The Advisors' Blog

– Subodh Mishra, ISS Governance Exchange

With mandatory say-on-pay now in its third year and fewer companies thus far failing to receive majority support than in 2012, shareholder proposals have in 2013 reclaimed some of the proxy season spotlight they once held. While this year’s crop of high-profile shareholder proposals focused largely on board reforms, a number of compensation-related resolutions and campaigns stood out, with the number of such filings also seeing gains in volume over 2012 and creeping back to levels last evidenced in 2010, prior to the Dodd-Frank Act’s obviating the need for investors to file say-on-pay resolutions.

Calls for Stock Retention
ISS is tracking 34 votes year-to-date for proposals calling on executives to retain a significant portion of their equity awards until reaching retirement age, well in excess of the roughly two dozen that came to a vote in 2012. The increase in the volume of filings is largely attributable to retail shareholder activists, including John Chevedden, who have led the campaign in 2013.

Average support for the resolution in 2013 stands at 24.4 percent of votes cast “for” and “against,” with two votes–International Business Machines and Actavis–seeing support levels in excess of 40 percent. Average support this year aligns with that evidenced in 2012 and is slightly higher than that for 2010 and 2011. Two more votes–at Delta Air Lines and McKesson–are expected over the coming weeks.

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.

Prorata Vesting
While fewer in number than proposals calling for stock retention, resolutions seeking to bar the accelerated vesting of equity awards upon a change-in-control have seen higher average support levels–33.4 percent of votes cast “for” and “against”–across 27 resolutions voted to date. (Notably, ISS tracked 45 pro-rata vesting proposal filings for 2013, with many being omitted at the U.S. Securities and Exchange Commission.)

Beyond barring accelerated voting, these 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.

This year, six resolutions–at Walgreen, Honeywell International, Gannett, Quest Diagnostics, Alaska Air Group, and Raytheon–saw support above 40 percent though none secured a majority of “for” votes. Moreover, support levels are down from 2012 when average support touched nearly 40 percent of votes cast “for” and “against.” Still, the 45.7 percent support level at Quest this year is the highest level dating back to January 2010.

New Proposals See Mixed Results
A new crop of peer group proposals, filed by the Utility Workers Union of America and calling for an end to the practice of benchmarking the CEO’s total compensation to that of CEOs of peer companies, went to a vote this year at NiSource, Consolidated Edison, and FirstEnergy. The companies argued against support for the proposal, typically noting that peer group usage was just one of many factors in determining CEO pay and that performance-based measures outweighed consideration of pay relative to peers. Consolidated Edison holders voting “for” and “against” gave 11.2 percent backing to the resolution, the highest of the three.

Meanwhile, the AFL-CIO had greater success on a similar yet slightly different proposal filed to Waste Management. The labor fund sought a more nuanced policy that called for the compensation committee to use a benchmark not exceeding the 50th percentile company peers, when peer group benchmarking is used to establish target awards for senior executive compensation. That proposal netted 21.9 percent support.

Another proposal new for 2013 on performance standard disclosure for 162(m) plans went to a vote at Nabors Industries, and Abercrombie & Fitch–and filed to two others firms–receiving support of 25.3 and 21 percent, respectively, a solid showing for a first-year resolution. The proposal, which urges the compensation committee to adopt a policy that all equity compensation plans submitted to shareholders for approval under Section 162(m) of the Internal Revenue Code specify the awards that will result from performance, also was filed at Chesapeake Energy and Citigroup, according to ISS records.

Clawback Success Through Negotiations
Perhaps the most significant win for supporters of tougher executive pay curbs were campaigns by the UAW Retiree Medical Benefits Trust (URMBT), the New York City Comptroller’s Office (“New York City Funds”), and Amalgamated Bank on strengthening clawback policies.

Most notably, URMBT crafted two types of clawback policies, with the first meant for health care companies that had health care fraud settlements with the government and did not have existing clawback policies in place. The policy’s language, which was more rigorous than provisions of the Dodd-Frank Act (yet to be enacted) providing for recoupment, called for the recovery of pay promised but not yet paid out, applied to senior executive supervisors, and sought to broaden misconduct triggers beyond that which would trigger a financial restatement. The second policy, meanwhile, did not discriminate based on industry and was designed for companies with clawback policies in place, effectively asking boards to annually disclose whether or not it used its clawback policies and the circumstances under which they were used.

Following negotiations with companies where the first of the two policies was applicable, the URMBT announced in early April that it and other investors–including the New York State Comptroller’s Office, Hermes, and Connecticut Retirement Plans & Trust Funds–had reached agreement with pharmaceutical giants including Eli Lilly, Merck, Amgen, Pfizer, Bristol-Myers Squibb, and Johnson & Johnson to adopt a set of principles “setting an industry standard on clawbacks related to health care.”
In addition to the six pharmaceutical agreements, the Trust negotiated similar clawback agreements with Quest Diagnostics, Healthways, and, with New York City Funds, Boston Scientific.

With regard to the second policy, URMBT filed a proposal this year to Wal-Mart calling for enhanced disclosure, following allegations of bribery against the retailer in emerging markets such as Mexico and China. Just 4.8 percent of shares cast supported the measure at a June 7 annual meeting, though the figure climbs, notably, when an insider voting block is discounted, resulting in roughly 32.5 percent of independent investors backing the policy.

The Amalgamated Bank has filed a similar proposal to San Francisco-based McKesson, where a vote is expected on July 31. That proposal was challenged at the SEC with the company arguing it was vague and indefinite, materially false or misleading, and that implementation amounted to micromanagement of the company. SEC rejected McKesson’s petition in a May 17 no-action letter, stating, in atypically forceful language, “that the proposal focuses on the significant policy issue of senior executive compensation and does not seek to micromanage the company.”

Meanwhile, New York City Funds also scored a victory on the issue ofclawbacks, successfully negotiating agreement for enhanced polices with a number of financial services firm earlier this year. The funds withdrew clawback resolutions filed to Wells Fargo, Citigroup, and Capital One after all agreed to address the issue with Capital One agreeing to disclose the dollar amount clawed back so long as the event prompting the clawback “has been publicly disclosed in regulatory filings.”