The Advisors' Blog

– Ira Kay, Pay Governance LLC

Recently, we conducted a study that finds the executive compensation practices at more than 1,000 companies – a third of the Russell 3000 – fail a common test that will likely subject them to enhanced scrutiny at annual shareholder meetings. These findings are based on a survey of each company’s recent total shareholder returns compared to industry medians. This screening test is used by some institutional investors and proxy advisory firms to find potential disconnects between executive pay and performance.

With say-on-pay votes on the annual meeting agendas of all U.S. companies this year, investors and proxy advisors will be scrutinizing pay practices and looking for indications of pay-for-performance alignment. Each interested group, including shareholders, institutional investors and proxy advisors, have their own separate criteria for evaluating pay for performance alignment – and each has its own ‘hot button’ issues.

Using total shareholder return as a gauge of company performance, we identified more than 1,000 companies whose one- and three-year total shareholder returns trailed that of other companies in their industry. Of those, 40 percent – about 400 companies – also have negative total shareholder returns over the past three-year period. If early 2011 proxy voting results are indicative of a developing trend, companies fitting this profile should expect reduced levels of shareholder support on advisory “say on pay” votes.

In addition, these companies also must develop a clear understanding of the perspective of proxy advisory services that analyze company practices and advise institutional investors on the voting of their shares. ISS uses a detailed set of factors to assess companies’ executive pay practices. These criteria include:

– The long-term relationship between CEO pay and total shareholder return

– The portion of total compensation delivered via performance-based vehicles

– The use, type and disclosure of performance measures and goals

– The existence of “poor” pay policies and practices.

Shareholders will scrutinize upcoming disclosures, looking for indications of how compensation programs support pay for performance and whether disclosed compensation figures demonstrate this alignment. Many companies already recognize the challenge of demonstrating this alignment under today’s disclosure rules. A growing number of companies’ disclosures contain specific references to historical pay for performance analysis, using both company and industry data, and supplemental disclosure tables.

Our independent research evaluating realizable pay for performance demonstrates that, at most companies, executive pay is truly aligned with performance. In today’s environment, it’s crucial that companies use their CD&As to demonstrate how well they meet this criteria. They must be able to show that compensation programs truly align an executive’s interests with those of shareholders.