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Will 'Say on Pay' Votes Prompt Firms to Listen?

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Executive compensation has been an important topic in the investor community for over a decade. Unfortunately, shareholders have gone largely unheard and the issue has been little more than a blip on the radar of corporate America.

No doubt, it is in the best interest of a company and its shareholders to secure talented and capable executive officers to lead it into a profitable future. But pay packages in recent years have skyrocketed and continue to grow ever larger and more disparate from the ordinary workers' income. These bloated packages have received the blessing of a multitude of courts hearing challenges to executive compensation.

The recent rejection by shareholders of Citigroup's executive pay packages, however, and the resulting firestorm of publicity, has thrust the issue of executive compensation — and, more generally, whether shareholders' voices should be heard in major corporate decisions — front and center.

The question thus arises: Is the tide shifting in favor of giving shareholders a greater voice in the critical arena of executive compensation, and will this extend to other areas of corporate management? In other words, do shareholders now matter?

Although I do not believe we will see a cataclysmic shift in the way companies respond to shareholder input on executive compensation and other issues traditionally controlled at the board level, the Citigroup vote should definitely serve as a wakeup call to all directors serving on public company boards that they need to start listening to the ultimate owners of the company. Otherwise, shareholders may – and should - find new board members who will.

As of January 2011, section 951 of the Dodd-Frank Act requires public companies to periodically hold a shareholder vote approving or disapproving of the company’s executive compensation program. The vote is non-binding so a company can choose to simply ignore the will of the shareholders and deal with the resultant publicity fallout.

Boards actually had it easy for the 2011 proxy season. Only a very small number of public companies had a negative "say on pay" vote. Thus, most executives got their hefty packages with the stamp of approval from the shareholders. Even in those instances where there was a negative vote, the votes were largely ignored, spurring a number of derivative actions. These cases have almost universally been rejected by the courts with one notable exception in Ohio, largely deemed to be an outlier opinion. All in all, not a very successful first year.

This year, the number of negative votes is looking to again be relatively low. This may, in part, reflect the fact that many companies have already scaled back executive compensation packages in the face of financial hardships and negative publicity.

Then, on April 17, came the stunning Citigroup vote. Only 45% of shareholders approved of the executive pay program covering five of the top executives, handing the company the largest and most public rebuke to date under the say on pay provisions. Several other banks have since followed suit. How Citigroup handles the rejection may determine whether we see an increased number of no votes in the next few years as shareholders find their voice.

If Citigroup and other companies hear the message of these no votes and substantially reduce or rework the previously approved pay packages, that would be a big win for shareholders and would mark a positive shift in perceptions about whether shareholders matter. But what happens if Citigroup (or any other company in the face of a no vote) ignores the vote — which under Dodd Frank they have every right to do — and grants the executives their lucrative pay packages over the voice of the shareholders?

The short term answer is nothing. Surely there will be litigation over it (at least one suit has already been filed against Citigroup) but in most states, including Delaware, executive compensation is a quintessential issue for the board's business judgment and courts are reluctant to second guess that judgment.

Only if the board is somehow conflicted or otherwise unable to exercise their business judgment is there any likelihood of a successful shareholder derivative suit for a board’s breaches of their fiduciary duties. Theoretically, excess compensation could also amount to corporate waste if the pay was so egregious that it amounted to throwing away the company's money. A long shot at best — just look at the Disney decision approving Michael Ovitz's whopping exit package.

The long term remedy for being ignored by the board on executive compensation or any other issue is for shareholders to simply replace the board by offering up a proposed slate of directors committed to giving shareholders a voice. This can be an arduous and time consuming but ultimately effective process and the one that activist shareholders will have to commit to if they really want to send the message that, yes, shareholders do now matter. To all the directors out there, it will happen so it's time to wake up and listen.

Christine S. Azar, an advocate of shareholders' rights, is the partner in charge of Labaton Sucharow’s Delaware office. She concentrates her practice on prosecuting complex merger and derivative litigation.

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