12/04/2013 04.24 EST
With “Say-on-Pay” and Dodd-Frank being practically household names, perhaps it is time for a 101 version in case you missed it.
With the financial crisis in 2008, the United States government developed the Troubled Asset Relief Program (TARP), which was set up to buy assets and equity from financial institutions to strengthen the financial sector. It was signed into law by President George W. Bush on October 3, 2008, and it was a component of the government’s measures to address the subprime mortgage crisis. TARP originally authorized expenditures of $700 billion.
Out of this same financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was born, with its fundamental purpose being to rein in Fannie Mae and Freddie Mac. It also reduced the amount authorized by TARP to $475 billion. Barney Frank has described TARP as “highly successful and wildly unpopular.”
Fundamentally, over several years, tons of risk was being taken in the housing market by financial institutions that did not suffer any consequences. These actions created significant economic change, which required a BIG change in legislation. Translation: loans were made by people who were going to sell the loan, with the incentive being to issue many loans with little concern for borrowers’ ability to pay them back. Not a good thing.
We saw the Lehman failure followed by the AIG failure. None of the debts for Lehman were paid, while “all” of the debts for AIG were paid. However, AIG literally had no idea how much it owed, so the first estimation of $80 billion was paid, followed by another $80+ billion. Yes, that is billions.
The intent of Dodd-Frank was actually to re-attach responsibility to risk, and to only ban giving mortgage loans to those who cannot pay them back. However, also out of Dodd-Frank came “Say-on-Pay,” which provided a means for shareholders to have a voice regarding executive pay, as the Act requires companies to bring a non-binding shareholder vote on senior executive compensation at least once every three years. Virtually all companies elected to take an annual vote. In 2011, the first mandated Say-on-Pay votes occurred.
As mentioned, the vote is “non-binding,” meaning that the company is not obligated to abide by its outcome or take specific actions. However, it is another factor for the Board of Directors or compensation committee to consider in determining the company’s executive compensation policies; actually, it does have more than symbolic importance, as it’s a vote of “no confidence” in the company’s exec comp program. Shareholder firms such as ISS and Glass Lewis have used a 70 percent positive vote as a sort of benchmark that may trigger further mischief from the “watchdogs.” What’s worse – Boards that have not responded to a negative (or even low) vote have been sued.
Interestingly, the failure rate for Say-on-Pay is extremely low. Is this penalizing corporations that weren’t doing anything wrong, as they now have significant costs to comply? What are your thoughts?