Regulators have increasingly forced publicly traded companies to inform shareholders what they pay their executives and why. Now, some shareholders want the chance to talk back.

Following on the heels of efforts to beef up executive compensation disclosure, some shareholder advocates have called for regulators to demand that companies also be required to hold advisory votes on their compensation plans. These votes wouldn’t be binding on a company’s board, but they would give shareholders a voice in the acceptability of pay plans. Moreover, the existence of such votes would serve as a deterrent to excessive pay packages that could risk sparking a shareholder revolt.

Such “say on pay” measures have been a feature of the British market for several years. Now, they have started catching on elsewhere. In Canada, the idea of “say on pay” votes got its first public hearing as shareholder proposals on the proxy circulars of the Big Five banks’ earlier this year — and they were surprisingly successful.

Typically, shareholder proposals in Canada get minimal support, but the motions to introduce advisory votes on executive pay garnered an average of about 40% support among bank shareholders, according to Vancouver-based Shareholder Association for Research and Education, which filed the resolutions. Support ranged from about 35% at Bank of Montreal to 45% at CIBC.

This high level of shareholder support came despite oppo-sition from the Canadian Coalition for Good Governance, a Toronto-based group of institutional investors that advocates improved corporate governance. Instead of endorsing calls for advisory votes, however, the CCGG has called for other governance improvements that, it believes, would obviate the need for these sorts of votes.

Nevertheless, the banks’ shareholders were unusually enthusiastic supporters of the idea, and that has some shareholders pushing for regulators to make the votes mandatory. The regulators have already imposed new executive compensation disclosure requirements that are intended to give shareholders more insight into how much companies pay their executives and why. (See story, above.) But some advocates would like to see this effort extended to include advisory votes as well.

SHARE’s comment on the last version of the Canadian Securities Administrators’ rule says that it “views an advisory vote on executive compensation as a necessary companion to pay disclosure.

“We believe that shareholders require an efficient and inclusive mechanism that will allow them to provide their respective views of the information about executive compensation that they receive from companies.”

The comment letter adds that SHARE advocates non-binding, advisory votes that would provide directors “with feedback on the decisions they have made about executive pay without compromising their ultimate responsibility for it.”

That demand is echoed by London, England-based pension fund manager Hermes Fund Managers Ltd. In its comment on the CSA’s proposed executive compensation disclosure rules, Hermes reports that based on its experience with these “say on pay” votes in Britain, it “has seen the significant benefits that such votes can bring for the relationships between companies and their shareholders.

“Such votes need not generate controversy and dissonance between companies and their shareholders. In fact, the contrary has been the experience so far,” Hermes’ comment letter maintains. It notes that only a handful of boards of directors have ever seen their proposed pay packages voted down by shareholders. For most, it continues: “The significant impact of the right to approve the remuneration report is that there has been a dramatic increase in the level and quality of discussion between remuneration committees and investors.”

Hermes suggests the Canadian market would also benefit from improved dialogue, chiefly because that would enhance the accountability of boards of directors to the shareholders.

“We believe that more accountability would be a basis for less prescriptive regulation of companies,” the Hermes letter states. “Certainly the European experience is that there has been much less demand for detailed regulatory rules because there are better mechanisms for ensuring that directors are accountable to and actively pursuing the interests of shareholders.”

The idea that companies can trade off detailed rules for more constructive relationships with shareholders is an appealing one, but it only works in markets in which these practices are broadly adopted. If just a few companies are doing it at the behest of their shareholders, it isn’t likely to result in general regulatory relief.

@page_break@Indeed, Hermes suggests, advisory votes should be compulsory. It points to the high level of shareholder support for the idea at the Canadian banks’ annual meetings, and argues that some companies aren’t averse to the idea, either.

“Having spoken with some bank representatives, there is a sense that companies prefer not to take the lead voluntarily on this issue but that, in principle, they are not opposed to having an advisory vote as long as all companies are subject to it,” Hermes states in its comment. “Given this market reality, we think the time has come for the Canadian Securities Administrators to revisit this issue.”

SHARE also argues that it’s necessary to make advisory votes a regulatory requirement, albeit for a different reason. It claims that there is no practical way to get all the companies in the S&P/TSX composite index to do so otherwise.

MANY WAY TO AVOID VOTES

A handful of companies in the U.S. have adopted advisory votes in response to shareholder proposals, but, SHARE says, this is only an option for about half the companies in the primary Canadian index (140 of the index’s 257 constituents). The rest can avoid these measures for one reason or another, it says, either because they are organized as trusts, they are incorporated under provincial legislation that makes shareholder proposals tougher to bring in or they have dual-class structures that keep voting control away from minority shareholders.

“It is, therefore, not legally or strategically possible,” the SHARE comment insists, “to advance the advisory vote toward implementation across Canada’s flagship index by way of shareholder proposals.”

Regulators, however, have shown no indication that they are ready to impose mandatory advisory votes at this point. The upcoming proxy season will be an interesting test of whether any companies experiment with the notion voluntarily, or are pushed even further toward it by another round of shareholder proposals.

The imposition of new disclosure requirements may soothe some of the hunger for advisory votes, suggests Christina Medland, a partner with Torys LLP in Toronto and head of its executive compensation practice. If the new rules work as hoped and give investors a better idea of just how much executives are being paid and why, she adds, investors may not feel the need to have their say on the issue with the board.

Perhaps what investors need is not so much a “say on pay,” but a better way to understand executive pay. To that end, earlier this year, New York-based consultancy RiskMetrics Group Inc. introduced an executive compensation project that aims to demystify the world of executive pay for investors and give them tools to determine how well executives’ interests are aligned with their own.

It notes that aligning the interests of shareholders and executives has long been a corporate governance goal, but there’s no way for measuring whether they are truly in sync. To that end, RiskMetrics has developed a model that aims to quantify an executive’s risk, which can then be compared with an investor’s own risk profile.

“By comparing upside and downside risk for shareowners and executives,” a RiskMetrics report says, “the model can identify situations in which the executive’s risk is not aligned with shareholder risk; for example, the executive’s downside risk is limited while the upside risk is larger than shareholders’.”

Moreover, the RiskMetrics report suggests that the model can provide insight into whether executives might be enticed to take big business risks in an effort to meet goals that drive their compensation.

Whether advisory votes ever become widely adopted in Canada remains to be seen. But it certainly couldn’t hurt shareholders to get a better understanding of executive compensation. That way, if they don’t like what they see, they can always vote with their feet. IE