This document provides a literature review and analysis of say-on-pay policies around the world. It begins with an introduction on rising CEO pay and the need for increased transparency. Section 1 defines say-on-pay and reviews supporting and opposing literature. Section 2 discusses the UK experience, finding say-on-pay increased pay-performance sensitivity. Section 3 covers the US, where 92% of companies approved pay but boards could ignore dissent. Section 4 briefly outlines other countries' experiences. The conclusion is that say-on-pay may improve transparency and address problems, but more research is needed.

1. Nottingham University Business School
MSc in Business and Management
2015/16
Individual Coursework Coversheet – Electronic
Submission
NAME: Pierfrancesco Bresolini Eibenstein
Student ID: 4257378
MODULE TITLE: Corporate Governance (N14104 UK)

3. Topic 2
Say-on-pay: characteristics, literature review and findings from
various countries
Contents
Introduction .......................................................................................... 1
1 Say-on-pay: characteristics and literature review ........................... 2
2 The UK experience of say-on-pay ................................................. 4
3 The US experience of say-on-pay ................................................. 5
4 Say-on-pay in the rest of the world............................................... 6
Conclusion............................................................................................. 7
References

4. 1
Introduction
The past decades have been characterized by a dramatic rise in Chief Executive Officer
(CEO) compensation and benefits (Frydman and Jenter, 2010). This phenomenon was
highly criticized during the financial crisis, when CEO pay-package structures encouraged
them to take excessive risks. The result was often financial ruin for many companies
(Bhagat and Romano, 2009). Nevertheless, CEOs continue to earn millions of dollars
when leaving a company. This so-called “golden parachute” practice is also called “pay-
for-failure” and is one that generates a high level of unhappiness amongst investors (Cai
and Walkling, 2011).
So as to solve this problem and give a voice to shareholders, the governments of
various countries have set-up a tool called “say-on-pay”. Say-on-pay gives investors a
binding or non-binding opportunity to vote and approve the composition and level of the
compensation package awarded to executives. Its aim is to improve the transparency
and accountability of executives’ compensation, as well as attempting to link the
compensation payments and company performance more effectively (Baird and
Stowasser, 2002). However, some important researchers are not convinced by the
effectiveness of say-on-pay. In fact, according to Deane (2007), the current market
system for compensation is already effective and say-on-pay only distracts and reduces
the authority of company boards.
The purpose of this essay is to describe and assess the true effectiveness of this
policy through the analysis of the academic articles and studies.
The essay proceeds as follows: section 1 offers a definition and the characteristics
of say-on-pay through a literature review. Section 2 describes say-on-pay and findings
from the UK, and then say-on-pay and findings from the US in section 3. Section 4 gives
a brief panorama of say-on-pay in the rest of the world, followed by the conclusion.

5. 2
1 Say-on-pay: characteristics and literature review
In 1976, Jensen and Meckling developed the principal-agent problem. This agency
problem is a risk for companies. In fact, the ownership of public firms is usually
widespread and shareholders delegate to the company’s board to negotiate managers
compensation. This could create misalignments of interest between owners and
managers. As Gabaix and Landier (2006) show, from 1980 to 2003 there was a six-fold
increase in CEO salaries. Furthermore, in recent years, generous severance contracts
and controversial pay structures have made shareholders unhappy and feel powerless
(Ferri and Maber, 2013). To increase the shareholders voice in the matter of CEO
compensation, governments have adopted a say-on-pay policy. Say-on-pay is the
shareholders’ right to vote on executive pay (Ferri and Maber, 2013). It can be binding
or non-binding. In the latter scenario, the final decision is for the board to make.
However, even if the board does not take shareholders opinion into consideration,
negative publicity in the media could still help to achieve the desires of the shareholders
(Conyon and Sadler, 2010). Before Say-on-pay, Ertimur et al. (2010) indicate that
shareholder proposals were generally ineffective in forcing changes, especially if
proposed by trade unions. Instead, Brav et al. (2008) show that hedge funds activism
gain success in 60-70% of cases. Levit and Malenko (2011) also indicate that non-
binding advice was often ignored. However, in recent years, the use of majority voting
for shareholder proposals has risen together with their implementation (Ferri and Maber,
2013). Hodgson (2015) shows over 90% of companies approve executive pay packages,
while Chasan (2015) describes how just 2% of companies voted against the pay
proposals. These results show few companies have shareholders who are unsatisfied
with CEO pay proposals. Conyon and Sadler (2010) find the higher the pay of a CEO, the
higher the dissent of shareholders, and to vote against it allows an opportunity to
manifest their dissent. They find that, in general, shareholder dissent is usually low.
However, this level of dissent rises dramatically when concerned with issues of higher
compensation levels, huge bonuses and weak pay-for-performance. Perhaps, Say-on-pay
is the most effective tool that shareholders have to influence compensation and having

