By SARAH MORGAN
Investors finally got a "say on pay" last year, and most said "fine with us." But now some shareholders hoping to rein in executive pay are now taking their grievances to the courts.
As part of a public backlash against bank chiefs pocketing lavish pay prior to (and during) the recent financial crisis, one provision the Dodd-Frank financial reform act passed in 2010 gives investors a say on the matter -- sort of. Companies must hold shareholder votes on top executive compensation at least once every three years, but the votes are non-binding. They don't have to change anything if shareholders disapprove.
Last year investors got their first opportunity to voice their approval -- or lack thereof -- and the numbers were disappointing to many shareholder advocates. Only 1.6% of companies in the Russell 3000 saw their pay policies rejected, according to a report by Schulte Roth & Zabel. Most companies' policies passed with more than 90% majorities.
The muted response was something of a shock to some investor advocates. For years, there's been a steady stream of public outcry about the huge growth in executive pay. What's more, some experts say reining in executive compensation can boost earnings and in turn stock prices. Every dollar spent on pay and perks for the CEO is a dollar that doesn't flow through to shareholders, says Glyn Holton, the executive director of the United States Proxy Exchange, a shareholder rights organization.
But institutional investors, the ones with the most shareholder votes, tend to focus mostly on whether pay is linked to performance, not whether the overall level of pay is too high. "The institutions are the ones who control the votes, and they're the ones who let us down in 2011," Holton says.
Fed up with the lack of influence the new vote carries, a few groups of shareholders have filed suit against a handful of companies, including Umpqua Holdings and Beazer Homes. The suits claim that the boards have violated their "fiduciary" duty to act in shareholders' interest by overpaying executives or failing to punish them financially for poor performance. While both of those firms have been successful in getting the cases thrown out, investing experts say another case recently settled out of court may be a game changer.
The case against Cincinnati Bell, in which a union pension plan alleged that the board had breached its fiduciary duty by increasing top executive pay while investor returns fell, wasn't immediately dismissed. Cincinnati Bell chose to settle the case in December, five months after it was originally filed, and agreed to "reaffirm" its commitment to paying for performance and use clearer language and more specific examples when describing its pay policies in proxy statements.
Despite the settlement, the case is a warning sign for other companies, says Michael Littenberg, a partner at Schulte, Roth & Zabel who focuses on corporate governance issues. "When these lawsuits were initially filed the conventional wisdom was that they were frivolous and would be dismissed," he says. The fact that at least one case made it over that first hurdle "is likely to embolden other plaintiffs to bring suit and underscores the need for companies to take the [say on pay] vote especially seriously," Littenberg adds.
Suing over executive compensation is tricky. The so-called business judgment rule requires courts to assume boards are acting in good faith for the best interests of the company unless plaintiffs can provide solid evidence that would call that assumption into question. Plaintiffs in this new crop of cases are trying to use failed say on pay votes as evidence of poor business judgment, R. Adam Swick, an associate in the securities litigation practice at Greenberg Traurig explains.
The recent lawsuits are only the latest move in investor advocates' long quest to lower executive pay. While there have been some notable victories -- earlier this month, the former CEO of Nabors Industries agreed to give up a lavish termination payment in the face of investor unrest -- advocates say there's more work to be done. The most recent report by GMI Ratings shows that total pay for executives at S&P 500 companies rose about 36% from 2009 to 2010, compared to only a 15% increase for the index itself.
Companies are making changes when it comes to pay. Take Hewlett-Packard: Shareholders voted against CEO Leo Apotheker's compensation package in 2011. The company was widely criticized when the CEO left 11 months later, having earned more than $30 million in a period when the company's stock fell 45%. The new CEO, Meg Whitman, will make $1 a year in salary, and 80% of her stock options will be contingent on meeting specific stock price goals, according to SEC documents filed last month.
Many companies have also removed widely criticized provisions called tax gross-ups, where companies make an extra payment to cover the taxes an executive would have to pay on a large bonus, severance payment or other perk, says Fabrizio Ferri, a professor of accounting at Columbia Business School who has studied the impact of say on pay.