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Investors join Obama on CEO pay

More shareholders want 'say on pay' rules - steps the next administration might make into law.

By Richard Siklos, editor at large
Last Updated: November 14, 2008: 10:50 AM ET

LOS ANGELES (Fortune) -- President-elect Barack Obama had plenty to say about corporate excess on the campaign trail. One place his presidency should have a direct and early impact is on so-called "say on pay" legislation that would make annual shareholder votes on senior executive compensation part of securities law.

The question is whether that would actually help rein in over-the-top executive pay.

Regardless, the natives are restless amid an economic meltdown that has wiped out trillions of dollars of shareholder value. That's put corporate leaders under an intense glare. With executive pay as a flashpoint, shareholder advocates say big changes may lie ahead in the new administration.

"Over the next six months or so, it's going to get very interesting," says Richard Ferlauto, director of pension policy at the American Federation of State, County and Municipal Employees union.

Indeed, the day after the election, Sun Microsystems (SUNW) shareholders also cast ballots for change and voted in favor of a "say on pay" resolution by the largest margin yet, with 67% in favor. The tech company has seen its stock drop 83% in the past year and some shareholders were up in arms over CEO Jonathan Schwartz's $7.7 million in compensation, which included private aircraft use and the installation of a home security system.

Connecticut state treasurer Denise Nappier, who oversees $23 billion in state pension funds and who spearheaded the vote, depicted the Sun vote as a "turning point" in how shareholders will address executive pay in next year's proxy season.

Last year, Obama introduced a "say on pay" bill that would make non-binding "advisory" shareholder votes on executive compensation packages mandatory at annual meetings. Congress has already passed a similar bill, while the one proposed by Obama has languished in the upper house - a state of affairs that probably won't last for long.

Including Sun, some 100 companies have voted on the subject since 2006 and in close to 20 instances shareholders were in favor of having a say on pay. To be clear, these are votes to agree to adopt a policy of holding votes on executive compensation going forward, rather than votes on the compensation itself.

The first actual vote on pay at a U.S. public company was in May at insurer Aflac (AFL, Fortune 500) - and 93% of the votes cast were in favor of approving the CEO's pay package. According to the Corporate Library, these resolutions to adopt "say on pay" policies have gained, on average 42% of votes supporting them.

It's an ironic season, and ironically some of the companies where these resolutions have gained the weakest support over the past couple of years are financial firms, including Merrill Lynch (MER, Fortune 500), Morgan Stanley (MS, Fortune 500), Citigroup (C, Fortune 500) and Wachovia (WB, Fortune 500). And, interestingly, even in cases where the resolutions have gained the majority of votes, most of the companies have not gone ahead and adopted the provisions (something legislation would make mandatory).

There are a few nagging questions raised by all this. For starters, is CEO pay really the hot issue right now, or is this another step down what Obama's harshest critics see as his "Marxist" path? I'd argue that so long as the votes are "advisory," and the intent is to make sure that compensation is tied to performance, then there's no harm. It sounds like good business to be open to more shareholder input.

If anything, the "say on pay" movement - which mirrors shareholder right practices in the U.K. and elsewhere - sounds a bit toothless because of the advisory nature of the vote.

"Say on pay is in and of itself but a baby step," said Charles Elson, a governance expert at the University of Delaware. "Ultimately the issue is replacing the directors who approve the bad pay."

This is where "say on pay" could get interesting because it is closely linked to another movement, known as "proxy access," which basically gives investors greater ability to nominate their own slates of directors - and perhaps include some kind of statute to reimburse shareholders' for the costs of nominating dissident directors if they are successful. (This would replace the current practice of investors withholding votes for directors, which is often more of an exercise in moral suasion than accountability.)

An important issue raised by what appears to be a new era of shareholder rights on U.S. stock markets is to make sure that "say on pay" doesn't become euphemism for "CEO payback". The tenure of a typical American CEO is already declining, and attracting and keeping the best and the brightest is going to be critical in the years ahead.

Clearly, a balance needs to be struck between rewarding success and, as Connecticut's Nappier put it, some corporate boards' "tendency toward unfettered greed at shareholder expense."

On the stump, Obama noted that in 2005 the average CEO earned 262 times the pay of the average worker. That's an attention-getting and in some ways distasteful statistic to be sure but then again, 2005 sure looks good about now. To top of page

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