6. 3
worthwhile dialogue with the board. Also, endorsement of the board by shareholders
encourages directors to negotiate more effectively with CEOs (Ferri and Maber, 2013).
Say-on-pay is both more diplomatic and effective than shareholder proposals, which
constitute strong actions that could strain relationships with management (Conyon and
Sadler, 2010).
Cai and Walkling (2011) indicate three necessary conditions to benefit from say-
on-pay: 1) a firm’s compensation policy should be excessive, ineffective and inadequate;
2) shareholders should be actively participating; 3) especially in the case of non-binding,
the firm must be open to discussion, renegotiation and improvement of their
compensation policy. They also indicate that say-on-pay could reduce agency cost and
improve the value of the firm through the alignment of owner-manager interests.
However, opponents of say-on-pay consider the current payment system effective
enough thanks to market efficiency and competition (Fama, 1980; Cai and Walkling,
2011). In addition, say-on-pay could distract the board from its work and push it to
make suboptimal decisions (Bainbridge, 2008). Furthermore, the existing free market
can regulate the inefficiencies through mechanisms such as Market for Corporate Control
(Wright et al., 2009) and the possibility, if unsatisfied, of selling shares to reinvest in
companies with a more effective system of pay management. Core et al. (1999) suggest
that higher CEO pay is associated with less than effective boards. This could be
problematic for company sustainability and ability to generate future profits. However,
with say-on-pay, shareholders could have the opportunity to improve the compensation
design, align interests and increase a firm’s sustainability without selling assets (Ferri
and Maber, 2013). Say-on-pay is an additional tool of control with respect to shareholder
rights. Finally, there is no evidence of it being influenced by micromanage compensation
from various interest groups (Ertimur et al., 2010). Thus, there is no evidence of abuse
of say-on-pay due to conflict of interest.
There are many arguments for and against say-on-pay, but the free market as the
sole determiner of profitable companies is not a reality. Given this, say-on-pay could act
as an external governance tool in terms of control. (Alissa, 2015).

7. 4
2 The UK experience of say-on-pay
As logic suggests, shareholders are not willing to sanction high levels of compensation
for poor performance (Conyon and Sadler, 2010). Thus, there is evidence that suggests
say-on-pay increases the sensitivity between pay and performance (Ferri and Maber,
2013). Given that, the Directors’ Remuneration Report (DRR) was introduced in the UK
in 2002, which permitted shareholders an advisory non-binding vote on executive
remuneration at least once every three years (Ferri and Maber, 2013). They also found
there to be a positive market reaction to the introduction of say-on-pay. This positive
reaction was the result of optimistic expectations from investors. It was especially
positive for firms with excessive executive pay and low performance or generous
severance contracts (Ferri and Maber, 2013). However, Conyon and Sadler (2010)
showed that only less than 10% vote against CEO remuneration. This could indicate that
90% of shareholders vote in favour. They also found that shareholder dissent decreases
over time. Moreover, Balachandran et al. (2007) found a rise in sensitivity of CEO
payment to operating performance but not to market performance. Hooghiemstra et al.
(2015) underline the importance of media. They found that negative media coverage is
associated with a higher rate of dissent in voting.
In 2013, the UK enhanced the regulation with the Enterprise and Regulatory
Reform Act. This new regulation introduced a say-on-pay binding system (Gregory-Smith
and Main, 2014). They found a reduction in dissenting votes due to the concern that a
negative signal would trigger a negative market reaction. However, Alissa (2015)
showed that boards react to shareholders discontent by increasing CEO turnover and
reducing CEO pay when performance is low. Thus, overall say-on-pay could increase
“transparency, performance-linkage and accountability” Alissa (2015: 750).
Gregory‐Smith et al. (2014) found that say-on-pay voting constrains pay but only to a
small degree, and instead primarily acts on excessive rewards. They also found an
increment in CEO resignation and turnover. Recently, a government report has shown
long-term incentives have increased while salary and bonus growth rates have reduced
(DBIS, 2015).

