October 26, 2011
(Editor’s note: On July 21, 2010, the Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law. Dodd-Frank represented the largest financial regulatory reforms since the Great Depression, and many are still trying to figure out exactly how they are impacted by the 850-page Act. Throughout the month of October, we’ll be looking at some of the major features of this complex law.)
For the first installment on the Consumer Financial Protection Bureau, click here.
For the second installment on whistleblower bounties, click here.
For the third installment on Bank of America’s debit card fee, click here.
We’ll close out the Dodd-Frank month with one of its more populist provisions that also has some corporate board of directors concerned: “say-on-pay.”
The “pay” is that of corporate executives, and the “say” is that of the shareholders of publicly-traded companies.
It’s actually about as simple as it sounds, for once.
As of January 2011, publicly-traded companies must include a separate shareholder resolution to approve executive compensation – including golden parachutes – at least once every three years.
Three years is only the statutory minimum, and shareholders are allowed – by vote – to reduce that number to either one or two years.
“Golden parachutes” refer to agreements whereby executives are to be compensated, often with severance pay, cash bonuses, or stock options, in case their employment is terminated.
Even with all of these new rules, any shareholder resolution disapproving of executive pay is nonbinding on the final compensation decision.
In addition, the law does not impose any explicit fiduciary duties on shareholders to limit executive compensation in response to a shareholder vote of disapproval.
So what’s all the fuss about?
Some commentators were concerned before the law went into effect that it would trigger a flood of litigation.
While there have been some, it’s anything but a “flood” – only 1.6% of all public companies that have held such votes through June 2011 have returned negative votes on executive pay, and even fewer (about 12) have resulted in lawsuits.
But with no new fiduciary duties to fuel them, and, indeed, no real changes in legal standards, these lawsuits seem doomed to fail.
Or are they?
Although there’s nothing new legally, there is now something new factually: the shareholder resolutions.
Specifically, board of direction decisions made in spite of opposing shareholder resolutions can act as (very strong) factual evidence of some influence of fraud, bad faith, or abuse of discretion.
Legally, under the business-judgment rule, that is the only door that courts can enter through to question executive decisions and assign liability.
Albeit, this evidence is anything but conclusive on the matter, but it certainly gives activist shareholders potent ammunition.
Even if a lawsuit doesn’t result from a negative shareholder vote, a board of directors can take the hint that they shouldn’t be going against the majority of their shareholders’ wishes and subsequently revise executive compensation downward.
So the shareholder “say” obviously does have some punch, regardless of its being non-binding.
Was that the intent in the law’s creation?
That’s hard to say for sure, since so many factors played into its addition to Dodd-Frank.
Like the rest of the Act, the “say-on-pay” provision was greatly motivated by the financial crash of 2008, with many economists and commentators citing executive pay practices and culture as contributors.
However, with chief executive pay rates soaring from 1965, when they were 24 times the average worker’s salary, to today, when they are 275 times the average worker’s salary, discontent has been brewing for awhile.
In the grand scheme of things, though, Dodd-Frank’s “say-on-pay” is really pretty soft regulation, and it is probably unlikely to prevent the continued upward drift of executive salaries.
Conversely, though, it may act as a “gateway law” to stronger regulations – with “say-on-pay” acting as the new floor for executive pay regulation – and litigation – through increased shareholder participation in corporate governance.
Still, given how fresh it is, we may still have a bit of waiting before witnessing the law’s full effects.
Check out NECA–IBEW Pension Fund v. Cox as an example of a breach of fiduciary duty shareholder derivative suit on executive pay.