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Dodd-Frank’s Say on Pay: Will It Lead To A Greater Role for Shareholders in Corporate Governance? Randall S. Thomas, Alan R. Palmiter and James F. Cotter VANDERBILT Law School VANDERBILT Law School

Background • Implementation of a mandatory say on pay vote for shareholders was first enacted in the U.K. in 2002. • Executive pay critics argued that it would provide an important check on the observed upward movement in pay levels. • Skeptics claimed that at best it would operate as a check on pay arrangements that deviated far from the norm (Cheffins and Thomas 2001). VANDERBILT Law School VANDERBILT Law School

Arguments in Favor of Say On Pay • Make corporate management more accountable to shareholders and shift balance of power in favor of shareholders. • Encourage boards to align pay and performance. • Arrest the upward spiral of pay levels. • Push boards to eliminate pay structures that encourage excessive risk taking. VANDERBILT Law School VANDERBILT Law School

Arguments Against Say On Pay • Upset the traditional balance of power between managers and shareholders. • Shareholders are poor judges of proper pay practices and levels. • Increase power of ISS and voting advisors. • Increase disclosure and voting costs, especially for smaller companies. • Push American companies to adopt one-size- fits-all pay programs. VANDERBILT Law School VANDERBILT Law School

Dodd Frank’s “Say On Pay” Mandate • Section 951 of the Dodd-Frank bill requires public companies to give their shareholders an advisory vote to approve or disapprove the compensation paid to named executives during the prior fiscal year. • SEC rules implemented this requirement with detailed specifications on the form of the proposal and the particular officers whose compensation will be subject to the vote. VANDERBILT Law School VANDERBILT Law School

Data– Shareholder Proposals On Executive Compensation • For many years prior to the enactment of Dodd-Frank, shareholders had submitted advisory proposals related to executive compensation matters using Rule 14a-8. These included proposals to approve certain features of executive pay, including SERP payments and Golden Parachutes. • Voting support for these proposals ranged from around 10% for less popular categories to 50+% for the most popular ones. VANDERBILT Law School VANDERBILT Law School

Pre-Dodd Frank: Shareholder Executive Compensation Proposals (2003-2010) Table 1: Shareholder Proposals on Executive Compensation (Number and % Support) Majority Support 2003 2004 2005 2006 2007 2008 2009 2010 0 Report 16 5 25 3 4 3 3 9 11.2% 10.3% 8.4% 9.0% 6.9% 7.6% 10.2% 6.2% 0 Disclose 1 9 3 4 3 2 5.5% 27.4% 8.0% 8.3% 10.8% 10.2% 43 Approve 16 23 14 15 7 3 5 4 56.6% 48.9% 55.4% 41.4% 45.8% 57.3% 31.9% 58.3% 0 Cap 1 9 6 8 7 1 2 5.1% 10.2% 10.7% 5.2% 5.4% 9.2% 5.1% 14 Link 48 7 35 37 73 27 8 12 16.6% 34.6% 29.6% 32.5% 29.8% 32.3% 26.0% 32.5% 14 Reduce 47 33 7 11 16 15 6 10 32.6% 13.2% 12.0% 23.2% 23.0% 20.2% 23.9% 29.1% 0 Restrict 3 7 25 38 30.1% 23.1% 29.1% 25.8%

Shareholder Proposals -- Overview of Voting Results • Report, cap and disclose proposals attract little support (<10%). • Link, reduce and restrict attract moderate levels of support (15% to 25%). • Approve proposals, asking a board to institute an advisory shareholder vote on particular pay practices such as SERPs, attract the highest average levels of support (49.6%) and the most “majority support” proposals. VANDERBILT Law School VANDERBILT Law School

Shareholder and Management Proposals on “Say on Pay” • Shareholders began submitting “say on pay” proposals in 2006, recommending to boards that they give shareholders an advisory vote on executive pay. • Shortly thereafter, management sponsored say on pay proposals began to appear – a few on a voluntarily basis but largely because TARP-funded firms were required to do so. VANDERBILT Law School VANDERBILT Law School

