Which Shareholders Benefit From Low-Cost Monitoring Opportunities? Evidence From Say On Pay

Miriam Schwartz-Ziv

Michigan State University

Russ Wermers

University of Maryland – Robert H. Smith School of Business

November 21, 2015

Robert H. Smith School Research Paper No. RHS 2510442


Theories of free-riding behavior predict that only large shareholders will monitor management. We document that when all shareholders are given a low-cost opportunity to monitor and discipline management, small institutional shareholders are particularly likely to do so. We focus on the “Say On Pay” (SOP) vote, because it currently represents the best low-cost opportunity that shareholders have to give feedback to management. Our paper contrasts SOP voting behavior on three levels: the aggregate level, the mutual fund level, and the institutional level to provide a finer granularity of voting patterns. We document that funds and institutions owning a small fraction of a company, or a small portfolio weight in a company, are particularly likely to vote against management. This indicates that low-cost monitoring opportunities allow many small institutional shareholders to voice a coordinated message to management. Moreover, we find that firms are particularly likely to demonstrate responsiveness to a low shareholder support rate when non-insider blockholders are also present in the capital structure.

Which Shareholders Benefit From Low-Cost Monitoring Opportunities? Evidence From Say On Pay – Introduction

Who monitors and disciplines management—is it the small shareholders of the company, or the large ones? And from an investor’s perspective—should one bother monitoring her small investments? The traditional view in the finance literature is that shareholders holding a large stake in a company are more likely to take costly actions, such as initiating a proxy fight or confronting management, while small shareholders will enjoy a free-ride (Grossman and Hart, 1980; Shleifer and Vishny, 1986; and Hart, 1995).

Recently, shareholders were given a new opportunity to monitor their companies. Effective January 2011, shareholders of companies listed in the U.S. were given a relatively costless opportunity to provide feedback to management through the “Say On Pay” (SOP) vote.1 The formal goal of the SOP vote is to allow shareholders to express whether they approve of the compensation awarded to the named executive officers of a firm during the previous fiscal year.2 However, as Iliev and Vitanova (2015) and Cuñat, Gine, and Guadalupe (2015) argue, the SOP is an opportunity to provide a more general feedback to management.

In this paper, our primary goal is to understand which shareholders (if any) use the Say On Pay vote to govern their companies. In particular, we wish to explore whether small shareholders use the SOP vote differently than large shareholders. We focus on the SOP vote because this vote is held annually, by the majority of the Russell 3000 companies, and it is the best low-cost opportunity for shareholders to provide feedback to management. Institutional investors have a fiduciary obligation to vote on issues such as the SOP vote (Bew and Fields, 2010), and the SOP vote is a low-cost opportunity for them to attempt to govern the company’s management.

Our primary finding is that, compared to large shareholders, small institutional shareholders are more likely to vote against management on the SOP vote. This voting pattern implies that, when ownership is dispersed, the low-cost Say On Pay vote provides an opportunity for many small institutional shareholders to coordinate, and to voice a unified opinion.

We find evidence documenting the pattern of small shareholders opposing the SOP vote, by examining Say On Pay votes cast on three levels. The first voting level we examine is at the aggregate level. We find that, in companies with a large percentage of shares held by blockholders (defined as any shareholder holding at least 5% of the outstanding shares; henceforth, “5% blockholders”, or “blockholders”), shareholders are more likely to vote in support of management on SOP. Thus, when ownership is more concentrated, shareholders are likely to enforce less stringent monitoring through the publicly disclosed SOP vote. In contrast, when a company’s shareholder composition is dispersed, shareholders are more likely to oppose management on the SOP vote. We estimate, for example, that, if the median company, in which 24% of the outstanding shares are held by blockholders, were to shift to a shareholder composition with no blockholders, the opposition rate to the Say On Pay vote is expected to increase by approximately 12.1%.

Say On Pay

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