- On October 27, 2016
A very interesting academic paper was published last week, titled Common Ownership, Competition, and Top Management Incentives. The authors published a more readable summary at HBR: Research: Index Funds Are Fueling Out-of-Whack CEO Pay Packages.
The research paper from Anton, et al suggests that some institutional investors are influencing the design and adoption of performance-insensitive CEO pay packages, and more specifically, seem to be reducing the performance-orientation of the pay packages.
The question the team poses is this:
And they propose the following answer:
The research team reviewed data from among 1500 companies across various industries and studied the nature of executive pay among companies competing in industries with more common ownership, as well as those competing in industries with less common ownership. Their findings:
- BlackRock is the largest shareholder of approximately 20% of publicly-listed US companies, often including the largest companies in the same industry; Fidelity is the largest shareholder of approximately 10% of public companies in the U.S.
- “Common ownership” concentration (including ownership of multiple institutional investors that also co-own other companies in the industry) has doubled in the last 20 years in several industries
- Common ownership among companies in an industry is directly related to pay packages that are less sensitive to company performance and more related to industry performance.
- Pay that is not related directly to company performance — including base pay — is higher in industries with high common ownership, than those without.
The hypothesis by Anton et al is that institutional shareholders such as BlackRock, Fidelity, Vanguard and others may be pushing performance-insensitive compensation arrangements as a way to mitigate competition with their other portfolio firms. In other words, they are directly or indirectly encouraging “pay-for-collective-performance” or “pay-for-collaboration”, not “pay-for-company-performance”.
While a major shareholder often exercises outsized influence on the Board, even the largest institutional shareholders own at most only 5%-10% of outstanding shares. Even counting common ownership, institutions collectively own at most 30% of shares, while even among those institutions, many will have differing perspectives on executive compensation. Outside of institutional ownership, a significant majority of shares will still be held by other shareholders — shareholders that have a primary interest in having the Board and its Compensation Committee focusing on maximizing the long-term sustainable value of the enterprise, not the industry. So, even if a significant number of shares are held collectively by funds that have an interest skewed toward industry performance rather than individual company performance, the Board and Compensation Committee still has a responsibility to represent the majority of shares that are held by other shareholders who have a strong interest in the performance of the company — specifically, company outperformance of the industry.
We find the Anton et al research interesting and thought-provoking. However, we are not convinced that index funds are exerting a great influence on the design of executive compensation programs. Still, an important takeaway is reinforced by this research: every Board’s Compensation Committee must continually ensure that the company’s executive compensation levels and programs are designed to support the company’s business strategy and ultimate objective of maximizing long-term value for shareholders, not the interests of a few shareholders who may prefer industry performance to company performance.
Sheffield Barry is a Compensation and HR Consulting firm, focused on providing effective and customized advice to clients in an efficient manner. We leverage technology to deliver data and analysis as efficiently as possible, so we can invest more time understanding our clients’ unique business issues to develop custom solutions and advice. Please visit us at SheffieldBarry.com or email us at info@SheffieldBarry.com.