Say-On-Pay Trends at Banks: Proxy Firms Increase “No” Recommendations

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What should public bank boards know about proxy firm recommendations? McLagan evaluated Institutional Shareholder Services’ (ISS) recommendation patterns for management say-on-pay (MSOP) votes at bank shareholder meetings this year. ISS’ “no” vote recommendations were up from 2013 to 2014, summarized in the chart below:McLagan_linechart.png

Larger banks receive greater scrutiny from ISS and are more likely to get a negative recommendation. Banks with assets greater than $5 billion received “no” recommendations almost twice as frequently as banks below $5 billion.

Despite the increase in negative recommendations, overall shareholder approval remained high. Nearly 75 percent of banks received greater than 90 percent support for MSOP, and half were above 95 percent approval.

Caution! Receiving a negative recommendation can have a dramatic impact on the level of shareholder approval. McLagan performed an analysis of actual shareholder votes after ISS had made a recommendation on pay practices, either “for” or “against.” The table below shows a distribution of vote results.

MSOP Vote Results
Percentile ISS Recommendation
For Against
25th Percentile 92% 59% 
50th Percentile 96% 75%
75th Percentile 98% 85%

At the median, those banks receiving a “for” vote recommendation from ISS also received a 96 percent approval vote from shareholders. In contrast, a bank receiving a “no” vote recommendation only received a 75 percent approval vote—a drop of 21 percentage points at the median! The drop was even more significant at the 25th percentile, where a “no” vote recommendation resulted in an approval rating of only 59 percent, down 33 percentage points from banks that received a “for” vote recommendation.

Here are the landmines to watch out for that can trigger a “no” vote recommendation.

Top 3 Reasons for ISS “No” Recommendation
Pay for Performance Disconnect
Mega-grants of Equity (e.g. sign-on or retention bonus)
Problematic Pay Practices (e.g. excise tax gross up or re-pricing options)

An example of a pay for performance disconnect is when the CEO is paid above the 75th percentile of ISS’ comparative group, but the bank’s performance as measured by total shareholder return (TSR) is below the 50th percentile. Another example would be an increase in CEO compensation as TSR decreases.

Some banks escaped receiving a “no” recommendation in 2014 even though their pay practices would presumably have merited one. The reason? One example is TSR for a bank may have improved and been relatively strong compared to the comparative group; as a result, some pay practices might be given a pass. But, if TSR slips, these banks may well receive a different recommendation.

In summary, don’t take your MSOP vote results for granted. Be proactive in making appropriate adjustments to executive compensation and watch out for the top 3 reasons for “no” vote recommendations, especially if your bank’s TSR is decreasing. It’s much easier to fix the problems before receiving a failing MSOP vote result.

What to Do When Caught Between Investors and Regulators

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hands-tied.jpgIt’s tough to please both regulators and shareholders these days, especially when they want contradictory things. Take the case of executive compensation.

Shareholder groups have been pushing for a greater tie between performance and executive pay. One of the most powerful of these, Institutional Shareholder Services, screens executive pay packages to see how they stack up against peers relative to performance and how the change in CEO pay mirrors change in total shareholder value over five years. ISS recommendations to shareholders on such matters can strongly influence a company’s say-on-pay shareholder advisory vote. Umpqua Holdings Corp. and other banks found this out, as described in a recent story in Bank Director magazine.

But looking at the stock price and shareholder value is exactly what regulators don’t like.

Jim Nelson, a senior vice president of supervision and regulator for the Federal Reserve Bank of Chicago overseeing large banks and savings institutions, is concerned with the use of stock price or return on equity as a measure of performance in making pay determinations. Return on equity doesn’t factor in the risk that executives might be taking to achieve such returns, he said at Bank Director’s Bank Executive & Board Compensation conference recently in Chicago.  There are many factors that can influence the stock price which are outside the realm of management’s control, he said.

“We think most of the people in the firm don’t have a direct impact on the value of the stock price,’’ he said. “We’re looking for a measurement tied to something that that person does control.”

Regulators also explained how they feel about shareholders in their 2010 Guidance on Sound Incentive Compensation Policies, which applies to all banks and thrifts.

The joint regulatory guidance says “shareholders of a banking organization in some cases may be willing to tolerate a degree of risk that is inconsistent with the organization’s safety and soundness.”

So there’s the rub. Do you please shareholders or do you please regulators? But there are ways to combine the concerns of both.

“It’s not the amount [of bonus or incentive pay],’’ Nelson said. “What we’re looking at is the arrangements. You should reward individuals who are producing an attractive risk-adjusted return for you. If they are making more money with low risk, they should be paid more than someone who is making money with high risk. I think that is aligned with what shareholders want and the board wants. There is a lot more free enterprise in this approach than people think.”

He said some big banks are adjusting their profits based on risk metrics before handing out bonuses.

Meanwhile, big banks also are taking into account the needs of shareholders and the recommendations of shareholder advisory groups. Tying short and long-term bonuses, at least in part, to shareholder return is one way to do that.

For example, Buffalo, New York-based First Niagara Financial Corp., one of the nation’s 25 largest bank holding companies with $35 billion in assets, paid out long term incentives to top executives in three ways: stock options, time-vested restricted stock and performance-based restricted stock that vests in three years based on total shareholder return relative to the SNL Mid-Cap Bank Index.

Barbara Jeremiah, a First Niagara director who chairs it compensation committee, said when the bank ran into troubles trying to raise capital for its acquisition last May of HSBC branches in New York and had to cut its dividend in half, the board recognized the hit shareholders took and wasn’t locked into paying short-term bonuses based on earnings per share. The board had made sure it had some level of discretion in determining the bonus, she said.

