The rights of shareholders to curb excessive executive pay is an increasingly hot topic. When even the Institute of Directors publishes a survey showing that executive pay is out of kilter with performance then you know that there is a problem. As for shareholder rights in attacking excessive remuneration, the practical effectiveness of such rights depends upon the size and nature of the company in question.
The current media focus is on shareholder revolts in big companies / Plcs. Recent examples include Aviva and WPP where shareholders have voted in large numbers, and in the latter case a majority, against executive pay packages.
In such companies the votes of shareholders are not binding (see various previous posts on this subject) but that is not to say that they do not have any impact. The votes amount to a vote of no confidence in the executive and set against a general background of negative market sentiment can send out a very powerful message. The chief executive of Aviva left shortly after a negative vote and Martin Sorrell of WPP is having to reconsider his own remuneration package after a majority of shareholders voted against it.
However, the fact remains that the vote is largely symbolic and it is only in these straitened times, when commentators are talking of a “shareholder spring”, that the votes have a real impact. For examples of previous votes which have been all sound and fury signifying nothing then you need to look no further than some of my previous posts on the subject.
The situation is different in smaller owner managed companies. Although the principle is the same, in that directors fix remuneration and shareholders do not have direct rights to intervene, a flagrant abuse of the power will give shareholders a right to fight back.
First, and most obviously, a majority of shareholders can get together and remove an overpaid director. This is much less likely to happen in larger companies where getting large numbers of shareholders to agree a pay package is excessive is one thing, getting them to vote to remove a director is another. The majority must of course ensure that the removal of the director is fair to avoid a couner-action against them but nevertheless they hold the power.
It is more of a problem where the overpaid directors hold the majority of the shares. What can a minority shareholder do in this situation? It will depend on whether this is unfairly prejudicial to the minority shareholder.
Each case will depend upon its own facts but the following example illustrates the principle.
Three people set up a company together, each holds 1/3 of the shares, is a director and working for the company. They invest their time and money in getting the company up and running. Each is paid a salary and when the company makes a profit then it is paid out via a dividend.
After a few years one decides to retire as director. The others don’t want to or cannot afford to buy out their shares so the departing director keeps the shares but otherwise stops taking an active part in the company or drawing a salary.
The departed director gets paid dividends for a couple of years but then the two remaining directors decide that it is not right that they do all the hard work and somebody who has left the company is still entitled to a share of the profits. Their clever ruse is to to simply raise their salaries to ensure that there are no profits to be paid out as a dividend. The departed director ceases to get any return on his shares.
Is this unfair? It will ultimately depend upon the context. If the directors had traditionally taken very modest salaries and the majority of profit had been extracted via dividend then if they suddenly double their salaries to absorb the profit then this is likely to be held to be unfairly prejuidicial to the third shareholder. If, however, they gradually increase salaries and this is justified by reference to the market / peer group salaries or increased responsibilities then this is not likely to be held to be unfair even if the departed shareholder ultimately receives no ongoing return on their shareholding.
The bottom line is that even in small owner managed companies where shareholders do have a more direct line of control it can still be difficult to control executive pay. As for the shareholder spring in relation to larger companies, this is likely to be short lived and the risk is that this will be used as a reason not to bring in a more formal mechanism for shareholders to mount a challenge to fat cat salaries.