Getting Shareholders to Say “Yes” to Your Pay Plan

12-11-13-Naomi.jpgHonolulu-based Territorial Bancorp’s Vice Chairman Vernon Hirata has a piece of advice for other bank boards: communicate with shareholders about potentially sensitive compensation related matters. Or else.

Territorial received a 74 percent approval rating from shareholders in its annual “say on pay” advisory vote in 2012. Sure, it was a passing vote, but too close for comfort, said Todd Leone, a partner at McLagan, the bank’s compensation advisor.

“We called McLagan and said, ‘Houston, we have a problem,’’’ said Hirata, who spoke at Bank Director’s recent Bank Executive and Board Compensation Conference in Chicago.

As Hirata remembers it, the $1.6-billion asset company approved a new equity incentive plan for top management in 2010 after an initial public offering of bank stock in 2009. The company spent lots of time with investor groups explaining the compensation plan, and passed its first shareholder advisory vote with no sweat. But the next year, in 2012, there was almost no communication with shareholders about the incentive plan, aside from a written description in the proxy.

And that was unfortunate because the proxy statement’s summary compensation table that year had some high numbers in it. Most notably, chairman, president and chief executive officer Allan Kitagawa had been paid almost $6.8 million in 2010, more than double his pay in 2009 or 2011. Other executives saw similar jumps that year.

Hirata said the executives were paid stock awards that year that vested over a six-year period, but the company had to report the amounts as a one-time grant, per rules from the Securities and Exchange Commission. Apparently, shareholders were not pleased. “Soon after our proxy was distributed, we got a call from our proxy distributor and said a proxy firm was deciding to recommend a ‘no’ vote,’’ Hirata said.

It was a little late to do anything, as the shareholder meeting was right around the corner. But this year, the bank reached out to shareholders and explained the equity plan better, he said. The bank was rewarded with a 91 percent approval vote this time around.

Shareholder advisory firms, which recommend votes to the large institutional investors who are their clients, don’t like big equity payouts when they don’t seem to be linked to performance, said Chris Fischer, a partner at Aon Hewitt consulting, which owns McLagan. Institutional shareholders owned about 55 percent of Territorial Bancorp’s stock, which meant the bank had to pay attention to the advisory groups.

Other compensation practices that draw the ire of shareholder advisory groups include tax gross ups, where the company agrees to pay an executive’s taxes when a change-in-control would trigger a “golden parachute” and additional taxes under the Internal Revenue Code. Also, shareholder groups don’t like it when companies tell the market one set of goals for the institution’s financial performance, while benchmarking their executives to a lower standard for bonuses.

Another red flag for shareholder advisory groups is when companies compare their compensation to a peer group with other companies that are much larger. Instead, companies typically set up peer groups with similar-sized companies in the range of half to 2.5 times the bank’s asset size, Fischer said. Communication with shareholders is important to winning a say on pay vote, he said.

“It’s better on an annual basis to reach out to your institutional investors about what concerns them with your pay package,’’ he said.

Leone agreed.“You are generating some good will with them, and most important, in your next proxy, you get to say you went out and talked to your investors,’’ he said.

As for Hirata, he had his own lessons learned from the crisis at his bank.

“Do the hard work now,’’ he said. “You don’t want to have that call and scramble at the last minute. You need to do the work before your proxy gets out there.”