Giving shareholders more managerial power over corporate affairs-the goal of many recent corporate reform proposals-comes with costs that commentators have failed to recognize. In general, the more involved shareholders are in a firm’s managerial decisions, the more dfficult it is for directors to be held accountable for the outcome of those decisions. This can weaken directors’ ex ante incentives to act in the interests of shareholders. This Article argues that this phenomenon may undermine the ambitions of the recent high-profile corporate reform requiring each public company to hold periodic, non-bonding shareholder votes on its executive compensation.
Supporters of the reform, known as “say on pay,” predict that corporate directors will be fearful of shareholder “no” votes because they will attract embarrassing attention to directors and the firm. In other words, shareholder voting will amplify the “outrage constraint”- the threat of shame or embarrassment in the media that, according to the influential managerial power model of executive compensation, limits directors’ ability to award pay packages that are too big and not sensitive enough to performance. To avoid the amplified outrage associated with a “no” vote, directors will be compelled to modify executive pay in ways amenable to shareholders.
Shareholder voting on executive compensation, however, could hurt shareholders in ways supporters of the reform have overlooked. Once shareholders have approved a firm’s compensation arrangements, directors will no longer bear complete responsibility for them. If any negative attention-any outrage-is directed at the firm’s pay practices in the future, directors can escape a portion of the blame that otherwise would have been theirs alone. This diffusion of responsibility will partially insulate directors’ reputations from future outrage, and because directors will no longer bear all of the future costs of taking risks in the CEO’s favor,they may end up taking more of those risks.
By clouding the functioning of the outrage constraint, shareholder approval thus may liberate directors at some firms to offer executive pay packages that are larger and more insensitive to performance than if the board were acting alone.In view of this effect, giving shareholders a say on executive pay may injure as many firms as it helps. To eliminate this over breadth problem, this Article proposes amending the legislation to allow firms to opt-out of the say on pay regime by shareholder vote. This preserves the benefits of say on pay for those firms where shareholders wish to retain it and allows other firms to exit the regime at little cost.