– Broc Romanek, CompensationStandards.com

Earlier this week, I blogged about the dismissal of Beazer Home’s say-on-pay lawsuit being dismissed and I noted that the judge rule from the bench. The judge has now issued a 24-page court order explaining the dismissal, which we have posted in the “Say-on-Pay” Practice Area.

– Broc Romanek, CompensationStandards.com

Here’s news from ISS’s Ted Allen in his blog: The Council of Institutional Investors (CII) released a report that addresses how institutional investors approached “say on pay” votes during the spring 2011 U.S. proxy season. As expected, most investors said “pay-for-performance” disconnects were a major reason for voting against corporate compensation practices.

The investor group hired Farient Advisors, which interviewed 19 CII members about how they cast their “say on pay” votes. These investor participants consisted mostly of public pension systems (58 percent), mutual fund firms (32 percent), and union pension funds (11 percent).

Investors gave various reasons for opposing corporate pay practices, but the factors most frequently cited were:

– A disconnect between pay and performance (92 percent)
– Poor pay practices (57 percent).
– Poor disclosure (35 percent).
– Inappropriately high level of compensation for the company’s size, industry, and performance (16 percent).

The report’s other findings include:

– Investors were extremely thoughtful about evaluating executive compensation for “say on pay” votes
– Due to resource constraints, investors used proxy advisory firms’ analyses to varying degrees.
– Investors considered multiple factors as well as inputs from various sources in determining their say-on-pay votes.
– Investors evaluated performance and pay over multiple years, and focused primarily on total absolute shareholder return (TSR) over one-, three- and five-year periods.
– Investors spent the most time and resources analyzing pay at “outlier” companies: those with large disconnects between pay and performance, high overall pay and/or low TSR in comparison to their industry or peers.
– Investors focused on CEO pay, rather than the pay of other NEOs, and on the overall “reasonableness” of the level of compensation in view of the company’s size, industry, and performance.
– Investors mostly regarded the “say on pay” vote as an opportunity to voice their concerns about a particular pay program, not a referendum on directors’ oversight of compensation.

The report also had this observation: “This first year of mandatory say on pay has been a learning experience for all participants. Farient encourages investors to conduct a ‘post-mortem’ of their voting processes, including an assessment of any additional resources needed to evaluate ‘say on pay’ proposals fairly and efficiently. Concerned investors should follow up to see what steps, if any, companies take in response to failed ‘say on pay’ proposals, and consider appropriate action.”

– Broc Romanek, CompensationStandards.com

On Monday, ISS released the results of its latest policy survey, which both companies and investors are invited to fill out. Although investors and companies appear to be on the same page regarding some pay practices, there are many where they may not be. Among the findings per Mike Melbinger in his blog:

– A majority of both investor (60%) and companies (61%) cited executive compensation as one of the top 3 governance topics for the coming year, similar to last year.

– Investors and companies had different views on when companies should address shareholder opposition during “say on pay votes.” On a cumulative basis, 72% of investors said there should be an explicit response from the board regarding pay practice improvements if opposition exceeds 30%. Among companies, 48% said an explicit response wasn’t necessary unless there was more than 50% dissent. (The most commonly cited level of opposition on a say-on-pay proposal that should trigger an explicit response from the board regarding improvements to pay practices was “more than 20%” for investor respondents.)

– A majority of investors (57%) indicated more engagement activity with companies in 2011. When asked about engagement activity with institutional shareholders, companies almost equally cited “about the same as in 2010” and “more engagement in 2011.”

– Pay levels relative to peers and a company performance’s trend are relevant for both investors and companies when determining pay for performance alignment. When determining whether executive pay is aligned with company performance, an overwhelming majority of investors considered both pay that is significantly higher than peer pay levels and pay levels that have increased disproportionately to the company’s performance trend to be very relevant. On the other hand, most companies indicated that both of these factors to be “somewhat relevant.”

– A majority of investors (57%) and 46% of companies agreed that discretionary annual bonus awards (i.e., those not based on attainment of pre-set goals) to be sometimes problematic if the awards are not aligned with company performance.

– Regarding new equity plans, responses from investor and companies varied as to whether positive factors, such as above median long-term shareholder return; low average burn rate relative to peers; double-trigger CIC equity vesting; reasonable plan duration; robust vesting requirements, should be taken into account to mitigate an equity plan where shareholder value transfer (SVT) cost is excessive relative to peers. Most investors were reluctant to indicate that any of those factors would “very much” mitigate the cost.

– Where SVT cost is not excessive and whether negative factors, such as liberal CIC definition with automatic award vesting; excessive potential share dilution relative to peers; high CEO or NEO “concentration ratio”; automatic replenishment; prolonged poor financial performance; prolonged poor shareholder returns, weigh against the plan, a majority of investors indicated all of the factors, with the exception of high CEO/NEO “concentration ratio,” should “very much” weigh against the plan.

