Business school teaching case study: executive pay and shareholder democracy

This is the latest in an FT series of mini case studies on business dilemmas, for exploration in the classroom and beyond. Read the argument and then consider the questions raised in the box below

Across the western world, big pay rises for chief executives have triggered shareholder dissent.

In May, aerospace group Boeing’s outgoing chief executive David Calhoun was awarded a pay rise of 45 per cent to $32.8mn despite shareholder opposition, following a series of recent incidents and accidents.

In March, the board of pharma giant AstraZeneca proposed to pay chief executive Pascal Soriot £18.7mn. Two proxy advisers called the package “excessive”, but one major shareholder argued Soriot was “massively underpaid” and the package was approved. Also in March, a proposed increase to the fixed salary part of Banco Santander executive chair Ana Bótin’s package drew fire from adviser ISS.

These debates about executive pay, on both sides of the Atlantic, raise questions about the checks and balances on remuneration.

ISS research found that chief executive officers’ pay went up by 9 per cent in the US in the first part of 2024, even when company performance went down. And, in response to a widening pay gap between US CEOs and their European counterparts, many FTSE 100 companies have also proposed significant pay rises this year.

To retain senior executives, the chair of UK-based medical devices maker Smith & Nephew argued it was necessary to raise pay for US executives working at “Brilo” companies: “British in listing only”. The head of the London Stock Exchange Group even called on investors to support higher executive pay, to prevent UK-based companies that generate only a “fraction of their revenue in the UK” relocating to the US.

Research on the effects of CEO pay on performance is extensive but many questions remain. Some work suggests that long-term stock options most effectively align incentives between shareholders and executives, and that large differences between senior and junior employees may be associated with higher long-term profitability. Other studies warn that high pay and large differentials may undermine the extrinsic motivation of top executives and hurt employee morale.

Executive pay is subject to a company’s governance. In line with the OECD’s principles of corporate governance, the board of directors establishes a remuneration committee, which proposes the components and level of the CEO’s and executive team’s remuneration. Ultimately, shareholders vote on this proposal at the company’s annual general meeting.

Occasionally, a board of directors is criticised for not having done its work properly. In January, the Delaware Court of Chancery turned down a $55.8bn pay deal proposed by the Tesla board for Elon Musk. The judge said the board behaved “like supine servants of an overweening master” and the chair’s objectivity had been compromised by “life-changing” sums of money she received when selling Tesla shares worth $280mn in 2021 and 2022. Musk replied that Tesla should move its headquarters from Delaware to Texas.

In theory, when the board fails, shareholder democracy should kick in. But it is rare for an AGM to vote down a remuneration package. One exception was in May 2023, when Unilever shareholders rejected a base salary increase for Hein Schumacher, the incoming CEO.

Sometimes, a large minority will vote against a pay proposal, as happened with the €36.5mn package put forward for carmaker Stellantis’ CEO, Carlos Tavares, in April. However, while such signs of dissent may be embarrassing, they rarely change the outcome.

There are concerns, therefore, that shareholder democracy is not functioning properly.

One explanation for this is that an increasing percentage of shares is owned by passive investors such as BlackRock, Vanguard and State Street. They act on behalf of other financial actors, such as pension funds, but rarely voice opinions on CEO pay. In 2020, BlackRock, the world’s largest passive investor, announced that, by the year-end, “all active portfolios and advisory strategies will be fully ESG integrated” — raising hopes among activists that executive pay would be linked to environment, social and governance standards. But the recent anti-ESG backlash has left some boards uncertain if, and how, to link remuneration to sustainability goals.

A second explanation, as at AstraZeneca and Banco Santander, is that proxy advisers play a growing role. Many institutional investors delegate their voting rights to these specialists. The two largest of them — ISS and Glass Lewis — control most of the proxy advisory market and state opinions on a growing variety of issues. As a result, board members increasingly complain about the influence on pay that these advisers have.

To many critics, then, shareholder democracy is failing in arbitrating on fair executive pay.

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