Shareholders and investor advocacy groups have long criticized executives for being paid top dollar while achieving subpar returns for shareholders. In response, the Securities and Exchange Commission (SEC) passed the Dodd-Frank Act of 2010, which has two, related provisions that aim to improve the governance of executive compensation.

The first gives shareholders of publicly traded firms the right to cast advisory votes related to executive compensation (also known as say-on-pay votes) and was implemented in 2011. Say-on-pay represents the shareholders’ independent view of executive compensation and is one of several mechanisms that Congress considers useful in setting pay to maximize shareholder value.

The second provision was implemented more than a decade later, in 2022 (SEC 17 CFR Parts 229, 232, and 240, Release No.34-95607). It requires publicly traded firms to disclose additional details related to executive compensation and pay-versus-performance, including an alternative measure of executive compensation known as compensation actually paid – CAP. This new measure is intended to capture the value of total compensation paid to an executive during a fiscal year and includes the changes in the values (unrealized gains and losses) of an executive’s portfolio of previously awarded equity compensation (stocks and stock options). Because CAP accounts for changes in the fair value of an executive’s equity awards, it is arguably the most relevant measure of executive pay. Another novel feature of CAP is that negative values are possible – existing measures of executive compensation disclosed in the summary compensation table of a firm’s proxy statements (excluding claw-backs) have a lower bound of zero.

In a new paper, we focus on the relationship between these two provisions of Dodd-Frank. We use the newly available data of executive CAP to investigate situations where executive pay is misaligned with firm performance – i.e., the executive is receiving positive CAP while the firm is performing worse than its peers. We study say-on-pay votes in S&P 500 firms in the first two proxy seasons following the implementation of the CAP disclosure requirement. Data related to CAP in fiscal years 2022 and 2023, as well as data related to proxy voting in fiscal years 2023 and 2024 are hand-collected.

We find that when firm performance is misaligned with executive CAP, a larger proportion of shareholders vote against executive compensation. These results indicate that shareholders, when casting say-on-pay votes, consider not just the features of executive compensation but also how it relates to firm performance. We do not, however, find a significant relationship when using summary compensation table-based measures of executive compensation to identify pay-performance misalignment. These contrasting findings provide empirical evidence of the utility of the SEC’s latest pay-versus-performance disclosure requirements.

Given the public’s low opinion of high CEO pay , we also investigate whether shareholder dissent varies with the level of that pay. We find that shareholders are more likely to vote against higher levels of executive compensation when pay and performance are misaligned, but there is no significant correlation between levels of executive compensation and levels of shareholder disapproval when pay and performance are aligned. These results suggest that shareholders tolerate high  CEO pay when the CEO also generates value for the shareholder, but not otherwise, and that shareholder dissent increases with CEO pay only when pay and performance are misaligned.

The results of our additional cross-sectional analyses indicate that features of executive compensation can affect the degree to which shareholders react to instances of pay-performance misalignment. A larger portion of shareholders vote against executive compensation when it contains a larger proportion of equity. A possible explanation is that equity awards dilute shareholder control of the firm, and shareholders may have higher expectations for executives given such awards. A smaller portion of shareholders vote to disapprove executive compensation when a larger portion of non-equity incentives are determined according to total stock returns. This suggests that the use of total shareholder returns as a performance metric may help align CEO pay with shareholder interest.

Our paper provides empirical evidence on the utility of the newly mandated pay-versus-performance disclosures. Our results yield new insight into how important the pay-performance relationship is to shareholder voting. Our results also document that shareholders do not view all instances of high CEO pay the same, and the alignment or misalignment of pay with performance shapes their voting behavior.

This post comes to us from professors James Jianxin Gong at California State University, Fullerton, Nian Lim (Vic) Lee at California State Polytechnic University, Pomona, and Sophia Wang at California State University, Fullerton. It is based on their recent paper, “Do Shareholders Vote against Executive Compensation When Pay is Misaligned with Performance?” available here.