Posts Tagged ‘Fabrizio Ferri’

Shareholder Votes and Proxy Advisors: Evidence from Say on Pay

Posted by Fabrizio Ferri, Columbia University, on Thursday October 31, 2013 at 9:12 am
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Editor’s Note: Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. An earlier version of the empirical study mentioned in this post was previously discussed on the Forum here.

In our paper, Shareholder Votes and Proxy Advisors: Evidence from Say on Pay, which was recently accepted for publication at the Journal of Accounting Research, my co-authors (Yonca Ertimur of the University of Colorado at Boulder and David Oesch of the University of St. Gallen) and I examine the economic role of proxy advisors. As non-binding shareholder votes have come to increasingly affect firms’ governance practices, there has been growing interest in understanding the value of proxy advisors’ recommendations, a key driver of shareholder votes.

To shed light on this question, we follow the entire process surrounding proxy advisor activities and examine the analyses underlying proxy advisor recommendations, how firms, stock prices and voting shareholders respond to the release of these recommendations, firms’ reactions to the votes triggered by them and, ultimately, whether they have an impact on firm value. The setting we use for our examination is based on the analyses provided by the two most influential proxy advisors, Institutional Shareholder Services (ISS) and Glass Lewis & Co. (GL) to arrive at voting recommendations for the non-binding shareholder vote on executive pay mandated by the Dodd-Frank Act in 2010, commonly known as say-on-pay (SOP).

…continue reading: Shareholder Votes and Proxy Advisors: Evidence from Say on Pay

Shareholder Votes and Proxy Advisors

Posted by Fabrizio Ferri, Columbia University, on Monday April 9, 2012 at 10:17 am
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Editor’s Note: Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. Work from the Program on Corporate Governance about executive compensation includes the book Pay without Performance and the article Paying for Long-Term Performance, both by Bebchuk and Fried.

In the paper, Shareholder Votes and Proxy Advisors: Evidence from Say on Pay, which was recently made publicly available on SSRN, my co-authors (Yonca Ertimur of Duke University and David Oesch of the University of St. Gallen) and I examine the analyses underlying the voting recommendations issued by Institutional Shareholder Services (ISS) and Glass Lewis & Co. (GL), the two most influential proxy advisors, for the non-binding vote on executive pay mandated by the Dodd-Frank Act, also known as “say on pay” (SOP). We then investigate the effect of these recommendations on shareholder votes, stock prices and firm’s behavior. Due to the complex and highly firm-specific nature of executive compensation, mandatory SOP votes provide an especially powerful setting to examine the analyses performed by proxy advisors and their impact.

Our analysis of the SOP-related part of the ISS and GL proxy reports for S&P 1500 firms in 2011 shows that both advisors provide a quantitative and qualitative examination of the executive pay plan (structured around certain categories, e.g. pay for performance, disclosures), assign a rating for each category and issue a final voting recommendation (For or Against). ISS issues Against recommendations for 11.3% of the firms and GL for 21.7%, suggesting a more aggressive stance by GL. The difference also reflects the different approaches ISS and GL follow in assessing the “pay for performance” category, a key driver of the final recommendation, with ISS focusing its analysis of pay practices mostly on poorly performing firms. Firms receiving an Against from ISS are not a subset of those receiving an Against from GL. Rather, among firms with potentially questionable executive compensation practices (i.e. firms with an Against from at least one proxy advisor), ISS and GL agree on which firms warrant an Against only in 17.9% of the cases. We interpret this as evidence that the complex nature of SOP has allowed proxy advisors to differentiate themselves from each other. Additional analysis suggests that neither proxy advisor applies a “one-size-fits-all” approach in evaluating the compensation plans for the 2011 proxy season. Specifically, there are numerous cases where the proxy advisors identify similar controversial provisions yet issue different recommendations, based on firm-specific circumstances and other elements of the pay plan.

…continue reading: Shareholder Votes and Proxy Advisors

Say on Pay Votes and CEO Compensation

Posted by Fabrizio Ferri, Columbia University, on Monday February 20, 2012 at 10:15 am
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Editor’s Note: Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. Work from the Program on Corporate Governance about executive compensation includes the book Pay without Performance and the article Paying for Long-Term Performance, both by Bebchuk and Fried.

As we begin to analyze the first proxy season under “say on pay” in the US, it may be useful to review the evidence from the UK experience with say on pay. In the study, Say on Pay Votes and CEO Compensation: Evidence from the UK, co-authored with David Maber of University of Southern California and forthcoming in the Review of Finance, we examine the impact of “say on pay” in the UK, the first country to adopt a mandatory, non-binding annual shareholder vote on executive pay.

