IR Papers: When say starts to pay
US CEOs anxious about shareholders opining on their pay packages can take comfort: the yacht is safe. But they may find themselves working that bit harder to keep it.
A study of US say-on-pay adoptions between 2006 and 2010 (prior to Dodd-Frank) reveals little effect on the level and structure of executive remuneration. By rather dramatic contrast, the international research team finds adopting a say-on-pay vote proposal plumps up an array of corporate performance indicators, including market value, company profitability and long-term performance.
‘Say on pay doesn’t seem to have the negative effect many warned it would,’ says study co-author Maria Guadalupe, associate professor of economics and political science at INSEAD. ‘In fact, it significantly increases shareholder value.’
Guadalupe suggests that rather than curbing pay, say on pay provides a powerful mechanism for shareholders to monitor firms and express dissent. In turn, this raised shareholder voice is a key driver of the increased performance.
‘The say-on-pay vote is qualitatively different from other sorts of shareholder votes,’ she comments. ‘It is a referendum that summarizes the opinion of your shareholders in a concrete and easy-to-publicize metric. It gives a very clear signal to management. Something about [management] behavior changes as firms operate more efficiently.’
Moreover, says Guadalupe, the stock market rewards say-on-pay companies, with investors expecting the greater scrutiny to boost CEO incentives to work harder and increase shareholder value. ‘A negative say-on-pay vote can definitely affect a CEO’s career prospects,’ she adds.
She also says that as US managers were systematically opposed to pre-Dodd-Frank proposals, firms were apparently not fully able to self-regulate and independently adopt measures that benefited shareholders. ‘In cases where the market does not deliver such things, government intervention can be warranted,’ she concludes.
For investors, all consistent firms are alike, but each inconsistent company is inconsistent in its own way. Recent research blending psychology and finance finds that shareholders notice not only the magnitude of earnings surprises but also their frequency.
‘Firms can go to great lengths to never miss consensus estimates,’ notes study co-author Lisa Koonce, professor of accounting at the University of Texas at Austin. ‘But streaks end. It may seem like the end of the world at the time, but investors take into account a longer time frame.’
Previous work in this field has focused on the valuation benefits of consistent benchmark-beating performance. But Koonce, along with colleague Marlys Gascho Lipe, professor of accounting at the University of Oklahoma, conducted a series of experiments using MBA students to test investor reaction to a company’s inconsistent benchmark performance.
Their findings suggest that when discriminating between inconsistent companies, investors have a strong preference for those that are least inconsistent – even in the face of large differences in magnitude (such as EPS). ‘Not every inconsistency is the same,’ explains Koonce. ‘All the attention has been on magnitude. Our research shows investors use a frequency heuristic as well.’
Scientists report a significant correlation between the likelihood of a cross-border M&A deal’s success and the number of informed investors with target region expertise on its shareholder roster. The effect is strongest in less mature M&A markets. Study co-author Anna Faelten, a research fellow at City University London, says winning companies are contacting their investors, soliciting valuable opinions about regional experiences and corporate strategy from these unbiased and informed sources.
‘In this instance, two-way communication [between knowledgeable shareholders and companies] can add significant value,’ notes Faelten. She advises firms to establish a proactive IR program for the recruitment of dedicated, research-intensive, institutional investors whose portfolios also include significant regional exposure before launching into a cross-border M&A program.