in the United States under the Dodd-Frank Act, compares the terms of the United State's regulations to the U.K. regulations, and addresses the projected effectiveness of the Dodd-Frank Act in the United States. Part IV concludes that the Dodd-Frank Act say on pay regulations appear to meet the goal of allowing for increased accountability of executive compensation via shareholder engagement, though only time will tell if the application of the regulations fulfills its promise.

II. SAY ON PAY IN THE UNITED KINGDOM

The United Kingdom provides a helpful comparison to the U.S. regulatory scheme for say on pay. This Part explores the history, terms, and results of the U.K. say on pay regulations.

A. History

In the United Kingdom in the 1990s, national attention focused on stories of newly privatized utility companies granting executives significantly increased salaries for performing the same job duties as before the privatization. (12) The press also focused on executives' receipt of increased salaries in other industries. (13) What made the increased salaries especially newsworthy was that they happened at a time when significant layoffs were also occurring. (14)

In response to the public outcry, the United Kingdom passed the Combined Code on Corporate Governance ("Combined Code") in 1998. (15) The Combined Code required public companies (16) to comply with the Combined Code or explain noncompliance with its requirements. The Combined Code also required companies to consider and record their decision to seek shareholder approval of the company's remuneration policies on an annual basis. (17)

The Combined Code, however, had limited effect, (18) and changes were necessary. Because of salary escalation, economic troubles, and golden parachute payments to dismissed CEOs during the late 1990s and early 2000s, in 2002 the United Kingdom drafted an amendment to the U.K. Companies Act, the Directors Remuneration Report Regulations ("DRR Regulations"). (19) The DRR Regulations required an increased level of detail in company disclosure to shareholders as well as a new advisory vote by the shareholders on the Directors' Remuneration Report ("DRR"). (20)

B. Regulatory Requirements

The DRR has to include specific disclosure of the types of compensation paid to senior executives in addition to a statement of the company's overall compensation policy. (21) The statement must include an analysis of a company's performance compared to its peers and must be signed by remuneration committee members. (22) The remuneration committee is a committee made up of members of the board of directors for the company, and its responsibility is to oversee remuneration issues at the firm, including the DRR. (23) The quantitative compensation elements of the DRR are required to be independently audited. (24)

There is a mandatory vote on the DRR by shareholders for every public company. (25) However, the results of the vote are nonbinding on the actions of the company, meaning the company technically suffers no repercussions or adverse effects if the shareholders vote a disapproval of the DRR. (26) Nonetheless, if a board fails to satisfy the requirements mandated under the DRR, its directors are guilty of an offense punishable by a fine. (27)

C. Say on Pay Results

Proponents of these say on pay measures in the United Kingdom have claimed the disclosure requirements under the DRR to be a success. (28) The first successful vote of "no" under DRR occurred at GlaxoSmithKline in the first year of the new regulation requirements. (29) In that case, the Chief Executive Officer's severance package included a very large golden parachute payment that angered the shareholders and led them to vote "no." (30) However, outright rejections of DRRs occurred very rarely following the enactment of the legislation in 2003 (31) until 2009. (32) In 2009, following the economic downturn of 2008, five companies received rejections of DRRs and a number of others were close to rejection. (33) In 2010, three companies had their DRRs rejected by shareholders. (34)

Interestingly, observers partially attribute this low number of rejections of DRRs to the existence of the say on pay legislation itself. (35) The existence of the legislation has increased dialogue between corporate boards and management and large shareholders, as corporations do not wish to have the increased public scrutiny of a successful "no" vote. (36) Because of companies' aversion to receiving "no" votes, they are more receptive to discussing compensation plans with shareholders before and after changes are made. (37)

As an additional effect, the influence of institutional investor associations (38) has greatly increased. Institutional investor associations have introduced guidelines which provide a recommendation to shareholders for how they should vote based on a company's adherence to the guidelines. (39) The guidelines have become widely used. (40) In essence, shareholders are taking their cues on whether to vote "yes" or "no" directly from the institutional investor association's comments on how well the company is conforming to the guidelines created by the institutional investor association. (41)

Moreover, the prevalence of long-term guaranteed contracts for executives has decreased, likely because companies do not want to appear to "pay for failure." In such cases, although company performance has been poor, an executive receives large amounts of compensation because the employment contract guaranteed the amount of compensation for multiple years regardless of company performance. (42) Companies have also decreased the amount of stock options awarded to executives and increased the amount of long-term incentive plan awards. (43)

Additionally, the U.K. government views the say on pay provisions as providing a competitive advantage to their capital markets for two reasons. (44) First, from a public relations standpoint, such measures serve as a message that the government wants to deter excessive executive compensation. (45) Second, international investors are attracted to their capital markets because of the increased influence over a company that say on pay provides to investors. (46)

While there has been substantial anecdotal information and opinion surveys gathered regarding the success of the legislation, (47) the empirical evidence tells a somewhat different story. The empirical studies offer evidence that the institution of say on pay has decreased "pay for failure" instances, (48) but the actual rate of pay for executives has continued to increase steadily, even after the implementation of say on pay measures by the United Kingdom. (49)

Ultimately, while there have been some unexpected developments as a result of say on pay, such as increased institutional investor influence and a relatively low number of shareholder rejections, the effects of the legislation have been largely positive.

III. SAY ON PAY IN THE UNITED STATES

In the United States, the Dodd-Frank Act has created a requirement for a nonbinding shareholder vote on executive compensation for public corporations similar to the DRR in the United Kingdom. (50) Interest in say on pay in the United States existed before the passage of the Dodd-Frank Act, with a number of companies voluntarily adopting say on pay provisions prior to the passage of Dodd-Frank Act. (51) Additionally, say on pay provisions already existed for firms receiving federal aid under the Troubled Asset Relief Program ("TARP")...