We perform three sets of analyses. First, we examine the market reaction to the (largely unanticipated) announcement of say on pay regulation and find positive abnormal returns for firms with weak penalties for poor performance, e.g. firms with excess CEO pay combined with poor performance and firms with generous severance contracts, which can weaken penalties in the event of poor future performance.

…continue reading: Say on Pay Votes and CEO Compensation

Reputation Penalties for Option Backdating and the Role of Proxy Advisors

Posted by Fabrizio Ferri, Columbia University, on Wednesday December 28, 2011 at 9:51 am
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Editor’s Note: Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. Work from the Program on Corporate Governance about executive compensation includes the book Pay without Performance and the article Paying for Long-Term Performance, both by Bebchuk and Fried.

In the paper Reputation Penalties for Poor Monitoring of Executive Pay: Evidence from Option Backdating, forthcoming at the Journal of Financial Economics, my co-authors (Yonca Ertimur of Duke University and David Maber of the University of Southern California) and I examine whether directors are held accountable for poor monitoring of executive compensation.

Theoretical and empirical work suggests that outside directors incur reputation penalties in the director labor market for poor monitoring. However, it is unclear whether these penalties extend to poor monitoring of executive pay. A widely held view—articulated by Prof. Bebchuk and Prof. Fried in their book Pay without Performance—is that there is little or no accountability for excessive or abusive pay practices. Yet no study has empirically examined this question. Part of the reason is the difficulty of defining and identifying “poor monitoring” with respect to executive pay. In most cases, pay levels and structures can be justified on economic grounds (e.g. retention, incentives, attraction of talent) and with reference to the behavior of peer firms. Unless these practices are perceived as clearly “outrageous,” it is unlikely that directors will be concerned about reputation costs. Opacity in pay disclosures makes it even more difficult to assess the quality of pay practices.

…continue reading: Reputation Penalties for Option Backdating and the Role of Proxy Advisors

Does the Director Election System Matter?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday August 22, 2011 at 9:28 am
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Editor’s Note: The following post comes to us from Yonca Ertimur of the Department of Accounting at Duke University and Fabrizio Ferri of the Department of Accounting at Columbia University.

In our paper, Does the Director Election System Matter? Evidence from Majority Voting, which was recently made publicly available on SSRN, we examine the economic consequences of a change in the director election system, namely, the switch from a plurality voting to a majority voting standard.

Under a plurality voting standard—until recently the default arrangement under most state laws—the candidate with the most votes “for” is elected, a system that helps avoid the disruptive effects of failed elections. In uncontested elections, the plurality voting standard means that each nominee will always be elected as long as she receives one vote “for,” irrespective of the number of votes “withheld” (under SEC rule 14a-4(b) shareholders cannot vote “against” a director nominee, they can only vote “for” or “withhold” support).

Under a majority voting (MV) standard, instead, even in uncontested elections a director would not be elected unless the majority of votes were cast in her favor. Starting in 2004, firms have begun to adopt some form of MV standard, often in response to non-binding shareholder proposals filed by activists and policy makers have debated whether to mandate a MV standard. By the end of 2007, about two thirds of the S&P 500 firms had adopted some form of MV.

…continue reading: Does the Director Election System Matter?

Reputation Penalties for Poor Monitoring of Executive Pay

Posted by Fabrizio Ferri, Columbia University, on Wednesday August 11, 2010 at 9:07 am
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Editor’s Note: Fabrizio Ferri is an Assistant Professor of Accounting at the New York University Stern School of Business.

In the paper Reputation Penalties for Poor Monitoring of Executive Pay: Evidence from Option Backdating, which was recently made publicly available on SSRN, my co-authors (Yonca Ertimur of Duke University and David Maber of the University of Southern California), and I examine whether directors are held accountable for poor monitoring of executive compensation.

Theoretical and empirical work suggests that directors suffer reputation penalties in the director labor market for poor monitoring. However, it is unclear whether these penalties extend to poor monitoring of executive pay. A widely held view—articulated by Prof. Bebchuk and Prof. Fried in their book Pay without Performance—is that there is little or no accountability for excessive or abusive pay practices. However, no study has empirically examined this question. Part of the reason is the difficulty of defining and identifying “poor monitoring” with respect to executive pay. In most cases, pay levels and structures can be justified on economic grounds (e.g. retention, incentives, attraction of talent) and with reference to the behavior of peer firms. Unless these practices are perceived as clearly “outrageous,” it is unlikely that directors will be concerned about reputation costs. Opacity in pay disclosures makes it even more difficult to assess the quality of pay practices.

