In our paper, Say Pays! Shareholder Voice and Firm Performance, which was recently made publicly available on SSRN, we estimate the effect of increasing shareholder “voice” in corporations through a new governance rule that provides shareholders with a regular vote on pay: Say on Pay. Say on Pay policy is an important governance change mandated by the Dodd-Frank Act that provides shareholders with a vote on executive pay. It is part of a general trend toward more CEO accountability and increased shareholder rights. Shareholders may use this new channel to voice their discontent regarding the link between pay and performance. This new policy is at the forefront of the debate on executive pay and its efficacy to deliver firm performance.
However, so far it has been difficult to assess its economic impact. Its mandatory imposition is not useful to identify its effects, as it is mandated together with other changes in governance practices at the firm level. Moreover, prior voluntary adoption of Say on Pay is an endogenous decision of the firm and is correlated with firm characteristics. To overcome these difficulties, we use a regression discontinuity design on the outcomes of shareholders’ proposals to adopt a Say on Pay policy. This allows us to deal with the presence of prior expectations and estimate the causal effect of adopting the policy. We first show that adopting Say on Pay generates value for shareholders. Say on Pay proposals that pass yield, on average, an abnormal return of 2.7 percent relative to ones that fail on the day of the vote. This positive market reaction delivers a cumulative abnormal return of 5 percent one week after the vote. We can estimate the actual value of a Say on Pay proposal, which ranges from 5.4 percent to 7.2 percent of firm value. This is an economically sizable effect, which may arise through different potential channels.
The declared role of Say on Pay proposals is to improve CEO pay policies of firms. As such, these policies may affect firm value through better designed pay policies that motivate CEOs more efficiently. Moreover it may also help curb excessive pay, generating cost savings for the firm. Finally, the policy lowers the shareholder cost of expressing dissent, and therefore makes monitoring by shareholders more attractive and effective. We explore the relative relevance of all of these mechanisms that could potentially be behind the shareholder reaction to the implementation of Say on Pay. We find that firms that pass Say on Pay display stronger performance outcomes. CEOs seem to be reacting to having a provision in place by providing shareholders with better EPS marks, stronger profitability, and higher Tobin’s Q. We also find better productivity ratios and reductions in costs. In short, Say on Pay provisions lead to stronger firm performance.
Regarding the effect of Say on Pay on the level of compensation, we find no effect on the total CEO compensation for firms that pass the policy. In terms of the composition of pay, we do observe a decrease in the fixed salary component and an increase in the variable component of pay. Despite finding small effects on CEO pay, we cannot rule out that part of the performance effects are due to adjustments in the pay structure that provide better incentives. It is important to note that the adjustments of the pay packages may be heterogeneous across firms. Even if there is room for improvement in CEO pay packages, there may not be systematic deviations across firms. If each firm requires a different treatment, this would induce small and imprecise estimates of the effect of Say on Pay.
Our results are consistent with viewing Say on Pay policy as resembling an annual confidence vote in which shareholders approve or reject the CEO’s performance relative to pay. This empowers shareholders, who have a new costless mechanism through which they can punish a CEO for poor performance. Overall, our results suggest that CEOs are performing better due to the increase in shareholder monitoring and potentially due to better alignment of incentives. As a result, they may be able to justify total levels of pay that do not differ substantially from their previous ones.
The full paper is available for download here.