How Shareholders Vote When Executive Compensation Does Not Match Performance

Shareholders and advocacy groups have often criticized company executives for receiving large salaries despite delivering poor returns to investors. In response to these concerns, the Securities and Exchange Commission (SEC) introduced the Dodd-Frank Act of 2010, which includes two key provisions intended to enhance the oversight of executive compensation. The first provision gives shareholders of publicly traded companies the opportunity to participate in advisory votes regarding executive pay, also known as say-on-pay votes, which became effective in 2011. These say-on-pay votes essentially provide shareholders with a platform to express their opinions on executive compensation and are seen as an important tool by Congress in determining appropriate pay levels that align with shareholder interests.

The second provision, which came into effect over a decade later in 2022 (SEC 17 CFR Parts 229, 232, and 240, Release No. 34-95607), mandates that publicly traded firms disclose additional information about executive pay and pay-performance relationships, including a novel metric called compensation actually paid (CAP). CAP is designed to capture the total value of compensation awarded to an executive during a fiscal year, factoring in changes in the worth of an executive’s equity-based compensation, such as stocks and stock options. The use of CAP is crucial as it reflects fluctuations in the fair value of an executive’s equity grants, making it a more relevant measure of executive pay. Additionally, CAP has the flexibility to show negative values, unlike other traditional compensation metrics, which start at zero.

Our research paper delves into the interplay between the two components of Dodd-Frank outlined above. By leveraging the newly revealed CAP data, we analyze scenarios where executive pay does not align with company performance, resulting in executives receiving positive CAP while their firms underperform compared to peers. We focus on say-on-pay votes in S&P 500 companies during the initial two proxy seasons following the introduction of the CAP disclosure rule, collecting data related to CAP for fiscal years 2022 and 2023, along with proxy voting data for fiscal years 2023 and 2024.

Our findings suggest that when there is a disconnect between company performance and executive CAP, a higher percentage of shareholders vote against the proposed executive compensation packages. This indicates that shareholders, when participating in say-on-pay votes, are not only evaluating the components of executive pay but also considering how it correlates with the overall performance of the company. Through this analysis, we aim to shed light on the ways in which shareholders use their voting power to influence corporate governance decisions related to executive pay and performance alignment.