"Say on pay" is coming: boards should act now to prepare for "say on pay.".

• Author: Raymond, F.Douglas, III

Since first reaching prominence in the landscape of corporate governance in 2006, "say on pay" initiatives have been steadily gaining momentum. Last year, over 100 publicly traded companies included in their proxy statements proposals they had received from shareholders seeking to obtain, at the annual meeting of shareholders, an advisory vote on the compensation of the executive officers. Pending federal legislation, if passed, would require all publicly reporting companies to adopt "say on pay" initiatives. In addition, it appears increasingly likely that the Securities and Exchange Commission will independently adopt similar requirements in the near future. If they haven't already done so, directors should begin to prepare for these initiatives.

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The "Say on Pay" Dilemma

With some justification, shareholders have become increasingly skeptical about the compensation paid to corporate officers. Their compensation is set by the board of directors, who often have close relationships with the officers, without any direct input from the shareholders and often with little or no real negotiation between the board and the executives. The traditional opposition of interests in third party negotiations is often muted in these friendly negotiations, to the benefit of the executive. The primary purpose of a "Say on Pay" initiative is to give the company's shareholders a clear voice with regard to the compensation of the company's executive officers and so to provide a brake on what some shareholders see as excessive compensation practices. Companies that adopt a "Say on Pay" initiative typically give shareholders an advisory, non-binding vote on executive compensation at the annual meeting of the shareholders.

Although the vote is non-binding, it nonetheless can be very influential if the company has also adopted majority voting requirements for directors, as has been the case with many companies. These majority voting requirements generally provide that, in an uncontested election of directors, a director is not elected if he or she does not receive a majority of the total number of votes cast.

A "Say on Pay" vote, in combination with a typical majority voting procedure, can become a very potent mechanism for shareholder action. If the shareholders, in a "Say on Pay" ballot, disapprove of the compensation of the company's executive officers, and the company does not thereafter change its compensation practices, the likely...