The Advisors' Blog

–Steve Seelig, Towers Watson

Here’s something I recently posted in Towers Watson’s blog: In the past, we’ve been critical of Compensation Discussion and Analysis (CD&A) disclosures containing boilerplate statements that don’t change from year to year. Not only has the SEC stated its disdain for boilerplate in its regulatory guidance, but we’ve long advocated that companies should omit repetitious disclosures that don’t add to shareholders’ understanding of pay decisions made or performance resulting in payments earned.

Now comes a recent say-on-pay court opinion that has us thinking that maybe that view should not apply to discussions of pay philosophy. Thanks to Mark Poerio’s blog that tracks executive pay litigation, we read the recent California Superior Count order dismissing the suit against Jacobs Engineering and were struck by how the judge reached his conclusion.

Among other claims, the plaintiff contended that the company’s board had authorized executive pay packages “in direct violation of the Board’s purported ‘pay for performance’ executive compensation policy and its own public statements, and it casts doubt upon the Board’s loyalty and business judgment.” The court cited favorably the fact that the company’s proxy statement for 2010 went into great detail about its compensation philosophy of using a mix of salary, short- and medium-term incentive compensation, equity-based compensation and benefits to:

– “Enable the Company to attract, motivate and retain highly-qualified executives by offering competitive compensation;
– Reward executives for superior performance through a performance-based cash incentive bonus program that places a substantial component of pay at risk based on the Company’s financial results;
– Provide retention and future performance incentives through the use of long-term equity based incentives and mandatory bonus compensation deferral vehicles;
– Encourage executives to have an equity stake in the Company; and
– Align the interests of the Company’s executives with shareholder interests.”

The California court found these disclosures set the stage for the actions taken by the compensation committee, guiding it to award a mix of stock options and longer-vesting restricted stock instead of relying predominantly on stock options. The court then cited the following passage from the Jacobs proxy:

“In the prior year, executive officers generally received stock options. Management and the HR&C Committee believe that the grants made in 2010 align executives with the Company’s and shareholder’s interests. In determining equity awards to executive officers for 2010 the HR&C Committee considered the survey data with regard to practices in the direct peer and general industry group, accounting impact on earnings, the CEO’s recommendations with respect to all executive officers other than himself, the HR&C Committee’s own evaluations of the individual contribution and performance of each of the executive officers and previous equity awards to executive officers.”

The court was then able to conclude that there was no reason for it to question that the business judgment rule protected the actions taken by the compensation committee, based on the CD&A description, and that the complaint should be dismissed.

It seems to us the statement cited by the court is rather generic, providing few details of why the compensation committee awarded equity of the magnitude it did at a time of declining returns to shareholders. But, the court did not see a need to get into such details because it was simply looking to see if there was some evidence from the proxy that the compensation committee had exercised its judgment. Once it found the evidence the committee had done so, the path was clear for it to honor the protections afforded by the business judgment rule.

The question at hand is whether the inclusion of the compensation philosophy was essential to the dismissal of the case. Said differently, would the court have dismissed the case anyway had the CD&A omitted the discussion of the compensation philosophy and instead simply mentioned the reasoning of the compensation committee in making the equity grants? These are open questions companies should ask of their litigation counsel as they determine how the say-on-pay lawsuits will influence their 2012 proxy disclosures.

You can view Mark Poerio’s blog.