The thin edge of the wedge: 'say on pay' prompts a perusal of prerogatives and powers.

• Author: Kaback, Hoffer
• Position: QUIDDITIES

DIRECTORS & BOARDS readers likely have heard the catch-phrase "say on pay" (referring to an advisory vote by shareholders on executive comp).

In a blistering late February 2007 memorandum, Martin Lipton of Wachtell Lipton attacked say-on-pay and the push for new legislation as "another attempt ... to emasculate boards ... and empower activist shareholders to control all aspects of a corporation's business."

In a March 8 House hearing, John J. Castellani, president of the Business Roundtable, testified that "If we moved to a referendum system, fractured shareholder groups would subsequently campaign for or against ballot questions. Boards and CEOs would spend less time on planning, product development, and oversight and more time on meetings with advocacy groups and lobbyists."

Arguing the other way have been, among others, Harvard Law professor Lucian Bebchuk, who holds that "an expression of widespread shareholder dissatisfaction would provide a valuable signal to the board," and Stephen Davis of Davis Global Advisors, who believes that companies should have shareholder roadshows to discuss executive pay.

In order to have an informed view about say-on-pay, should not directors first possess some firm general convictions--based on an admixture of legal principles, analytical thinking, and practical boardroom experience--concerning the separation of powers between shareholders and the board?

At the extremes:

(a) While it is basic that they always have an up-or-down vote on mergers, it is integral to governance that shareholders are not empowered to initiate, or to negotiate, such transactions. The business judgment whether a transforming transaction like this is in the best interests of the corporation is, in the first instance, made by the board, acting alone. This is not a matter for Athenian democracy or plebiscite; otherwise, governance chaos would prevail.

(b) Whether or not to open a small office or distribution center in a foreign country is never a matter for shareholders. This is plain. Or is it? Well, suppose that, for moral reasons (that is to say, on the basis of moral beliefs subjectively embraced and trumpeted by "social activist investors"), the corporation's having a presence in that particular country is deemed objectionable. Such shareholders will also argue that, even beyond morality, it is bad business (and therefore bad business judgment exercised by the thoughtless directors) for the company to be in that country.

What...