Giving Investors a Say on CEO Pay

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Patrik Giardino / Corbis

By most accounts, Goldman Sachs is doing pretty well for a financial services firm these days: its stock is down only 14% over the past year, compared to 29% for the currently embattled industry overall, and it earned $11.6 billion in profits in its most recent fiscal year. So does that mean CEO Lloyd Blankfein deserves the $70 million pay package he received for 2007? Maybe. Or maybe not. But at the very least shouldn't public shareholders — the people who actually own the company — get a say?

Timothy Smith thinks so, which is why on Thursday, at Goldman's annual meeting, the senior vice president of Walden Asset Management, which owns 65,000 shares of the Wall Street giant, will stand up in front of thousands of fellow shareholders and make the case for being able to vote on the firm's compensation practices. Smith's gambit is just the latest salvo in the ongoing battle over executive pay, but this time there's a crucial difference: the pressure isn't coming just from politicians and populist crusaders, but also from big institutional shareholders like mutual funds, pensions and foundations — a constituency companies often find difficult to ignore.

Investors this year have asked for so-called "say on pay" at some 100 companies, including Coca-Cola, IBM, General Motors, Exxon Mobil, Citigroup, Anheuser-Busch, General Electric and Wal-Mart. As companies hold their annual meetings throughout April and May, some 70 different institutional investors will be pushing to add an annual provision to let shareholders vote up or down on how companies pay their top five executives. Earlier this week, about 150 institutional investors and representatives from companies like Pfizer, Morgan Stanley, Dell, BP, Sara Lee, Fed Ex, Procter & Gamble and United Health gathered in New York for a roundtable on say-on-pay votes. Such votes wouldn't actually be binding, but they still might serve to pressure firms into behaving the way shareholders want them to, especially when it comes to linking pay to performance. "This isn't an attack on companies in general," says Smith. "This is good governance, just like ratification of auditors or majority vote for directors."

The founders of the "say on pay" movement probably wouldn't put it so diplomatically. In the fall of 2005, the American Federation of State, County and Municipal Employees (AFSCME), a union that runs a $850 million pension fund, was trying to figure out what to do about CEO pay — especially at Home Depot, one of its holdings, where then CEO Bob Nardelli was collecting a nearly $32-million pay package for the year, while the company's stock languished. "We had reached a level of frustration because it seemed CEO pay, no matter what we did as activist investors, kept spiraling out of control," says Richard Ferlauto, AFSCME's director of pension and benefit policy. The quintessential example: after Congress passed a law that gave companies incentives to cap CEO base salaries at $1 million a year, the issuance of stock options, an alternative way to pad pay packages, skyrocketed — to the point that by 2005, average large-company CEO compensation had reached 262 times the average employee's take, compared with 24 times in 1965, according to the Economic Policy Institute.

So AFSCME decided to try an approach that had been codified into law in Great Britain three years earlier: "say on pay" votes, a method meant to harness investor sentiment into a unified message more forceful than any one shareholder complaining to a company's board of directors could deliver. After AFSME petitioned for such votes at a handful of companies in 2006, a swath of other investors, including heavyweights like the California Public Employees' Retirement System (CalPERS) and TIAA-CREF, which sells retirement investments to educators, submitted shareholder proposals at dozens of companies in 2007. Of the eight companies that saw majority shareholder votes in favor of instituting say on pay, three —Blockbuster, Verizon and Par Pharmaceuticals — said they would do it.

Most companies, not surprisingly, aren't so amenable to the idea. The core argument against the movement is that CEOs get paid a market rate and say-on-pay votes undermine the very nature of corporate governance — a board of directors charged with luring and keeping the best talent. In the rebuttal statements to say-for-pay proposals found in their annual proxies, companies lay out all sorts of counter-arguments. IBM says there's no way that shareholders can know what's an appropriate pay practice since they're not privy to competitive information like which executives are receiving other job offers. Coca-Cola stresses that shareholders already have a way to deal with pay practices they find unpalatable: don't vote for members of the board when they come up for re-election.

Perhaps the savviest argument companies make is that there are mixed results about what, exactly, say-on-pay votes accomplish. In the U.K. there have been some resounding successes — most notably GlaxoSmithKline, which revamped its pay practices, aligning compensation with performance, after a "no" vote of 50.7% in 2003. (Its CEO at the time was on track to earn about $18 million.) Yet various studies have shown that in the years since say-on-pay went into effect, CEO compensation has continued to rise, anywhere between 5% and 11% annually.

But in a couple of important ways, the system seems to be working. In a recent paper, Fabrizio Ferri and David Maber of Harvard Business School document how, since say-on-pay went into effect in the U.K., CEO compensation has become more likely to fall when operating performance does. "'Say on pay' in the U.K. was effective in achieving one of its major goals," the authors write, "to reduce the 'rewards for failure' through a stronger link between pay and realizations of poor performance." That effect has been most pronounced at the firms handing out the biggest pay packages.

And there has also been another outcome, as extensively studied by Stephen Davis of Yale's Millstein Center for Corporate Governance and Performance: companies and shareholders talk a lot more about governance, not just next quarter's numbers.

Dan Amos knows something about talking to investors. The Aflac CEO was stunned a year and a half ago when he found out that a shareholder had submitted a proposal for a say-on-pay vote at his company. "My first inclination was, What have we done wrong?" he says. As it turns out, nothing. When he talked to the people at Boston Common Asset Management they said a vote was simply in the general interest of shareholders. Amos then went to the insurance company's largest shareholders and asked what they thought. He wasn't expecting large, fairly conservative mutual funds to be in favor of the idea — but they were. "I realized that when they decided yes, others would follow," he said, "That it was something that was coming."

And so when Aflac shareholders meet for their annual meeting on May 5, they'll have a say about whether or not they agree with the company's executive compensation practices. Amos, who has been CEO for 18 years, a nearly unheard of tenure at a Fortune 500 company, says that with a compound annual growth rate of 22% during his time in charge, he thinks he's worth his $14.8 million pay package, especially since it has been calculated with the same methodology for the past 12 years, with certain chunks tied to performance and long-term results. "I know it's a lot of money," he says. "I'm not naive. There are going to be some people who just say that's too much money. But as you read the [compensation] report, it really has nothing to do with me. There is a benchmark for what a position is worth, what a CEO is worth. My feeling is, I've been upfront. I'm willing to tell you I voted for it."