5 reasons to shift say-on-pay votes to employees

Illustration courtesy of hikingartist.com (Frits Ahlefeldt-Laurvig) on Flickr

Illustration courtesy of hikingartist.com (Frits Ahlefeldt-Laurvig) on Flickr

Rob Swystun, Pristine Advisers

Competitive benchmarking among public companies has driven CEO pay through the roof, which contributes to the widening wealth gap in the United States and exacerbates distrust by the general public.

The US Securities and Exchange Commission’s effort to curb excessive compensation with Say on Pay votes is technically a good idea … they just gave the say to the wrong group of people.

Judith Samuelson, executive director of the Aspen Institute‘s Business and Society Program, calls for a fresh look at the concept of Pay for Performance in a column for the Huffington Post. She cites Roger Martin in saying stock price is a crude measure of a company’s health that has little to do with management decisions and the company’s future.

And yet, executives have been receiving compensation in equity or rewards linked to price of the company stock since the dark ages of the 1980s. The result of this so-called “Pay for Performance” has been sky high executive pay, and an increase in management decisions — like stock buybacks, for example — that are meant to boost the stock price at the expense of the long-term health of the company (and economy).

The problem isn’t so much with the basic concept of Say on Pay, though, Samuelson notes. The problem is the wrong group is being asked. If employees were granted the right to a non-binding vote on the compensation of their chief executive, things would be a lot different in corporate America.

Here are several reasons to consider shifting Say on Pay votes to employees from shareholders:

  1. Shareholders don’t really care

Some people invest ethically and many more are actually interested and informed about what stocks they possess. The vast majority of investors, though, as Samuelson points out, don’t know what stocks they own and, frankly, don’t care. What’s important to them isn’t so much that the stock price goes up per se, it’s that their investments as a total continually increase in value.

“Most of us saving for retirement barely know what stocks we own; our shares are voted by institutions who make more money when the executives are making more money,” Samuelson says. “So the merry go round continues to spin.”

  1. It’s not working, anyway

If the non-binding say-on-pay votes — given to shareholders as part of the Dodd Frank Act passed by Congress in the wake of the mortgage crisis — are meant to slow down the rampant growth of CEO pay, then so far it gets an ‘F’ for effectiveness.

Samuelson says 95 percent of the votes are cast in favor of the pay plans and CEO pay at public companies has grown 12% annually since the votes began. Last year, according to The New York Times‘ annual survey on executive pay, the ten highest paid corporate executives each made more than $50 million and the top-200 received, on average, $22.6 million, a hefty increase over the prior year at $20.7 million.

  1. Employees are in the best position to judge fairness.

Top executive pay versus employee pay contributes to the overall sense of “felt-fairness” in a company and has a big impact on employee motivation. A negative vote by employees on the compensation of the top executive may be a warning signal to the board that something is amiss in the company that might eventually make its presence felt in the company’s productivity and quality of service.

  1. Employees have an insider’s perspective.

While things might look rosy on the outside, there’s no hiding shoddy business practices on the inside. Employees will notice poor business practices, like a company culture lacking integrity and transparency or maintenance and safety shortcuts. These things may take years to be noticed by outside observers and be reflected in the company’s stock price. But, employees who have to live with it and be affected by it everyday really know how well the CEO is performing. By virtue of being employees, they also have much more vested interest in the company doing well. Shareholders can simply sell their shares if things start to turn ugly. Employees may be out of a job if that happens.

As Samuelson points out, employees may not speak up when business practices are poor, but they are far more likely than shareholders to send some kind of signal that something is wrong in the company. Whistleblowers have been doing it for decades. If the company’s PR doesn’t match its reality, employees will know. They are in the best position to discern Pay for Performance rather than stock prices.

  1. Shareholders aren’t really owners, anyway.

Most shareholders of a company’s stock are traders rather than owners (and, as mentioned previously, many shareholders tend to be ignorant of what companies they actually have a stake in). They don’t really care if they ‘own’ a piece of Company X or Company Y. If a better deal comes up elsewhere, they’ll sell their stock in a flash, meaning they aren’t even truly investors. They don’t even have claim to the cash on the balance sheet (apart from bankruptcy after everyone else with a claim to the money has been paid). Unlike fleeting shareholder ‘ownership,’ employees have an obvious interest in the long-term health of the company. They may not really be the owners of the company, but they have much more at stake in it. Failure of the company could be detrimental to them.

Potentially exacerbating an already wonky situation is the SEC’s proposal to tie pay to a measure of “Total Shareholder Return”.

Samuelson says of the proposal: “The stock price is only the most rude measure of success and in the short-run is only vaguely connected to the kinds of performance that matter the most to people and the planet.”

Shareholders are right to be concerned with how a company spends its money, but it’s still the company’s money that it’s spending. Rather than counting on the perspective of a group of people on the outside of a company looking in, which provides little to no accountability, why not look to the group of people who know the company best and who could easily tell you if a CEO’s performance is truly good or not?

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