…continue reading: Reputation Penalties for Poor Monitoring of Executive Pay

Shareholder Activism, Say on Pay and Executive Compensation

Posted by Fabrizio Ferri, Columbia University, on Monday August 31, 2009 at 11:15 am
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Editor’s Note: This post is by Fabrizio Ferri of the NYU Stern School of Business.

Executive pay is taking center stage in the governance reform debate, with significant attention given to a proposal to mandate an annual advisory shareholder vote on the executive compensation report, known as “say on pay,” following the example of United Kingdom (U.K.). I have recently completed two studies examining this proposal—the first considers the impact of “say on pay” in the U.K., and the second analyzes the effect of mechanisms currently available to U.S. investors to influence executive pay (i.e. shareholder proposals and vote-no campaigns).

In the first study, co-authored with David Maber of University of Southern California, Say on Pay Votes and CEO Compensation: Evidence from the UK, we perform two sets of tests. First, we examine UK firms’ responses to say on pay votes by analyzing the changes to compensation policies made by firms after facing high voting dissent against their remuneration report. We document that a significant number of these firms removed or modified provisions that investors viewed as “rewards for failure” (e.g., generous severance contracts, low performance hurdles, provisions allowing the retesting of performance conditions)—often in response to institutional investors’ explicit requests—and established a formal process for proactive consultation with their major shareholders going forward. These actions paid off, in that voting dissent at the subsequent annual meeting was substantially lower. We also find evidence of similar actions taken before the vote by a subset of firms that subsequently experienced low voting dissent, suggesting that the threat of a vote induced some firms to revise CEO pay practices ahead of the annual meeting.

Second, we examine the trend in CEO pay and its sensitivity to economic determinants before and after the introduction of say on pay for a large sample of UK firms. We find no evidence of a change in the level and growth rate of CEO pay—after controlling for firm performance, size and other factors. However, we find a significant increase in the sensitivity of CEO pay to poor performance. The increase is most pronounced in (i) firms with high voting dissent, and (ii) firms with an ”excessive” level of CEO pay (relative to the level predicted by its economic determinants) before the adoption of say on pay, regardless of the voting dissent. Interestingly, we do not find a more pronounced increase in firms with higher raw levels of CEO pay. These findings confirm the insights from our small-sample evidence of explicit changes to pay contracts and suggest the following: (i) UK investors used say on pay to push for greater accountability for poor performance; (ii) firms responded to adverse shareholder votes, in spite of their non-binding nature; (iii) (at least some) firms responded to the threat rather than the realization of an adverse vote; (iv) shareholders focused on firms with controversial CEO pay packages (as captured by high voting dissent or excessive CEO pay levels) rather than firms with high (but not abnormal) CEO pay levels.

In the second study Shareholder Activism and CEO Pay, coauthored with Yonca Ertimur of Duke University and Volkan Muslu of the University of Texas at Dallas, we examine a comprehensive sample of 1,332 compensation-related shareholder activism events over the 1997-2007 period (134 vote-no campaigns and 1,198 shareholder proposals). We find that, in targeting firms, activists take both the ”predicted” and ”excess” components of CEO pay into consideration. In other words, activists (particularly institutional investors) appear sophisticated enough to identify excess CEO pay firms, but they also target firms with high (but not abnormal) levels of CEO pay, perhaps to bring greater visibility to their initiatives or because of concerns with social equity. Voting support for compensation-related proposals, in contrast, is higher in firms with excess CEO pay but not in firms with high (but not abnormal) CEO pay, suggesting that shareholder votes reflect a sophisticated understanding of CEO pay figures. Voting patterns depend on the type of shareholder proposal. In particular, proposals aimed at affecting the pay setting process (e.g., proposals requesting shareholder approval of certain compensation items)—which we label Rules of the Game proposals—receive the highest voting support, often resulting in majority votes. Support for proposals aimed at influencing the output of the pay setting process (e.g., proposals to use performance-based vesting conditions in equity grants)—which we label Pay Design proposals—is lower but has been increasing in recent years. Proposals directed at shaping the objective of the pay setting process (e.g., proposals to link executive pay to social criteria or to abolish incentive pay)—labeled Pay Philosophy proposals and mostly filed by individuals and religious funds—have consistently received little support. The rate of implementation for pay-related proposals is generally low (5.3%) but increases substantially for proposals receiving a majority vote (32.2%) most of which are Rules of the Game proposals. With respect to the overall effect on CEO pay, we document a $7.3 million reduction in excess CEO pay for firms targeted by vote-no campaigns, corresponding to a 38% decrease in CEO total pay. As for shareholder proposals, we find evidence of a moderating effect on CEO pay—a $2.3 million reduction—only in firms targeted by Pay Design proposals sponsored by institutional proponents in recent years.