The board adjusted incentive compensation for CEO John Koelmel to reflect the decline in stock price and reduction of the dividend. Jeremiah encouraged compensation committee members and human resources directors at the Bank Director conference to read and stay abreast of how others viewed executive pay, making note of an article by Gretchen Morgenson of The New York Times entitled  “C.E.O.’s and the Pay-‘Em-or-Lose-‘Em Myth.”

 “We need to keep that outside view,’’ Jeremiah said. “How do our customers and others view us?”

Will Citigroup Shareholders’ “No” Vote Change the Compensation Game?

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monopoly.jpgIn its discussion of its pay package this year for Vikram Pandit, Citigroup’s chief executive officer, the company extolled the accomplishments of the man brought in to clean up the mess that was left in the midst of the financial crisis.

Citigroup has been profitable for eight consecutive quarters. It has repaid the government’s Troubled Asset Relief Program money. Pandit had gone two years without drawing a salary in the midst of the company’s trouble, and was rewarded in 2011 with a salary and a bonus. Plus, the company had taken steps to align its incentive pay with future performance: 60 percent of top executives’ bonuses will be deferred over a four-year period based on performance.

None of this was enough to please investors and shareholder advisory groups such as Institutional Shareholder Services (ISS). Investors voted down this week the CEO’s pay by 55 percent in an advisory vote made possible by the Dodd-Frank Act.  ISS claimed Pandit’s compensation was misaligned with total shareholder returns (Citigroup’s stock price was down 23 percent during the past 52-week period and it was down 93 percent during the past five years.) Future bonuses would be “essentially discretionary” based on a variety of factors such as execution of long-term strategic goals and return on capital, according to ISS.

Basically, the pressure is on for Citigroup and other publicly traded companies to tie incentive pay to specific metrics that benefit shareholders, rather than more vague goals that give the board wide discretion.

It didn’t help matters that Citigroup was one of few big banks to fail the federal government’s stress tests this year, meaning it won’t be able to return capital to shareholders in the form of dividends or stock buybacks.

Plus, ISS determined that Pandit would be paid more than his peers at other big financial firms. Although Citigroup reported that his total compensation for fiscal year 2011 was $15 million, ISS determined that future awards could be worth as much as $34 million. A $10 million award is tied to the company earning pre-tax income for a two-year period of at least $12 billion, which “does not appear challenging given that the company’s income from operations exceeded $15 billion in each of the last two fiscal years.”

Citigroup may be scrambling to deal with the bad publicity now from the “no” vote on pay, even if technically, the advisory vote is non-binding. But will other banks scramble to make sure they don’t suffer the same fate?

Maybe not, says Peter Miterko, a managing director in New York City for Pearl Meyers & Partners, a compensation consulting firm.

“It may be a more subtle impact, rather than everyone saying ‘Let’s redo our pay packages,’’’ he says.

Most banks already have sent out their proxy statements for the year, making it hard to revamp any pay practices. But Miterko thinks the publicity will encourage companies to communicate better in the future with shareholders about why they pay what they do.

A typical problem in proxy statements is that it’s not clear to shareholders what performance metrics must be met for an executive to get incentive pay, he says.

“The positive development [with say-on-pay] is that shareholders tend to see a lot more clear connect with how they’re better off,’’ he says. “Shareholders want to know that executives are told in the beginning of the year, ‘This is what you have to do to get your bonus.’ They want to know the goals are stretch goals and the financial improvement will warrant the incentive payment.”

Don Norman, an attorney for Barack Ferrazzano Kirschbaum & Nagelberg LLP in Chicago, who handles compensation issues for community banks, says many banks have already made changes in order to defer a portion of incentive pay for executives and many have tied it to specific performance that benefits shareholders.

Much of that was set in motion following regulatory guidance on incentive pay in the aftermath of the financial crisis and the compensation rules for banks that received Troubled Asset Relief Program money.

But tying pay almost entirely to shareholder returns can place too much emphasis on short-term performance and thereby create undue risk, he says.

“The market doesn’t have a long-term focus,’’ he says. “It’s ‘what have you done for me lately?’”

Instead, he thinks it is not unreasonable for bank boards to maintain some level of discretionary decision-making over bonuses.   This is much easier in the private bank setting.

“If there’s no discretion, why do you need a compensation committee?” he says. “You have an intelligent and educated group of board members for a reason and there should be some level of deference to their judgment. There are management efforts that should be rewarded that are not always reflected in formulas.  Good or bad, this should be part of any pay assessment.”

Banks without a lot of institutional ownership will have less reason to worry about shareholder advisory groups such as ISS. Still, no one wants to find a majority of their shareholders voting down their pay packages.

Last year, 41 firms in the Russell 3000 (or less than 2 percent of the total index) reported that they failed to win majority approval from investors on pay, according to ISS. This year, 175 companies have had proxy votes and the average shareholder vote has been 90.4 percent in favor, ISS says.

So ending up as one of the firms with a no vote doesn’t look so good.

McLagan, another compensation consulting firm, offers some advice to avoid a “no” vote:

  • Analyze the shareholder base to determine the level of ISS or other advisory firm influence.
  • Monitor changes in each of your institutional investor’s proxy voting guidelines.
  • Audit your compensation and governance plans and programs for any potential exposure to guidelines of proxy advisor groups and institutional investors.
  • Track 1-year, 3-year, and 5-year total shareholder return relative to your ISS-established peer group.
  • Use the proxy compensation discussion section to clearly tell the “story” of executive pay and explain pay and governance decisions.
  • Be prepared to engage in meaningful dialog with shareholders.

2011 Shareholder Voting Trends – Preparing for 2012 Say on Pay

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vote.jpgStarting 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. 

In Summary

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.