As discussed in a PubCo post last week, say on pay has had some surprising consequences. While there hasn’t been much impact on the levels of executive pay, according to this paper, one group that have experienced some impact from say on pay are directors. The academic study indicates that, following low favorable votes for say-on–pay proposals, directors incur significant reputational damage and financial costs, which the authors contend should motivate directors to provide better oversight of executive comp from the get-go. Moreover, the authors believe that their study shows that say on pay “has given shareholders an important, albeit indirect, increase in influence over executive compensation.”

The study looked at a sample of companies in the S&P 1500 with interlocking boards (i.e., that shared board members) in the first year of the mandated say-on-pay vote (generally, 2011). The authors defined a “low-support” say-on-pay vote as a vote of less than 70% in favor (because say-on-pay proposals with less than 70% votes in favor trigger proxy advisory firm attention). The authors recognized, however, that low-support say-on-pay votes could reflect shareholder concerns other than executive comp. (See, for example, this PubCo post, which notes that studies have shown that pay is not necessarily the determining factor for shareholders in deciding how to vote on say-on-pay proposals and that, instead, shareholder votes are often based on stock price performance.) As a result, the authors refined their analysis to include only those companies with low-support votes “likely due to poor oversight of pay-setting, as measured by excessive executive compensation. All other low support votes are classified as driven by other causes….” As proxies for changes in director reputation, the authors looked at the interlocking firm’s stock price reactions around the subject firm’s announcement of the say-on-pay vote, as well as board appointments, departures or demotions from boards and compensation committees. The authors also analyzed changes to cash and total director comp and the results of say-on-pay and say-when-on-pay votes at the interlocking firms.

The authors concluded that the study’s results indicate that directors “incur significant reputational damage.” First, the study showed that shareholders of the interlocking firm “react negatively, on average, to the announcement of the [subject] firm’s low SOP support vote.” This result was reflected in a decline (-50 basis point abnormal return) in the interlocking firm’s stock price in the three days after disclosure of the subject firm’s say-on-pay vote; the authors infer that this decline is the result of negative information “regarding the director’s efficacy in monitoring executive compensation” causing “the market to reduce its estimate of director quality.” The study also found an increase in the likelihood of a director’s “losing an interlocking firm board seat (up to 21%) or compensation committee seat (10%) in the year following the vote.” In addition, following the low-support vote, the directors lost, on average, the present value equivalent of approximately $435,000 in future directorial compensation at interlocking firms or, by comparison, nearly one-half of the loss experienced when a subject company is sued for fraud. Finally, the authors find a higher probability of selecting “annual” as the chosen frequency for say-on-pay voting and of subsequent low say-on-pay votes at the interlocking firm.