'Say on pay': What the market thinks: we did the 'reaction' calculations to the passing of legislation and related shareholder-sponsored proposals.

• Author: Walkling, Ralph A.
• Position: EVIDENCE AND PERSPECTIVES

BOTH PRESIDENTIAL candidates support what has been termed "say on pay." In general, say on pay gives shareholders an advisory vote on CEO compensation. Heated arguments have been made on both sides of the issue, yet to date there is little actual evidence about the market's reaction to say on pay.

You can imagine three possible outcomes of say on pay legislation.

First, it's possible that the initiative could create value by better aligning the interest of owner and managers.

Second, since the vote is advisory only, it could have little impact on firm value. Firms need not take any action regardless of the outcome. Academic research generally finds little market reaction to advisory vote initiatives.

Third, the legislation could be disruptive. A strong case can be made that the authority for executive compensation must remain inside the boardroom and that attempts to alter this authority will destroy value. Recently, the chairman of DIRECTORS and BOARDS, Robert Rock, wrote eloquently about say on pay, making this very point: "Should shareholders have the right to an advisory vote on executive compensation? With the exception of where pay is egregious, I don't think so." ["Say on Pay Is a Populist, but Misguided, Notion," Third Quarter 2008.]

In a recent Drexel University working paper, "Shareholders' Say on Pay: Does It Create Value?" (available at http://papers. ssrn.com/sol3/papers.cfm?abstract id= 1030925) my co-author, Jie Cai, and I examine the market's reaction to current say on pay legislation and related shareholder-sponsored initiatives. Here are some of our results.

On April 20, 2007, the House passed the Shareholder Vote on Executive Compensation Act (H.R. 1257) by a two-to-one margin. The same day, Barack Obama introduced a companion bill in the Senate. Neither bill limits CEO pay but requires a non-binding shareholder vote on executive compensation.

To examine the market's reaction to the say on pay legislation, we calculated risk-adjusted rates of return for over 1,200 firms ranked by level of "abnormal" CEO compensation. Our results indicate that, after controlling for market movements and other confounding factors, firms with the highest level of unexplained CEO compensation and lowest pay for performance experienced significantly positive returns when the bill passed the House. This result is consistent with the market believing that say on pay legislation improves value for these firms. It is also consistent with Robert...