Shareholder Voice and Executive Compensation

Résumé

Managerial influence on the Board of Directors induces an agency problem in the design of executive compensation. I evaluate the role of shareholder voice in disciplining compensation practices by estimating a model of CEO compensation with non-binding shareholder approval votes (Say-on-Pay). The Board sets CEO pay and is biased towards a high wage; shareholders can fail the Say-on-Pay (SOP) and punish the Board for overpayment. Failed votes are perceived as costly by both the Board and shareholders: a cost of 2.06% (0.76%) of value for the Board (shareholders) is sufficient to match the data. SOP thus resembles a costly punishment mechanism and the disciplining effect on compensation increases firm value by 4.6% on average. Empirical evidence suggests the Board cost is a career and reputation concern for directors, and shareholders internalize a cost to dissenting from the Board on a prominent policy. I construct a counterfactual SOP mechanism which emulates giving a focal shareholder an advisory seat on the Board; this lowers the SOP failure rate, decreases wages and further increases firm value.