Are Shareholders Stupid? On The Surprising Impact of Binding Say-On-Pay On Stock Prices

We study the shareholder value implications of a shift in the corporate balance of power towards shareholders. We find that in response to an unanticipated event that made it likely that an annual binding shareholder vote on management pay would become compulsory for Swiss public companies, the shareholders of a large majority of companies reacted strongly negatively. We investigate two reasons for this surprising reaction of the apparent beneficiaries. First, while binding say-on-pay can offer alignment benefits, it can interfere with efficiently managed companies. Consistent with this idea, for example, firms that have performed well and those that pay their CEOs at market levels experienced particularly sharp share price drops. Second, CEOs may anticipate that any extra-contractual human capital investments they make in the firm are unlikely to be rewarded in full when shareholders vote on compensation in the next annual meeting. As a result, shareholders may worry that CEOs distort their specific investments and hence decrease firm value today. Consistent with this idea, for example, firms with younger CEO and firms which incentivize their CEOs only with cash bonuses saw steeper valuation declines