Podcast Summary: Is Business Broken? Episode: How Institutional Investors Influence Executive Pay
Host: Kurt Nickish
Guests: Bob McCormick (Executive Director, Council of Institutional Investors) and Charlie Tharp (Professor of the Practice, Boston University Questrom School of Business)
Release Date: February 27, 2025

Introduction

In this compelling episode of Is Business Broken?, hosted by Kurt Nickish, the conversation delves deep into the influential role institutional investors play in shaping executive compensation. Building on a three-part series on executive pay, this episode features insights from Bob McCormick of the Council of Institutional Investors (CII) and Professor Charlie Tharp from Boston University Questrom School of Business.

The Size and Influence of Institutional Investors

Charlie Tharp opens the discussion by highlighting the sheer magnitude of institutional investors in the public market. He notes, “Our members who are the public pensions have about $5 trillion under management. When we add in our members who are asset managers, that's another $60 trillion” (02:00). Major players like BlackRock, State Street, and Vanguard Fidelity collectively manage close to $35 trillion, owning approximately 70-80% of most public companies (02:22). This vast ownership translates to significant influence over corporate decisions, including executive compensation.

Kurt comments on the enormity, stating, “If I have a 401k or a 403b, those institutional investors own my stock and are representing me. That's kind of phenomenal” (02:34).

The Engagement Process Between Companies and Institutional Investors

The conversation shifts to how companies engage with these large shareholders regarding executive pay. Bob McCormick explains, “Companies are very conscious of having what Bob referred to as engagement and outreach to their institutional investors” (05:24). This proactive engagement ensures that companies are not blindsided by shareholder concerns during proxy statements.

Charlie adds, “The advent of say on pay, which is a non-binding vote on executive compensation that we've had in place for over 10 years now, has created the opportunity for institutional investors to voice their opinions” (03:58). These engagements often lead to companies reassessing their compensation structures to align more closely with investor expectations.

Pay-for-Performance: Aligning Compensation with Company Success

A central theme in the discussion is the alignment of executive pay with company performance. Charlie emphasizes, “Pay for performance is kind of the fundamental thing that shareholders are really striving to understand” (09:24). Investors scrutinize whether high compensation is justified by strong company performance. When there is a perceived disconnect, especially if compensation appears excessive relative to performance, investors may voice their concerns, prompting companies to adjust their pay structures.

Bob adds, “Directors pay a lot of attention to that vote...they don't have staggered boards anymore where only a few of the directors are up” (07:03). This underscores the importance of maintaining shareholder approval to preserve the board's reputation and ensure re-election.

Trends and Best Practices in Executive Compensation

The guests discuss emerging trends and best practices influenced by institutional investors. Charlie notes a shift towards more flexibility in compensation structures: “There's some initial rethinking of how long-term equity works...more towards a potentially more pragmatic approach of while that may be a good approach, it's not the right approach for every single company” (16:33). This move away from a one-size-fits-all model allows companies to tailor compensation packages that better reflect their unique business cycles and strategic objectives.

Bob highlights industry-specific considerations: “For example, in pharmaceuticals, how long it takes to develop a compound can be seven years...So tailoring the time horizon of compensation...is going to vary by company” (18:58). This nuanced approach ensures that compensation incentives are aligned with the specific challenges and timelines of different industries.

Misconceptions About Institutional Investors

A significant point raised is the misconception that institutional investors are a monolithic group with uniform views. Charlie clarifies, “Investors are not monolithic in their views...there's a significant range of views even within a certain type of investor” (23:33). Companies often mistakenly assume that addressing the concerns of one investor or investor type will satisfy the entire institutional investor base, leading to potential misalignments.

Bob concurs, emphasizing the diversity within institutional investors: “There’s a blend not only between investors, but it's changed over time too...there’s been an evolution of how investors think not only about pay, but some of the positions that companies take” (23:58).

Public Opinion and Media Scrutiny

Addressing the impact of public opinion and media scrutiny, Charlie asserts, “Public reporting and sort of public sentiment has very little impact on investors' views” (14:15). Institutional investors base their decisions on detailed analyses and performance metrics rather than external public sentiment. This focus on data-driven decision-making helps maintain a more objective stance on executive compensation.

Bob adds that transparency in the CEO pay market ensures competitiveness: “The CEO pay market is incredibly transparent....You’re not too far off of what the median is of what similarly sized industry competitors pay” (22:30). This transparency prevents excessive pay inflation, as companies must remain competitive to attract top talent.

Future Directions and Conclusion

Looking ahead, the guests discuss how institutional investors are adapting compensation practices to better align with evolving business landscapes. Charlie mentions, “A more pragmatic, realistic approach is to look at each company and better sense of what makes sense for that company” (20:37). This individualized approach promises more effective compensation strategies that reinforce company-specific strategies and performance cycles.

In conclusion, Bob summarizes the enduring influence of institutional investors: “They focus more on the structure and things like ESG or DEI...it's a small part of pay but it's a way for companies to communicate to investors and the public that it's important” (24:59). The dialogue between companies and institutional investors fosters a more transparent and strategically aligned approach to executive compensation, even if it doesn’t necessarily reduce overall pay levels.

Key Takeaways

• Institutional Dominance: Institutional investors manage vast sums, owning the majority of public companies, thereby wielding significant influence over corporate decisions, including executive pay.

• Engagement is Crucial: Continuous dialogue between companies and institutional investors ensures compensation programs align with investor expectations and company performance.

• Performance Alignment: There is a strong emphasis on linking executive compensation to company performance, ensuring pay-for-performance remains a core principle.

• Flexible Compensation Structures: Emerging trends favor customized compensation packages tailored to specific industry needs and company strategies, moving away from standardized models.

• Diverse Investor Views: Institutional investors are not a single entity; they hold diverse perspectives, necessitating comprehensive engagement strategies.

• Minimal Public Impact: Institutional investors prioritize data and performance over public opinion, maintaining objectivity in compensation decisions.

Notable Quotes:

• "Our members who are the public pensions have about $5 trillion under management. When we add in our members who are asset managers, that's another $60 trillion." — Charlie Tharp (02:00)

• "Pay for performance is kind of the fundamental thing that shareholders are really striving to understand." — Charlie Tharp (09:24)

• "Public reporting and sort of public sentiment has very little impact on investors' views." — Charlie Tharp (14:15)

• "Investors are not monolithic in their views...there's a significant range of views even within a certain type of investor." — Charlie Tharp (23:33)

This episode provides a nuanced exploration of the intricate relationship between institutional investors and executive compensation, shedding light on how this dynamic shapes the modern corporate landscape.