– An overwhelming majority of investor respondents do not consider automatic accelerated vesting of outstanding grants upon a change in control or accelerated vesting at the board’s discretion after a change in control to be appropriate. The vast majority of companies disagree, and consider both scenarios appropriate.

During our upcoming pair of say-on-pay conferences (one regarding disclosure and one regarding pay practices – both combined for one price), come hear investor views from the investors themselves during the panel – “Say-on-Pay Shareholder Engagement: The Investors Speak” – featuring T. Rowe Price’s Donna Anderson; Cap Re’s Anne Chapman; Blackrock’s Michelle Edkins; CalSTRS’ Anne Sheehan and AFL-CIO’s Vineeta Anand. In addition, investors are sprinkled throughout the panels over the two days to help you learn their latest thinking.

Act Now: Come join 2000 of your colleagues in San Francisco – or thousands more watching live (or by archive) online – to receive a load of practical guidance and prepare for what is promising to be a challenging proxy season. Register now.

– Broc Romanek, CompensationStandards.com

Last week, I blogged how the Cincinnati Bell say-on-pay lawsuit survived a motion to dismiss. Now the count is 1-1 since – as noted at the end of this Thomson Reuters article – a state court judge in Georgia dismissed the shareholder derivative say-on-pay lawsuit against Beazer Home with a ruling from the bench.

Meanwhile, Steve Quinlivan has analyzed the Cincinnati Bell decision and has identified errors in his “Dodd-Frank Blog” – and Marty Rosenbaum characterizes the decision as a “game-changer” in his “OnSecurities Blog.”

– Broc Romanek, CompensationStandards.com

In this podcast, Euan Fergusson of White & Case and Tony Gilbert of the Hay Group discuss how say-on-pay has fared in the United Kingdom, including:

– How did say-on-pay start in the UK?
– How does the UK say-on-pay regime differ in the UK compared to the US?
– What have been the most recent say-on-pay developments in the UK?

– Broc Romanek, CompensationStandards.com

Early yesterday, I tweeted that the first say-on-pay lawsuit has survived a motion to dismiss and boy, did a get a reaction as nearly everyone had predicted that these lawsuits would be seen as frivolous. As noted in this order, the US District Court for the Southern District of Ohio refused to grant Cincinnati Bell’s motion because the company had not proven that it had met its fiduciary duties. The fiduciary duty standard in Ohio is a “deliberate attempt to cause injury to the corporation” or “reckless disregard for the best interest of the corporation.” Pretty breathtaking that the court thought the complaint supported “deliberate intent to injure” or “reckless disregard.” Thanks to Paul Hastings’ Mark Poerio for pointing this lawsuit out.

What does this all mean? A few things to consider:

1. More Lawsuits Coming – There have been 9 say-on-pay lawsuits filed so far. But I hear there are more in the pipeline because these 9 didn’t include demands on the board first. There are a slew of others that have first made demands – and if an agreement is not reached, lawsuits will be filed. And this development will likely encourage more suits to be filed as well.

2. More Failed Say-on-Pays in ’12 – I’ve been saying that this year was a test year for say-on-pay and that companies who just had their say-on-pay pass should not rest easy for next year. Here are just some of the factors that have led me to this belief:

– Conversations with institutions who appear willing to fail more companies next year now that they have had real experience with voting on large numbers of SOPs and realize that more engagement is possible if necessary

– Increasing anger about income inequality generally, including ramped-up rhetoric in an election year

– A rapidly declining economy and stock market – compared with all boats rising earlier this year

– Throw into the mix that we don’t know what positions ISS and Glass Lewis might change for the coming year. As well as investors and their policies.

– Directors were spared “against/withhold” vote campaigns this year in deference to say-on-pay. I wouldn’t necessarily bank on that happening again. And directors are likely to take a large number of “no” votes personally compared to SOP votes.

As I have learned from the prep calls for our upcoming pair of say-on-pay conferences (one regarding disclosure and one regarding pay practices – both combined for one price), I can tell you that we are still in the infancy of how say-on-pay will ultimately play out. And you will hear for yourself the horror stories when a company does fail its say-on-pay – and how the say-on-pay lawsuit really shakes up a boardroom – during the “Failed Say-on-Pay? Lessons Learned from the Front” panel during the conference.

Act Now: Come join 2000 of your colleagues in San Francisco – or thousands more watching live (or by archive) online – to receive a load of practical guidance and prepare for what is promising to be a challenging proxy season. Register now.

– Jon Lukomnik, Sinclair Capital

From “The Mind of an Institutional Investor” Blog: Just yesterday, 23 people gathered in a windowless conference room at a convention hotel in Paris. The ostensible reason was to comment on the work of the International Corporate Governance Network’s remuneration (executive compensation) committee The conversation took a quick and sharp turn, however.