What do these studies tell us about the potential impact of “say on pay” in the U.S.? While drawing policy implications requires caution, a few lessons can be learned. First, there is no indication that special interest groups pushing for radical changes have hijacked shareholder votes in the U.K. or the U.S.—a concern expressed by critics of say on pay. U.S. shareholders have systematically rejected proposals trying to micromanage executive pay and supported those that ask for a say on the pay process. Similarly, U.K. shareholders have shied away from opining on pay levels and focused instead on strengthening the link between pay and performance by imposing certain rules of the game (e.g., no retesting of performance conditions). Second, in both countries, investors use their voting power in a moderate and sophisticated manner, raising their voice only at few firms with controversial pay practices and suspiciously high pay levels. Fears that many firms would face massive chaos and revolts at annual meetings have not materialized. Third, while both in the U.S. and the U.K. boards do listen to shareholder votes, even if advisory, say on pay votes and vote-no campaigns are more effective in getting boards’ attention than shareholder proposals. A say on pay vote against the remuneration report (or votes withheld from a director) greater than 20% usually prompts a firm’s response. In contrast, shareholder proposals have a reasonable (but still low) chance to be implemented only if they win a majority vote. This difference is not surprising. Vote-no campaigns and say on pay directly question directors’ performance and, thus, affect their reputation. In addition, unlike shareholder proposals, they enable shareholders to express their general dissatisfaction with CEO pay rather than with a single problem and do not require an ex ante agreement on the solution. As such, they may force a broad dialogue between investors and boards on all aspects of CEO pay, without putting shareholders in the difficult position to micromanage specific and technically complex aspects of CEO pay through a 500-word “yes or no” proposal. The fourth lesson is that the U.K. experience with say on pay indicates that boards try to prevent an adverse voting outcome through ex ante consultation with institutional investors and that enhanced communication is crucial for boards to “interpret” the say on pay vote.

Overall, these factors suggest that concerns with say on pay may have been exaggerated. Say on pay may be as effective as vote-no campaigns in causing boards to listen and act, and with an added benefit. Specifically, say on pay may allow greater activism by those institutional investors concerned with CEO pay but reluctant to compromise their relation with boards by engaging in vote-no campaigns and voting against the re-election of otherwise valuable directors.

However, a number of caveats are in order, particularly in drawing inferences from the experience of a different country with its own governance environment. First, for say on pay to work investors must have something to say in the first place. In the U.K., institutional investors have developed and agreed upon (and continue to update) a set of guiding principles, or “best practices,” on executive remuneration, complementing the principles in the Combined Code. Under the U.K. “comply or explain” governance model, these best practices provide firms and shareholders with a clear benchmark against which to make assessments of pay practices. In addition, concentrated institutional ownership has led to a relatively high level of engagement which also allows for firm-specific adjustments of these best practices. It is not clear whether institutional investors in the US will take such a proactive role or outsource it to proxy voting services, which may be tempted to adopt “cheap” one-size-fits-all solutions, as cautioned by Jeffrey Gordon of Columbia Law School in a piece in the Harvard Journal on Legislation. In addition, higher concentration and stability of institutional ownership may make communication with boards easier in the U.K. Second, in the U.K. it is generally easier for investors to replace directors, thereby making directors more responsive to shareholder pressure (though the trend toward majority voting and proposed proxy access legislation may make the threat of replacement stronger in the U.S.). In view of these and other caveats, proposals to limit mandatory say on pay to large firms may be a sensible first step (after all, our studies show that most compensation-related activism is focused on the largest firms).

A final word of caution: in the heat of the reform debate, say on pay has often been used in the same sentence as excessive risk-taking to suggest that an advisory shareholder vote would lead to compensation packages that discourage excessive risk-taking. Such a statement is incorrect. Say on pay is a neutral tool that shareholders will use (if they decide to use it) to influence compensation practices in a way consistent with their objectives. The risk-taking profile desired by shareholders may very well differ from the level of risk-taking that regulators may deem optimal for the economy. Similarly, say on pay should not be expected to be a tool to deal with wealth inequality. After all, shareholders have long supported compensation packages that have encouraged risk-taking and resulted in higher compensation levels.