Pre-Dodd Frank: Management and Shareholder Say On Pay Proposals Table 2: Say-On-Pay Proposals Pre-Dodd Frank (Number, Support and Majority Support) Panel A – Shareholder Sponsored Proposals Year Number of Shareholder # receiving "say on pay" support (% For) majority support 14a-8 proposals 2006 5 42.5% 0 2007 52 37.5% *** 7 2008 71 38.1% *** 8 2009 61 41.1% *** 21 2010 48 40.3% *** 9 Panel B – Management Sponsored Proposals Year Number of Shareholder # receiving "say on pay" support (% For) majority support proposals 2006 0 0 0 2007 2 2 98.2% *** 2008 8 8 89.2% *** 2009 152 152 87.6% *** 2010 143 146 88.7% *** *** represent a test of the difference of the mean of the percentage of shares voted in favor of “Say-On-Pay” vote by year between shareholder and management proposals at the 1% level in a two tailed test.

Say On Pay Proposals– Overview of Results • Shareholder say on pay proposals ask the board to institute an advisory say on pay vote. They average 42% support and 16% receive majority support. • Management say on pay proposals ask shareholders to approve the top 5 executives pay. They average 88%, and only 1% failed to attract majority support. These are overwhelmingly for financial institutions. VANDERBILT Law School VANDERBILT Law School

Pre-Dodd Frank: Impact of ISS Voting Recommendations (2003-2010) Table 4: Pre-Dodd Frank Management and ISS Recommendations (Number and Support) ISS and Management “For” Management Only “For” ISS Only “For” ISS and Management Recommendation Recommendation Recommendation “Against” Recommendation Report 0 1 1 66 24.5% 15.5% 8.6% Disclose 0 0 5 17 41.7% 9.0% Approve 2 0 79 6 84.4% 50.3% 28.2% Cap 0 0 1 33 24.7% 7.1% Link 1 0 156 89 91.3% 35.5% 14.1% Reduce 0 0 53 88 43.1% 10.4% Restrict 0 0 70 3 27.6% 8.3% S’holder Say 1 0 273 2 on Pay 51.8% 42.0% 12.7% M’gment Say 234 69 0 0 on Pay 92.4% 73.4

Interpreting the Results • Management rarely recommends in favor of a shareholder proposal on executive pay issues. • ISS generally recommended against shareholder proposals to report, disclose, cap and reduce pay. • ISS recommended in favor of management say on pay proposals 77% of the time. • A negative ISS recommendation on a management say on pay proposal is associated with approximately 20% lower “for” votes. VANDERBILT Law School VANDERBILT Law School

Post-Dodd Frank: First Year’s Experience (I) • Commentators on first season’s results have made several observations, including: • Management garnered 91.2% average support from shareholders on these mandatory votes. • Say on pay proposals were defeated only 1.6% of the time = 37 firms from Russell 3000. VANDERBILT Law School VANDERBILT Law School

Post-Dodd Frank: First Year’s Experience (II) • Low stock returns and high CEO pay resulted in lower support for say on pay proposals. • Pay for performance issues were raised at almost all companies with failed votes: half of them had double digit negative three year total share returns (TSR). • Firms with CEO pay in the top quartile and TSR in the bottom quartile received the weakest average shareholder support levels (73.9%). VANDERBILT Law School VANDERBILT Law School

Post-Dodd Frank: First Year’s Experience (III) • ISS issued negative say on pay recommendations at 285 firms, but 86% of them still obtained majority approval of their executives’ pay packages. • Negative recommendations were associated with a 25% average decline in voting support. • ISS negative recommendations largely focused on pay for performance issues (ex: high pay and negative TSR). VANDERBILT Law School VANDERBILT Law School

Impact of Say On Pay • Even before say on pay votes, many companies made changes to the substance and disclosures of their pay programs. • Some companies receiving negative ISS recommendations filed supplemental proxy disclosures and engaged shareholders actively. • Some companies with failed votes are named in derivative law suits alleging breach of fiduciary duties. VANDERBILT Law School VANDERBILT Law School

Open Questions • Has Dodd Frank opened new lines of communication between management and shareholders on executive pay issues? • Is there evidence of a change in corporate governance practices at firms experiencing low shareholder approval levels? • Will there be substantive changes to pay practices as a result of say on pay? VANDERBILT Law School VANDERBILT Law School