By Lennart Hermans, Head of Research, Osmosis Investment Management
Market appetite for new ways of ranking stocks remains inexhaustible and as ESG factors have developed, this is proving a fertile area of exploration. One of the main challenges is to find something new. One such measure could be Say on Pay votes – where shareholders exercise a right to vote on executive remuneration.
In 2017, a study published by the Harvard Business Law Review argued that Say on Pay may not be “operating as a useful tool for identifying potential problems with executive compensation, including structural problems that may create risks for the sustainability of that performance.” One concern was that the scope for shareholders to use Say on Pay votes to communicate concerns over near-term stock performance would thus increase director incentives to focus on short-term stock performance rather than long-term firm value. Regardless Say on Pay votes are now keenly watched.
Recently, leading investment bank Morgan Stanley updated work done associated with the Say on Pay effect. Specifically, 2019 marked the fifth consecutive year of weak returns from Say on Pay failures in the US companies they covered, averaging an annual underperformance of -15% since 2015. The record for 2020 flipped to outperformance as the Covid backdrop sharply reduced the predictability of corporate performance.
A year ago, the Journal of Index Investing noted that voting track records are not available in one format across asset managers; this is hardly a new problem in the ESG space. Accordingly, it would be useful to know if the Say on Pay ‘factor’ can be captured by other means; specifically, for us, through our Model of Resource Efficiency (MoRE) score.
Looking at those companies covered by Morgan Stanley’s report which failed a Say on Pay vote, we find that each year only one or two featured in our MoRE database of companies that disclose their carbon and water utilisation along with the waste they produced – 21 US companies suffered vote failures in 2019 . No non-disclosing stock attracts an active overweight in any of our programmes; though some exposure may be created for risk management purposes.
We find it unsurprising that companies focusing on delivering undue compensation to executives might also be those which place a low priority on full ESG disclosure. The restoration of pre-Covid equity market and economic conditions should see Say on Pay failures return as a strong indicator of stock price underperformance. Through our MoRE ratings, we have this covered.
Any views expressed are those of Osmosis only and should not be construed as investment advice or in any way recommending a specific security.
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