8. 5
3 The US experience of say-on-pay
Prior studies of individual shareholder proposals found there to be no impact on
executive pay (Ertimur et al., 2011). However, after 2002, when proposals were
sponsored by institutional investors, they were starting to help achieve more
transparency and better pay-for-performance (Ertimur et al., 2011). During the financial
crisis, President Obama limited CEO salary to $500,000 for bailout firms, and in 2010, he
signed the Dodd-Frank Act (Cai and Walkling, 2011). This law gives shareholders a non-
binding say-on-pay right. Cai and Walkling (2011) analysed the market reaction to this
say-on-pay announcement. They found it to be positive for companies with excessive
CEO remuneration and lower pay-for-performance linkage, but a negative reaction for
firms with the lowest governance. This suggests that say-on-pay could create value, but
it is up to a board to implement improvements.
Semler Brossy (2016) shows that 92.4% of companies approved compensations
every year. Additionally, WTW (2016) indicates that only 3% failed to achieve
shareholder majority during 2015. They also see a general positive trend in these four
years of mandatory say-on-pay. HayGroup (2014) sees say-on-pay positively in terms of
building a closer relationship between shareholders and a company. It addresses
compensation strategy to pay-for-performance and a long-term horizon (Bachelder,
2015). However, the non-binding nature of the vote allows for companies to ignore
shareholder complaints (Chasan, 2014). The problem is more acute in firms where the
founder is both CEO and main shareholder, and the person is identified with the
company.
Overall, the US findings seem to confirm that say-on-pay creates value for firms
open to change (Cai and Walkling, 2011), and generates a lower growth rate in CEO pay
(Conyon, 2015).

9. 6
4 Say-on-pay in the rest of the world
Ng et al. (2011: 1510) stated: “If well designed, equity compensation provides powerful
and effective incentives to managers that help align their interests with those of
shareholders”. For this, many other countries in the world implemented say-on-pay
regulation. The European Commission introduced say-on-pay for over 10,000 listed
companies in 2014 (EC, 2014). Denmark, The Netherlands, Norway, Sweden,
Switzerland have a binding system, while Australia, Belgium, France, Germany, Italy
have a non-binding system (Orsagh, 2013).
The Italian and German cases are interesting as both countries are characterized
by SMEs, which are generally family-run and having low widespread control. In Italy,
non-binding (binding for financial sector) say-on-pay was introduced in 2010. Even if
ownership structure is highly concentrated, the level of dissent is comparable to other
countries with widespread ownership (Belcredi et al., 2014). Dissent is higher for
excessive and opaque remuneration. Also, the non-binding nature does not reduce
dissent. In contrast, the level of dissent is lower in binding for fear of a negative market
reaction (Belcredi et al., 2014). In Germany, Eulerich et al. (2014) found higher say-on-
pay use for large firms, where media and public pressure often leads to find a solution
for the dissent. However, smaller firms use of say-on-pay is less, thus there is less
transparency in their compensation structures (Powell and Rapp, 2015).

10. 7
Conclusion
Rising executive compensation, poor pay-for-performance, low transparency and pay-
for-failure have made the introduction of new legislation a necessity: say-on-pay. This
paper supports the advantages and improvements brought by say-on-pay through the
analysis of academic papers and studies.
It was concluded that say-on-pay could be a way to improve and try to solve the
principal-agent problem with the alignment of interests amongst owners and executives.
It was also described as an additional tool for monitoring executive activity and
performance and, above all, it seems to be a way to foster democracy and discussion
inside firms, whilst also having the aim of increasing value, transparency and fairness.
This description-analysis was conducted using only secondary research. It would be
interesting to collate the different findings from different countries, and see if there are
correlations as there appears to be. In terms of limitations, some details and aspects of
this topic have not been included in this paper, but it would be interesting to investigate
say-on-pay further.
(Total words: 2000)

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