Say-on-Pay

Say-on-Pay is a rule in corporate governance that grants a company's shareholders the right to cast a non-binding, advisory vote on the compensation packages for its top executives. Think of it as a public report card on how well the board of directors is handling the CEO's paycheck. This practice gained prominence in the United States following the 2008 financial crisis, becoming a mandatory requirement under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The core idea is to increase transparency and hold boards accountable for executive pay, hopefully curbing excessive compensation that isn't tied to the company's actual performance. While the vote is typically advisory—meaning the board isn't legally forced to slash a salary based on the result—a significant “no” vote can be a major public relations headache and a powerful signal of shareholder dissatisfaction, often prompting boards to rethink their compensation strategies to avoid future rebellion.

At its heart, say-on-pay is a communication tool. It's a formal channel for shareholders, the true owners of the company, to voice their opinion on a critical issue: how their money is being used to reward management.

The most crucial detail to understand is that say-on-pay votes in the U.S. are advisory. This means the board of directors can, legally, ignore the outcome completely. If 90% of shareholders vote against the executive pay package, the board doesn't have to change a thing. So, is it pointless? Not at all. A poor showing in a say-on-pay vote is a significant red flag that carries substantial reputational weight. No board wants to be publicly shamed for being out of touch with its owners. A strong protest vote (generally considered anything over 20-30% 'against') puts immense pressure on the board's compensation committee. It can lead to shareholder lawsuits, attract negative media attention, and make it harder to get directors re-elected in the future. The “say” is less of a command and more of a powerful, public suggestion that is very difficult to ignore.

In the U.S., alongside the actual say-on-pay vote, shareholders also get to vote on its frequency. This is sometimes called a “say-on-frequency” vote. They can choose to have the compensation vote:

• Every year
• Every two years
• Every three years

While companies can offer a choice, the overwhelming preference among both investors and governance experts is for an annual vote. An annual review ensures that compensation is consistently aligned with performance and allows shareholders to provide timely feedback on any changes.

For a value investor, say-on-pay is more than just corporate procedure; it's a valuable analytical tool. It provides a window into the alignment—or misalignment—of interests between management and shareholders, a concept central to the philosophy of investors like Warren Buffett.

A contentious say-on-pay vote can be an early warning sign of deeper problems. When you see a company consistently getting high “against” votes, it's time to dig deeper. It might signal an entrenched board that prioritizes enriching executives over creating long-term shareholder value. As a value investor, you're looking for managers who act like owners, carefully stewarding the company's capital. Excessive pay, especially when decoupled from performance, is the polar opposite of this ideal. It suggests management views the company as a personal treasure chest rather than a business they are building for the long haul.

The real gold for an investor isn't the vote's outcome but the information it forces companies to disclose. Before the vote, companies must provide shareholders with a proxy statement, which includes a “Compensation Discussion and Analysis” (CD&A) section. This is required reading for any serious investor. When reviewing the CD&A, ask yourself:

• What metrics are used for bonuses? Are they based on flimsy, short-term goals like revenue growth (which can be achieved at the expense of profit), or are they tied to meaningful, long-term drivers of intrinsic value like return on invested capital or free cash flow per share?
• Is the pay structure overly complex? Sometimes, complexity is used to hide excessive rewards. If you can't understand how an executive gets paid, that's a red flag.
• Are there massive stock option grants? While options can align interests, oversized grants can heavily dilute the ownership of existing shareholders.
• Are there cushy rewards for failure? Look for egregious “golden parachutes” or bonuses paid out even when the company underperforms its peers.

Ultimately, the say-on-pay vote is a starting point. It's the smoke that should lead you to investigate for a potential fire in the company's governance.

Say-on-pay is not just an American phenomenon. It's a globally recognized feature of good corporate governance. The United Kingdom, for instance, has had a form of say-on-pay for longer than the U.S., and its rules are even stricter, with a binding vote on a company's pay policy every three years. Many other countries, including most of the European Union, Canada, and Australia, have adopted similar shareholder voting mechanisms on executive pay. This global trend underscores a simple, powerful idea: the people who own the company should have a say in how its leaders are rewarded.