Shareholder 'say on pay' is completely irrelevant


I was on Radio Five Live the other day debating CEO pay. On my side, arguing that high CEO pay is not necessarily bad, was Chris Philp, the Tory MP for Croydon South who sits on the Treasury Select Committee. His arguments echoed those I regularly hear: shareholder capitalism is good generally, but it's bad that non-executive directors on remuneration committees set pay for executives; that these pay awards are rarely voted down; and that few shareholders actually vote. What we need to make sure shareholder capitalism is working, this popular argument runs, is to make sure that shareholders are vocal and closely scrutinising boards.

This is completely false. For the obvious, intuitive reason as to why this is false, ask yourself why all public firms, owned by shareholders, would choose to set pay by remuneration committee if that meant they'd waste millions overpaying their executives.

But wait—isn't this because shareholders don't vote enough on firm decisions and boards get away with murder? No, this explanation is also false. It's false because shareholders have two tools to make sure their money is in good firms: making the firms they have money in better or moving their money to good firms. In practice, doing the former through shareholder action is pointlessly costly, and shareholder capitalism has much better mechanisms, so shareholders overwhelmingly, and effectively, do the latter.

When firms do bad things, shareholders simply move their money out. Since board members and executives tend to be large shareholders in a firm themselves, the departure of other shareholders, driving down the share price, is a huge personal incentive to run it well.

But ignoring this, it's clear how the exit mechanism alone, combined with profit-maximising market institutions like hedge funds, will shift capital towards well-run firms and away from badly-run ones; towards firms whose remuneration committees use shareholder money well and away from those who don't without any need for a single shareholder voting once.

Centuries of capitalism tell us that the market values 'say on pay' very little, and aloof, powerful boards quite a lot. So does the academic literature.

Similarly, to those unfamiliar with the power of 'exit', the fact that shareholders allow remuneration committees to write lucrative 'golden parachutes' into executives' contracts—seemingly rewarding them for failure—is bemusing. But golden parachutes are actually good for firms that award them, as they make bosses less worried about revealing bad info about a firm to non-execs in a timely manner. Regulatory fair disclosure rules, by contrast, don't work.

If say on pay was so necessary to shareholder capitalism's success, why have firms practising it not taken over the market, and the world? That's the question Philp et al. need to answer before they pressure—or worse, force—firms into broader adoption of stockholder votes on pay.