The Impact of Shareholder Activism on Financial Reporting and Compensation: The Case of Employee Stock Options Expensing

Posted by Fabrizio Ferri, Columbia University, on Thursday November 20, 2008 at 2:41 pm
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Editor’s Note: This post is by Fabrizio Ferri of the NYU Stern School of Business.

In our paper forthcoming in The Accounting Review, “The Impact of Shareholder Activism on Financial Reporting and Compensation: The Case of Employee Stock Options Expensing,” my co-author Tatiana Sandino and I examine the economic consequences of more than 150 shareholder proposals to expense employee stock options (ESO) submitted during the proxy seasons of 2003 and 2004. This was the first instance where the SEC allowed a shareholder vote on an accounting matter. Activists had argued that lack of ESO expensing had led to an excessive use of option-based compensation.

Under the current legal regime, shareholder proposals are typically non-binding, raising the question of their real economic consequences. Overall, our findings reveal an increasing influence of shareholder proposals on governance practices.

With respect to accounting choices, we find that firms targeted by ESO expensing proposals were significantly more likely to subsequently adopt ESO expensing relative to a control sample of S&P 500 firms, particularly when the proposals received a high degree of voting support. We also find that non-targeted firms were more likely to adopt ESO expensing when a peer firm was targeted by an ESO expensing shareholder proposal, suggesting the presence of spillover effects of this shareholder initiative.

…continue reading: The Impact of Shareholder Activism on Financial Reporting and Compensation: The Case of Employee Stock Options Expensing

Board of Directors’ Responsiveness to Shareholders

Posted by Fabrizio Ferri, Columbia University, on Friday July 25, 2008 at 1:01 pm
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Editor’s Note: This post is from Fabrizio Ferri of Columbia University.

In a recent working paper entitled Board of Directors’ Responsiveness to Shareholders: Evidence from Shareholder Proposals, Yonca Ertimur, Stephen Stubben and I investigate the frequency, determinants and consequences of boards’ responses to advisory shareholder proposals. Our sample consists of 620 non-binding, MV shareholder proposals between 1997 and 2004.

In recent years, there has been a significant increase in shareholder activism through shareholder proposals submitted for a vote at the annual meeting. Proposals pushing for the adoption or removal of certain governance features (e.g. classified boards, poison pills) are filed by activists in record numbers every year and, in spite of boards’ opposition, sometimes they win a majority vote. Boards face a tough decision. While shareholder votes on these proposals are advisory, ignoring them may have negative consequences, particularly if the proposal wins a majority vote. Directors failing to implement majority-vote (MV) proposals are often the target of “vote-no” campaigns and receive a “withhold vote” recommendation by ISS. Firms ignoring MV proposals end up on CalPERS’ “focus list”, receive lower ratings from governance services and attract negative press coverage. On the other hand, if boards truly believe the proposal is not in the interest of the company, they should not adopt it, in spite of the majority support by shareholders.

We find that, while proposals failing to achieve a majority vote are almost always ignored by the boards, about 30% of the MV proposals are implemented within a year from the vote. Strikingly, the frequency of implementation of MV proposals has almost doubled after 2002, from approximately 20% (1997-2002) to more than 40% (2003-2004), consistent with an increase in the cost of ignoring MV resolutions in the post-Enron environment. The likelihood of implementation seems to depend on the degree of shareholder pressure – in particular, the voting outcome and the influence of the proponent. For example, a MV proposal supported by 70% of the votes cast has a 10% higher chance of implementation than one supported by 55% of the votes cast. The behavior of peer firms and the type of proposals also have an effect, while traditional governance indicators do not seem to matter.

We then focus on the labor market for outside directors to evaluate the consequences of the implementation decision. We find that the implementation of a MV shareholder proposal is associated with approximately a one-fifth reduction in the probability of director turnover at the targeted firm. In addition, implementing a MV proposal is associated with approximately a one-fifth reduction in the probability of losing directorships held in other firms. These “rewards” for responding to MV proposals are higher when the proposal was supported by a higher percentage of votes. If the labor market for directors correctly reflects the quality of their performance, then the presence of reputation rewards (penalties) for responsive (unresponsive) directors may suggest that, on average at least, MV shareholder proposals are viewed as beneficial.

The full paper is available for download here.

 
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