Starting with the 2011 proxy season, public companies were required to conduct a non-binding shareholder advisory vote on executive compensation practices at least every three years. Of the more than 3,000 companies disclosing their say-on-pay votes in 2011, only 40 (including one bank) failed to receive majority shareholder support. While the percentage of failures was not high, we expect that number to increase in 2012 as investors (and advisory firms) have more time and resources to assess pay programs, and in 2013 when smaller reporting companies are required to hold their shareholder vote.
While non-binding, a failed vote can result in negative media attention, pressure on board members and shareholder lawsuits. Of the 40 companies failing in 2011, seven already face shareholder lawsuits against executives, directors and, in some cases, their consultants.
2011 Vote Results
While many companies initially recommended votes every three years (triennial), shareholders and advisory firms made clear their preference was for annual votes. By the end of the 2011 proxy season, shareholders at 76 percent, 1 percent and 22 percent of companies, respectively, voted in favor of annual, biennial and triennial votes.
Many companies’ compensation packages passed when put to a shareholder vote by an overwhelming majority (68 percent passed with more than 90 percent of the vote), while 8 percent of companies received less than 70 percent shareholder support.
Role of Shareholder Advisory Firms
Shareholder advisory firms such as Institutional Shareholder Services and Glass Lewis & Co. are having a significant impact on proxy vote results. While these firms have no sanctioned powers, their influence cannot be ignored by boards and companies. ISS in particular had an impact on 2011 vote results, especially at companies with high institutional ownership. Overall, companies with an ISS “against” recommendation received an average of 68 percent shareholder support, compared to 92 percent at companies that received ISS support. Going forward, ISS has indicated they will give extra scrutiny to companies that received less than 70 percent shareholder support in their prior year say-on-pay vote.
What Factors Influenced the Vote?
Based on our review of ISS and Glass Lewis vote recommendations, a common reason cited for receiving an “against” vote was a pay-for-performance disconnect. For ISS, this outcome was triggered when a company’s 1- and 3-year Total Shareholder Return (TSR) fell below industry GICS (global industrial classification standard) codes, without a corresponding adjustment in CEO pay. Poor pay practices such as the use of tax gross-ups and single-triggers on Change in Control benefits also influenced a number of “against” votes. In some cases, poor disclosure and excessive compensation were cited as contributing factors.
Increasing the Likelihood of Shareholder Support
Companies can do several things to increase their level of shareholder support for SOP votes in the 2012 proxy season.
Enhance Proxy Disclosure
The Compensation Discussion and Analysis (CD&A) is the basis of shareholder votes and should be written clearly and presented in an easy-to-read format. Using tables, graphs and bullets can focus the reader on key points. While not required, an executive summary allows companies to tell their "story," reinforce pay-performance alignment and highlight pay practices shareholders will view positively. The CD&A should plainly discuss incentive plan metrics and payouts, as well as any data, analysis and information considered in the compensation committee’s decisions. Peer groups will receive increased scrutiny next year, when ISS adds peer data to its vote methodology.
Understand Shareholder Criticisms
How companies respond to concerns about executive pay programs will be an important factor in future votes. It is critical to understand the voting policies of major shareholders and any issues raised as concerns, even if they didn’t result in an “against” recommendation. Compensation committees should discuss these concerns and consider whether to make changes to pay programs. Companies should provide enhanced disclosure to rationalize pay programs and decisions in light of investor concerns.
Some changes made by companies include amending employment agreements to eliminate golden parachute tax gross-ups (Disney); adding performance conditions for equity grants (Umpqua, Lockheed Martin, GE); reducing compensation (Key Corp), and changing peer groups (Occidental).
Improve Shareholder Communications
One positive impact of say-on-pay is that it has increased communication between companies and their shareholders. A two-way dialogue with major shareholders throughout the year can increase the likelihood of support for say-on-pay.
Shareholder advisory votes on pay packages were mandated with little notice for the 2011 proxy season, leaving investors and advisory firms with limited resources and time to prepare. As say-on-pay moves into its second year, scrutiny of executive pay practices will continue. ISS has already changed its methodology for their vote recommendations. Companies that received shareholder support last year are not guaranteed the same result in 2012.
Overall, monitoring and aligning the pay-for-performance relationship should be an ongoing responsibility and focus of compensation committees. It is not too late to make well informed decisions, engage shareholders and improve disclosure to increase the likelihood of receiving a positive say-on-pay result in 2012.