It began normally enough, with a discussion of alignment of interests between executives and shareowners, role of a Board’s compensation committee, disclosure of compensation, etc. However, I decided to ask what I thought was going to be an ineffectual verbal challenge.

Why, I asked, do institutional investors keep preaching alignment? We’ve been doing that for two generations and it has not worked. Perhaps it’s time to admit the obvious: Shareowners’ interests and executives’ are not perfectly aligned and cannot be made to be perfectly aligned. Perhaps it’s time to admit that fact and return to an old idea: Management, even senior management, are employees. They ought to be fairly – and I’d say even generously compensated – but they are employees of the corporation not suppliers of capital. Is it simply time to stop trying for alignment and deal with them as highly-compensated employees for whom the board must make a compensation decision, whether in cash, shares, options or whatever. But that means the Board must consider what has become know in Europe as “quantum,” which is shorthand for both “what do all the various compensation schemes add up to” and “how much is enough”. It does not include, however whether options or restricted shares or phantom shares or time-vested grants or performance-grants or deferred comp or three-year vesting rights or any of the other “comp speak” we’ve all come to know far too well over the years. In some ways, by considering the mechanisms of pay, and trying to make them aligned, we’ve emphasized form over substance, and the amount has become a fall-out, rather than a decision.

Surprisingly, I received an amazing amount of support. The comments came quickly, as if a dam had been broken. “We’ve become too complex,” “Even boards don’t know what they’re paying,” etc. Later, in a plenary session, a banker basically admitted as much, saying that for senior bank executives, compensation had become a slot machine: They pull a lever and three years later out comes a trickle of coins or a fountain of folding money.

To be sure, the shareowner community is not about to consign alignment to the scrap heap of history. Nor should we. The fact that alignment is not perfect is to make the best the enemy of the better. But to admit that alignment can never be perfect means that we must insist that the Board use judgment about quantum as well as instruments that align compensation as best it can. And that has been a taboo topic for institutional investors (including me) for too long.

– Broc Romanek, CompensationStandards.com

I’ve now been in this business quite a long time and I can honestly say that the upcoming pair of say-on-pay conferences will be a career peak for me. I’m proud of the high caliber of panelists that I have procured – and I’m now spending several months carefully orchestrating what topics each panel will cover so that there is minimal overlap. In fact, any overlap is intentional as there are numerous panels that have a distinct perspective.

There is a panel comprised solely of institutional investors; two panels with just ISS and Glass Lewis. There is a great panel with experienced corporate directors. But that’s not all – I have tailored many of the panels so they will drill down on practical topics that you hold dearly, such as “How to Work with ISS & Glass Lewis: Navigating the Say-on-Pay Minefield” and “Failed Say-on-Pay? Lessons Learned from the Front.” Check out the agendas for the conferences and see for yourself.

With the economy going into another funk – and anger over CEO pay likely to hit a fever pitch in an election year – I do believe that next year will bear out that this year was just a “test year” and many companies whose pay sailed through in ’11 could experience real struggles next season. This pair of conferences – focusing on both disclosures and practices – takes place on November 1st-2nd in San Francisco and by video webcast. Register now.

If you are experiencing budget woes but recognize that these conferences are a “must” – drop me a line as always.

– Broc Romanek, CompensationStandards.com

As I prepared to speak on social media to the crowd last week at the Society of Corporate Secretaries’ Western Regional Conference, I took in a say-on-pay panel – and almost dropped to the floor when Janice Hester-Amey of CalSTRS said no one that they had voted against say-on-pay wise had bothered to contact them yet to ask why they had voted negatively. Since CalSTRS voted “no” for 24% of the 3000 US companies in its portfolio, this means that not a single company out of hundreds has bothered to pick up the phone yet. CalSTRS publishes all of their votes on both its own website and through ProxyDemocracy.org.

As I’ve learned from my prep calls ahead of our pair of executive pay conferences, other institutional investors have been getting calls asking “why” – but this still is startling considering how large CalSTRS is. And it begs the question whether companies who held say-on-pay votes this year remember that they will be required by Regulation S-K Item 402(b)(1)(vii) to disclose whether, and if so how, they considered the say-on-pay advisory vote in determining compensation policies and decisions and how that affected their executive compensation decisions and policies. Maybe some companies are just intending to disclose that they didn’t consider the advisory vote in their deliberations? A dangerous prospect if you ask me…

– Daniel Cheng, ISS Corporate Services

The following are excerpts from a recent ISS white paper, “Executive Pay Through a Peer Benchmarking Lens,” which summarizes key findings from ISS Corporate Services’ study of almost 15,000 DEF 14A filings over the past four years. Drawing on ISS’ executive compensation database, this report analyzes both pay levels as well as the processes by which companies benchmark their pay relative to peers:

The enhanced executive compensation disclosures mandated by the U.S. Securities and Exchange Commission in 2006 have provided a significant new data set for investors and companies to analyze and benchmark pay practices across a broad set of U.S. corporate issuers. Moreover, precisely how companies choose to benchmark their pay practices has received much attention following the outcry over Wall Street payouts and the recent promulgation of legislation requiring most U.S. issuers to put their pay to a non-binding shareholder vote.

