In the wake of shareholders voting out Tata Motors’ executive pay plan, a fresh debate is rife on the role of minority shareholders in corporate governance. The issue has sparked views from various quarters, some even questioning the legitimacy of shareholder democracy, calling such acts of minority shareholders immature and churlish. Some executives complain of investors making it harder for them to do their job effectively, while others proclaim that the system of governance relying on minority shareholders to discipline companies, is doomed to fail.
According to the postal ballot data provided by Tata Motors, around 65 per cent of the votes cast by institutional investors and 41 per cent by retail investors went against the pay hike proposal. Thus, saying that it was only a handful of the company’s minority shareholders who voted irresponsibly, is far from the truth. Not to forget, the dominant shareholders, namely the promoter and promoter group, who hold 34.33 per cent of outstanding shares in the company, gave full ratification to these pay resolutions.
The Tata Motors case is by no means an isolated one. Legal and finance literature is replete with evidence on executive compensation and performance sensitivity. A seminal pay-performance sensitivity study of solvent firms by Jensen and Murphy in 1990 concluded that senior executives on average experience relatively little reduction in their personal wealth when their firms are unprofitable.
In another study by Baruch Lev in 2012, the statistical correlation between CEO pay and corporate performance was observed to be zero. In a study of viable but loss-making BSE-listed companies, this writer found that remuneration-performance sensitivity and elasticity are weak. Further, it seems that it is only the lower rung of executives whose cash remuneration gets adversely affected by the performance of the company.
But it is heartening to note that strengthening the shareholder franchise has made a difference in how shareholders vote on executive pay practices. Sudhakar Balachandran, Fabrizio Ferri and David Maber in 2007 compared UK pay practices before and after the UK ‘say-on-pay’ mandate, and concluded that the new rule had increased pay-for-performance sensitivity at UK companies.
Impact of legislation Another 2013 study by Ferri and Maber, looking at the impact of the UK legislation on stock prices for companies with high executive pay and the voting results under the UK ‘say-on-pay’ regime, found that shareholders reacted favourably to the legislation and to specific pay reforms at companies receiving negative votes on their pay practices.
James F Cotter, Alan R Palmiter and Randall S Thomas, using US voting data for the first and second year ‘say-on-pay’ votes under the Dodd-Frank Act, observed changes in corporate governance behaviour, such as more complete disclosure of pay-for-performance policies and the reversal of specific, controversial pay practices. More than any factor, identification of ‘outlier’ pay practices by proxy advisory firms was relevant to shareholder ‘say-on-pay’ voting.
This evidence puts to rest three contentions of sceptics on the role of shareholders in disciplining companies. First, shareholders would not be able to identify differences in pay plans, potentially leading to uninformed ‘say-on-pay’ votes. On the contrary, it has been observed that shareholders are capable of expressing dissatisfaction with companies that perform poorly. Second, that a mandatory regime would only increase the influence of proxy advisory firms, whose purportedly one-size-fits-all voting recommendations would be followed blindly by institutional shareholders. However, there is sufficient evidence put forth by James DC Barrall, Alice M Chung and Julie D Crisp in a 2012 study that the Institutional Shareholder Services voting recommendations did not always carry well with shareholders. (Incidentally, the proxy advisory firm Institutional Investor Advisory Services had recommended shareholders of Tata Motors Ltd to approve the company’s remuneration proposals.)
Keeping the balance Last, that shareholders’ vote on executive pay (whether advisory or binding) would upset the balance of authority between the corporate board and the shareholder. According to a 2011 PriceWaterhouseCoopers survey, 72 per cent of directors indicated that their boards would reconsider executive compensation if there are indications of significant shareholder dissatisfaction. Many directors increased communication with shareholders reflecting a change in their interactions with shareholders.
Our governance muddle comes from the fact that shareholders have been repeatedly frustrated in their attempt to contain executive actions and their pay packages. In law and practice over the years, these minority shareholders did not find a say over many big corporate decisions. Overall, shareholder ‘say-on-pay’ offers a model of how procedural reforms can catalyse better corporate governance practices.
The writer is a professor at the University Business School, Panjab University