The Advisors' Blog

– Jim Kroll, Towers Watson

Although the concept of shareholder advisory votes on executive compensation has been discussed and debated for years, it’s only been since the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July that most companies have given much thought to what say on pay might look like in practice for them. Now that companies and investors have had several months to digest Dodd-Frank’s provisions and the SEC has now proposed rules to guide companies in conducting their shareholder votes, some preliminary points of view – and even a few areas of agreement – are beginning to emerge on how companies can best implement say on pay.

One thing that’s clear is that say on pay and the other Dodd-Frank governance and executive compensation reforms have been the hot topics of late on the conference circuit. This article summarizes what we have heard in recent sessions around the country.

Voting Frequency

One of the main topics of discussion is the appropriate frequency of say-on-pay votes. Under Dodd-Frank, companies must conduct a say-on-pay vote at least once every three years and must allow shareholders to vote on their desired frequency at least every six years. Neither vote is in any way binding. For the 2011 proxy season, companies will need to conduct both say-on-pay and say-on-frequency votes.
Based on their comments at recent conferences, many proxy advisors and institutional investors appear to consider annual votes as their “default” preference. At least one large investment firm is already writing letters to the companies in its portfolio requesting annual votes, and some investors expect companies are likely to receive formal shareholder proposals seeking annual votes.

While investors acknowledge that there may be situations in which less frequent votes are appropriate (e.g., compensation programs with sufficient long-term orientation, true performance goals and little or no board discretion), the onus will clearly be on companies to make a strong case for any frequency other than annual votes. Articulating a sound rationale in the proxy statement will be critical in these cases. What’s more, many observers note that there will be an added possibility of negative votes for board members in years in which no say-on-pay vote is held. In other words, the view is that annual votes may even “protect” compensation committees.

Defining Success

Another hot topic is how success or failure will be defined in a say-on-pay world. For most companies, a majority of shareholders casting negative votes on executive compensation would be viewed as an embarrassment, even though the vote is advisory. But what about something less than a clear majority “no” vote? It’s worth noting that more than 80% of the U.S. companies that have conducted say-on-pay votes thus far have received support from 80% or more of their shareholders casting ballots, although negative votes have occurred in a few cases.

While the stated views on this issue varied somewhat, there are emerging opinions that negative vote levels above 15% should be viewed as a signal that shareholder concerns need to be examined or addressed, depending on the circumstances. The trend from one vote to the next will also be an important barometer of shareholders’ views. For example, a company that goes from 95% favorable in one say-on-pay vote to 80% the following year may have more to worry about than a company that consistently receives 75% shareholder support for its pay programs.

Shareholder Engagement

There’s also been much discussion of whether and how companies should engage their shareholders in a dialogue about executive pay. The prevailing view on this score is that shareholder engagement efforts need to be situational, rather than an across-the-board activity undertaken by all companies just for the sake of it.

For example, institutional investors note that shareholder engagement might justifiably be less of a priority for companies with sound pay practices and little or no history of shareholder concerns about pay matters. Investor groups also have expressed the view that they don’t want to be cast as “pay czars” and have no interest in setting pay levels. But, in cases where shareholders do have significant concerns about pay, companies are advised to establish effective and ongoing channels of communication to help them understand and address investors’ concerns.

Varying Approaches

Similarly, it’s clear that many investors will take a situational approach in preparing for and casting say-on-pay votes. Some investor groups and proxy advisors say they’re planning to focus primarily on the “outliers” (i.e., companies that push the envelope in terms of questionable pay practices). Priorities also vary in terms of what investors will scrutinize most closely. Examples mentioned in recent forums include:

– Pay practices and programs, which may be reviewed from the perspective of “do they make sense”
– A combination of committee process, pay practices, pay for performance and CEO pay

Other investors say no one thing will be most important and that they’ll be looking to understand the big picture. Moreover, it seems clear that the largest institutional investors will follow their own counsel and may rely less on the recommendations of proxy advisors in making their vote decisions. This does not necessarily diminish the influence of leading proxy advisors if smaller institutional investors find themselves relying on their vote recommendations when faced with the task of reviewing many more say-on-pay proposals.

One point of agreement regarding say on pay is that the quality and clarity of companies’ proxy disclosures on executive compensation should improve next year for some companies dramatically. Many investors feel that improvements in the Compensation Discussion and Analysis (CD&A) should be the starting point for companies in preparing for say on pay. Desired CD&A enhancements include executive summaries (e.g., to highlight changes and provide context) and more graphics, especially to help shareholders see the link between executive pay and company performance. Overall, investors want more clarity and insight, and less legalese and boilerplate language.

A Big Deal?

Given the widespread expectation that most companies will enjoy high levels of shareholder support in their say-on-pay votes and that say on pay will have minimal impact on pay at the vast majority of companies, one frequently debated issue has been whether say on pay will be a big deal or a big bust. The consensus is that say on pay will not be a big deal for many companies, despite the general perception that it will be a “game changer” for executive pay overall.

Ultimately however, perceptions of say on pay vary widely depending on which side of the fence one sits on. While shareholder groups may see it as a welcome addition to the corporate governance landscape, others tend to view the votes as a distraction that will provide little insight into the compensation issues shareholders care about and will have no significant impact on executive pay levels.