The Advisors' Blog

– Subodh Mishra, ISS’ Governance Exchange

Shareholder proposal filings related to compensation in 2013 will be a mix of old and new, covering issues ranging from stock retention for executives to peer group selection determining CEO pay. Pay-related resolutions will be filed principally by labor and retail investors, as has been the case in the recent years, and the volume of such filings is expected to easily eclipse that seen in 2011 and 2012, while approaching that for 2010, the last year in which investors filed proposals calling for say-on-pay.

Stock Retention
Proposals calling on executives to retain a significant portion of their equity awards until reaching retirement age will likely be more prevalent in 2013 than in 2012, when roughly two dozen came to a vote. Retail shareholder activists tell us they will file more such proposals next year, while labor funds, such as the AFL-CIO, confirm they have already submitted the proposals for 2013 with potentially more to come.

Stock retention proposal proponents typically call on the compensation committee to adopt a policy requiring that senior executives retain a “significant” percentage of equity awards until reaching normal retirement age, with a recommendation that the committee adopt a share retention percentage requirement of at least 75 percent of net after-tax shares. Advocates suggest such policies will better align the interests of executives with those of shareholders and typically target companies with weak executive stock ownership guidelines.

Companies typically counter that their stock ownership guidelines are sufficient to align executives’ interest with those of shareholders and caution against adopting such prescriptive policies that would hinder a company’s ability to attract and retain high caliber executives.

Pro-rata Vesting
While expected to be fewer in number than proposals calling for stock retention, resolutions seeking to bar the accelerated vesting of equity awards upon a change-in-control will be back next year. Roughly a dozen of these proposals came to a vote in 2012 with average support touching nearly 40 percent of votes cast “for” and “against.”

Beyond barring accelerated voting, resolutions typically provide that any unvested award may vest on a “pro rata basis” up to the time of a change-in-control. Proponents also seek to ensure performance goals are met to the extent any such unvested awards are based on performance, and specify the requested policy be prospective without “affecting any contractual obligations that may exist at the time.”

Companies receiving these resolutions often argue against the request by noting it is the prevailing practice among larger companies that typically see the proposal, and that accelerated vesting benefits shareholders by sharpening management’s focus on value creation, given they are apt to realize awards concurrent to shareholders doing so through the change-in-control transaction.

While labor funds have led the campaign on this issue, the relatively high level of support has made the resolution attractive to retail shareholders who have thus far filed at least 10 proposals for 2013. Moreover, we have learned that at least one proponent has said it will continue to push the resolution despite the presence of double-trigger severance agreements, focusing on whether performance-based goals are met.

Triennial Say-on-Pay
A new proposal for 2013 will be to request that companies alter the frequency of their say-on-pay from an annual to triennial cycle. These proposals, filed by the United Brotherhood of Carpenters and Joiners of America, or “UBCJA,” calls for a “for” or “against” vote on a company’s overall compensation plan at every third annual meeting, while also providing the opportunity to “register approval or disapproval” on annual incentives, long-term incentives, and exit packages for named executive officers.

UBCJA, which called for triennial votes prior to last year’s market-wide adoption of say-on-pay, says it has filed 14 proposals already and expects to “between 45 and 50” in sum for 2013, the Council of Institutional Investors reported last month. Targeted companies will be those with high levels of support in past votes with proponents contending annual votes are not needed at such firms and that a triennial cycle will allow more time for in-depth analyses of pay policies and practices. In addition, the UBCJA argues that a switch to triennial voting at firms where pay concerns are not evidenced or limited would be timely and ideal for investors with deep portfolios, given smaller issuers will begin holding say-on-pay in 2013, under SEC rules.

162(m) Performance Definition
These proposals, filed by the AFL-CIO, target companies with low say-on-pay support levels or failed votes in 2012 and are expected at roughly a half dozen firms next year. Specifically, the proponent calls on compensation committees to adopt a policy that future compensation plans, which are submitted to shareholders for awards intended to qualify as performance-based under Section 162 (m) of the Internal Revenue Code, “specify performance standards that will enable shareholders to determine what amount of awards will be generated by what level of performance.”

We’re looking for companies to “specify performance standards in such a manner that shareholders will be able to determine the level of awards,” Vineeta Anand, chief research analyst at the AFL-CIO’s Office of Investment, said on a recent Governance Exchange webcast. “We’re seeking a level of specificity that’s lacking right.”

Peer Group Selection
The AFL-CIO also will file novel resolutions to address concerns over the use of flawed peer groups in setting CEO pay. Pointing to a recent University of Delaware study that finds peer groups are central to the problem of “mega-pay,” proponents call on compensation committees to adopt a policy that its choice of benchmark should not exceed the 50th percentile of the company’s peers. Anand indicated “several” such resolutions had been or would be filed, adding the labor fund was “hopeful” that companies would be responsive on this issue.