‘Say on Pay’ Design and its Repercussion on CEO Investment Incentives, Compensation, and Firm Profit

Abstract

We investigate experimentally how the enforcement of negative say on pay (SoP) votes affects a CEO’s investment incentives, the level and structure of executive compensation, and firm performance. We operationalize the board’s discretion in response to a no-vote via three levels of SoP enforcement. Boards in our experiment either (i) neglect the vote and never adjust CEO compensation (no enforcement), (ii) enforce the vote and always adjust CEO compensation in accord with the vote (unconditional enforcement), or (iii) enforce the vote and adjust CEO compensation only when the firm performs poorly (conditional enforcement). We find that the unconditional enforcement of no-votes is an effective instrument to curb rents of powerful CEOs. However, it also creates a hold-up problem that undermines CEOs’ investment incentives and firm profit. Conversely, the conditional enforcement of SoP votes eliminates the hold-up problem and improves the pay-for-performance relation, but has no effect on firm profit. We also find that the non-enforcement of SoP votes increases CEO compensation without affecting firm profit. These negative effects of an unconditional enforcement of SoP votes remain robust when participants interact repeatedly and/or when shareholders communicate “acceptable” bonus levels to CEOs. Our results inform regulators and boards of directors on the externalities and the potential cost that may arise when negative SoP votes are enforced mechanically.