The median value of total CEO compensation for S&P 500 companies decreased 4.8 percent in fiscal 2009 but jumped 20 percent to $10.6 million in fiscal 2010. A similar trend was observed among small-cap companies (defined here as members of the Russell 3000 index excluding the S&P 1500). The decline in median CEO pay for those issuers was 10 percent from 2008 to 2009, followed by a 26 percent surge in fiscal 2010. Although the gains are evidenced across all industries in fiscal 2010, those with the biggest increases were financial and information technology companies with jumps in median pay of 47 percent, followed by energy companies at 30 percent. In fiscal 2009, utility companies were on top, paying their CEOs 13 percent more than the previous period, followed by consumer discretionary companies’ 11 percent jump, when most other industries cut CEO pay.

In fiscal 2009, the global economic slowdown, coupled with increasing pressure from investors to rein in executive pay, resulted in a sharp decline in the use of equity-based compensation. Our study shows that the median option value granted by S&P 500 companies in 2009 declined almost 17 percent, while nearly half of small-cap firms suspended option awards. Instead, discretionary and non-discretionary bonuses became popular alternatives. S&P 500 companies increased their payouts of cash bonuses to CEOs by 13 percent from levels in 2008, for example, while cash bonuses climbed 28 percent at small-cap firms in 2009.

In fiscal 2010, this trend saw dramatic growth. Companies across all indices not only resumed the grant of equity-based compensation but also increased discretionary and non-discretionary bonus awards. S&P 500 companies raised equity-based compensation by 28 percent, while small-cap firms increased such pay by 46 percent. Much of the increase can be attributed to the growing popularity of stock awards. For instance, 53 percent of equity-based compensation was composed of stock in 2010 among S&P 500 companies–up from 46 percent in the previous period. Continuing the trend from 2009, large-cap companies gave 40 percent more in bonus awards to their CEOs, while small-cap companies rewarded their chief executives 54 percent more, as reported in 2011.

Better Disclosure of Benchmarking Peers

More than 97 percent of S&P 1500 companies disclosed their benchmarking practices in fiscal 2010, compared with 84 percent in 2007. Among companies reporting in 2011, we see nearly 60 percent having selected 10 to 20 peers to benchmark their CEO’s pay level, with a median number of peers selected of 15. In addition, we found that peer group size typically increases at larger companies. More than 30 percent of S&P 500 companies selected over 20 peers to benchmark pay, with only 23 percent of companies beyond the S&P 1500 doing so.

When determining peer groups, a key observation is that a majority of companies tend to select benchmarking peers whose sizes are between 0.5 and two times their own. Another observation is that the most popular standards to measure company size are corporate revenue, market capitalization, and assets, in descending order of prevalence.

We studied over 40,000 pairs of company-peer data disclosed for fiscal years 2010 and 2007. Our analysis shows that about 60 percent of peers’sizes are between 0.5 and two times that of the choosing company’s revenue. The trend is consistent between fiscal 2007 and 2010 and applies across all indices. If the focus is turned to the percentage of total peers composed of larger-cap companies, defined as companies with revenues of more than two times their own, we find the percentage is about 19 percent for S&P 500 companies, and increases to 33 percent for small-cap firms.

Payout Targets Can Be Vague or Moving

Despite the SEC’s guidance to encourage companies to increase transparency and disclose targeted levels of compensation, our study found more than 66 percent of the studied sample did not specify targets or provided ambiguous disclosure. The poor quality of disclosure is more prevalent among small-cap companies, with 72 percent of Russell 3000 companies (excluding S&P 1500 constituents) failing to disclose what percentile levels of pay they plan to target, as reported in 2011. For companies revealing the targeted percentile, we find over half set the target at peers’medians while another 40 percent target the top quartile or above median.

The report’s other key findings include:

– Peer selection remains a key concern with roughly 1,400 companies including peers that significantly increased their CEO pay while, concurrently, shareholders saw weak returns.

– Highly paid CEOs are the most prevalent peers for benchmarking. For the highest paid group in our study, the average number of times that a company is benchmarked is 27, which is 34 percent higher than that of the lowest paid group at 20.2 times.

– For a sizeable portion of study companies, our analysis found a significant misalignment between our measure of relative pay rank and relative performance rank.