The Advisors' Blog

– Steve Seelig, Towers Watson

Here’s something that I recently blogged: A key ingredient of the six remarkably similar say-on-pay lawsuits filed recently involves a lack of specificity by the defendant companies and directors in disclosing what they mean in their executive compensation policies when they say they have a “pay for performance” program. Most companies leave their policies deliberately vague or describe them only at a high level, yet stating that a company will pay for performance has made its way into most policies we see.

Has this vagueness helped? In the suits filed so far, the plaintiffs have claimed that the defendants do not pay for performance when their executives’ pay has increased while total shareholder returns (TSR) have decreased. While that may appear to compensation professionals to be an overly simplistic view of the world, absent a different argument being made by the company in its proxy and Compensation Discussion and Analysis (CD&A), this basic measurement may be the only criteria by which the issue can be evaluated, at least until the next round of pleading on the cases.

The language used as the basis for the plaintiffs’ complaint in each of these cases comes directly from the company proxy and consistently cites the company’s claim that its pay program is designed to reward outstanding performance. However, none of the pleadings filed to date cite any mention of how the compensation committee explains to shareholders the rationale for reaching that conclusion, or how they would prove it. In most of the cases, this is because that explanation is absent from the CD&A.

Said differently, the defense of these cases might be easier if companies were able to describe in their proxy disclosures that they measure performance in a different way than the plaintiffs, who simply use the Summary Compensation Table number and compare it to TSR.

This heightens the need for companies to take additional care to demonstrate how they pay for performance and in a manner that reflects the consideration the compensation committee gave to the matter before making its pay decisions. Certainly, this should mean looking at what pay versus performance would look like for the company as it attains various levels of TSR. But, more importantly, it should take into account:

1. How the company measures pay
2. What it means by “performance”
3. Whether the company believes pay and performance should be measured absolutely or in relative terms (by comparison to peers), or in some combination
4. The time period over which they should be measured.

Enhancing the CD&A with this information can facilitate shareholder support for a favorable vote on say on pay — and a more proactive defense than not making the case at all.