Investor Preferences During Say-on-Pay Votes: Evidence from the UK

Shareholder say-on-pay voting is a powerful tool that investors can use to steer corporate behaviour by influencing the incentives of managers. Surprisingly, we know little what shareholders demand when they use say-on-pay rights. The preferences of investors on executive compensation have been largely overlooked in the ongoing debates on the role of say-on-pay in corporate governance and the impact of shareholder stewardship on sustainable corporate behaviour.

This information, meanwhile, is critical for understanding the impact of say-on-pay voting on managerial and general corporate behaviour. Shareholders can use say-on-pay votes as a tool for achieving different goals, such as restraining managerial rent extraction though excessive executive pay, improving the design of executive compensation plans to create stronger incentives for managers to put shareholder interests first, or—if we are to believe to the sustainability rhetoric of many institutional investors—stressing the need for a more inclusive and responsible corporate behaviour that considers the impact of business on a broad range of affected stakeholders. Furthermore, information on forces that influence shareholder preferences during say-on-pay votes is required to come up with effective solutions for changing the flaws of established practices.

My recent paper forthcoming in Legal Studies (an earlier version of which is available here) seeks to understand how and why shareholders use their compensation-related voting rights. It does so by analysing the voting records and vote explanations of institutional investors on all say-on-pay proposals put for a vote by the FTSE 100 companies during 2013-2021 to identify investor preferences during say-on-pay votes, changes in these preferences over time, and the key influencers of say-on-pay votes.

This analysis leads to several important findings.

• Institutional investors rely repeatedly on several dominant themes of engagement on executive compensation, including the structure and level of pay, the link between pay and performance, and better communication and disclosure. Investor attention to these topics suggests that shareholder stewardship of pay is driven by both the need to design optimal pay structures and the urgency of addressing the agency problems of pay through the oversight of pay levels and demanding better disclosure.
• Say-on-pay is largely an unused tool in the quest of steering companies towards a more sustainable path: except for a small number of asset managers and pension funds (the paper names the names) investors do not at present demand linking executive pay with environmental or social targets on a broader scale. Nevertheless, say-on-pay is also not an obstacle to promoting more responsible corporate behaviour because investors do not oppose remuneration contracts that include clearly defined and material ESG targets.
• Say-on-pay preferences of institutional investors are not homogenous: preferences differ depending on the particular investor. Nevertheless, institutional investors can be grouped into several clusters based on their preferences. Investors within a cluster vote similarly to each other, rely on shared reasons to explain their votes, and give priority to similar aspects of executive compensation. The major clusters are formed around the voting recommendations of proxy advisory firms. The ISS cluster, which is populated by mostly overseas asset managers, stands out in its size.
• Remarkably, a large cluster of primarily UK-based institutional investors takes a more firm-specific approach by voting independently from proxy advisors and from each other, engaging with companies individually, and relying more evenly on a broader spectrum of engagement topics.

These findings, as the paper explains, have important theoretical and policy implications. Some are highlighted here. First, the role of proxy advisors, especially ISS, grows with the increasing share of foreign institutional investor ownership in a market. Accordingly, regulators need to closely follow and subject proxy voting advice service providers to greater scrutiny in countries where local equity markets are dominated by overseas institutional investors. Notably, the shareholdings of domestic institutional investors are in decline in the UK.

Second, foreign investor reliance on proxy advisors means that institutional investor preferences do not move freely across borders. Consider, for example, the perception that shareholders in the US tolerate high levels of executive compensation. Paradoxically, the increasing share of US investors in UK-listed companies has not changed the stricter approach towards executive pay in the UK. Well-resourced asset managers, like BlackRock, may afford to conduct in-house analysis of voting agenda items in companies across the globe. But the rest do not vote independently and use instead the services of proxy advisors whose voting recommendations are informed by locally dominant governance practices. This stresses the need to design optimal governance standards locally instead of relying on the power of global investors to promote desirable business practices.

Third, the importance of best practice governance codes for the recommendations of proxy advisors highlights the crucial role of such codes as a tool for promoting certain values and influencing corporate behaviour. In the absence of a domestic corporate governance code, proxy advisors are likely to base their recommendations on best practices from elsewhere with outcomes that may be a poor fit for local companies. For example, if regulators consider stakeholder protection as an important goal of corporate governance, then a best practice recommendation on the integration of non-financial ESG targets in the design of executive compensation can lead to quick changes in the pay practices of local firms by directing voting and engagement efforts of investor clusters. But this also means that special care is needed in designing those soft law standards because, once in place, they tend to be promulgated by institutional investors (through their reliance on proxy advisors) and quickly become the market standard.

Fourth, pre-declaration of voting intentions and voting reasons, as well as subsequent changes in these intentions, can amplify the voice of an informed investor by allowing other ‘satellite’ investors to free ride on this information supply. Better knowledge and divergent engagement perspectives of domestic investors are now often wasted because of small shareholdings. Stewardship codes can exploit the expertise of informed investors by encouraging advance information sharing by the most actively engaging (local) investors.

Suren Gomtsian is an Assistant Professor at LSE Law School.