The Advisors' Blog

– Ted Allen, RiskMetrics

During the first U.S. proxy season with widespread advisory votes on compensation, there was broad investor support for corporate pay practices. For the 127 companies for which RiskMetrics Group has results, an average of 87.9% of votes were cast in support of management “say on pay” proposals this year. So far this year, every management proposal has passed; the lowest vote was 59% support at the Bank of the Ozarks. Nine other companies received less than 70% approval. (Editor’s note: This data doesn’t include vote results from small-cap firms below the Russell 3,000.)

Most of the advisory votes were held at the several hundred financial companies required by federal law to hold compensation votes because they received support from the Treasury Department’s Troubled Asset Relief Program (TARP). In addition, 17 non-TARP firms likely will conduct voluntary pay votes this year. However, the House of Representatives has passed legislation to impose marketwide annual votes on pay, so this year’s results may shed light on what might happen in the future.

Several TARP companies, including Flagstar Bancorp, Home BancShares, and Bank of Kentucky Financial, received support from over 98% of votes cast. Notwithstanding the public outcry over the company’s bonuses, American International Group’s pay practices received 98.2% support, but that result was inflated by the U.S. government’s almost 80% voting stake.

Most major financial firms received wide support for their pay practices. Goldman Sachs, JPMorgan Chase, Wells Fargo, Bank of New York-Mellon, and Morgan Stanley all received more than 93% approval. The two notable exceptions were Citigroup (84.2 percent support) and Bank of America (71.3 %). While Citi’s pay practices didn’t spark significant investor complaints this year, the American Federation of State, County, and Municipal Employees (AFSCME) waged a “vote no” campaign against six long-serving audit committee members, and the company posted a 76% share loss during the preceding fiscal year.

At Bank of America, there were two “vote no” campaigns against board members; both dissident groups complained that the company failed to provide adequate disclosure over more than $3 billion in bonuses for Merrill Lynch employees before investors voted in December to acquire the ailing brokerage firm. At the same time, the advisory vote at Bank of America received little attention from investors or the news media, which focused on an independent chair proposal, which won majority support, and the “vote no” campaigns. The company’s ballot also included a shareholder proposal seeking a permanent advisory vote; that resolution received 40.1% support.

Implications

Supporters and opponents of annual pay votes draw different conclusions from this year’s vote results. Ed Durkin, corporate governance director at the United Brotherhood of Carpenters, who has called for multi-part votes every three years instead of annual votes, said the TARP results “reinforce our belief that annual votes would be a mindless process.”

“It is a process that does not allow for thoughtful analysis and voting,” Durkin said of annual votes. “It is going to turn into a ratification process,” particularly if votes are held at an even larger number of companies, he told R&GW.

Annual vote proponents respond by pointing out that this year’s support levels were inflated by the inclusion of uninstructed “broker” votes in vote tallies at many firms. Unlike shareholder votes on equity plans, advisory votes have been deemed a “routine” matter, and thus brokers are permitted by New York Stock Exchange rules to cast uninstructed client votes in support of the management proposals. At many companies, broker votes can account for more than 15% of the votes.

AFSCME’s Richard Ferlauto, an annual vote proponent, also pointed out that many activist investors were more focused this year on submitting shareholder proposals to establish advisory votes. Another significant factor was that institutional investors did not learn of the mandatory TARP votes until late February after U.S. Senator Christopher Dodd inserted that requirement in economic stimulus legislation and prodded the SEC to require advisory votes during the 2009 proxy season. “The vote legislation was enacted late so many investors did not have voting guidelines in place,” Ferlauto said.

Tim Smith of Walden Asset Management, another prominent advocate of annual “say on pay” votes, said investors will have more lead time next year to dissect pay packages. He attributed this year’s generally high TARP votes to the fact that many financial firms “cut back pay dramatically” during the economic crisis. He also observed that significant “against” votes will be rare, as most companies should receive overwhelming support during advisory votes when there are no “red flags” over their pay practices.

Recalling the experience of the United Kingdom and other markets, Ferlauto said: “It will take some time for shareholders to figure out how to use this new tool.”

In Britain, advisory votes have been held since 2003, but remuneration report rejections were quite rare until this year, when reports were voted down at Royal Bank of Scotland, Royal Dutch Shell, and three other firms. In Australia, many companies have improved their pay practices since advisory votes were first held in 2005, so the average opposition vote (which include abstentions) at S&P/ASX 200 companies has increased slightly from 10.6% to 12.9%, according to RiskMetrics data. At the same time, investors have become more willing to reject reports in cases of excessive pay practices. The first majority “against” vote at an S&P/ASX 200 firm didn’t occur until 2007, while eight reports were rejected during Australia’s most recent proxy season in late 2008.

Possible Reasons for Low Votes

During this year’s U.S. proxy season, investors also expressed significant reservations over the compensation practices at two TARP firms, MB Financial (60.8% support) and Berkshire Hills Bancorp (61.6%), as well as Motorola (63.8% approval), which held its first voluntary pay vote this year.

At Arkansas-based Bank of the Ozarks, where there was just 59% support, the company increased the CEO’s salary during the most recent fiscal year, offered discretionary bonuses to executives, and paid for an executive assistant who performed personal duties for the CEO and his wife.

At Massachusetts-based Berkshire, the board lowered the performance thresholds in December 2008, which triggered bonus payouts for the named executive officers in January. Another potential concern for investors is that the company uses a one-year performance period and adjusted earnings per share for both its short-term and long-term incentive programs.

At Chicago-based MB Financial, the CEO’s employment agreement, which was revised in 2008, provides for automatic vesting of equity and supplemental retirement credits upon a change in control. The CEO also is entitled to up to 10 years of guaranteed retirement contributions (at 20% of salary). The company also agreed to provide tax gross-ups to executives for their change-in-control payments.

Illinois-based Motorola, which plans to split into two public companies, now has two co-CEOs after recruiting Sanjay Jha to join the firm. Both executives have been granted various perks, including personal use of the company aircraft, with the company paying the taxes on the perks. The 2008 employment contracts with Jha and co-CEO Gregory Brown provide for compensation in excess of 3,257 percent and 401 percent, respectively, of the company’s peer group median.