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.
A few days ago, I attended a session that included Pat McGurn of ISS.As he always does, Pat gave interesting insight into what is happening this proxy season. For example, here are some statistics on say-on-pay results so far in 2012 – and in comparison to 2011:
– Average “Yes” vote on say-on-pay among Russell 3000: 91% v. 90%
– % of companies that got at least 90% “Yes” vote: 73% v. 75%
– % fof failed votes: About 1% v. Less than 2%
– ISS recommendations: 86% in favor v. 88% in favor
So, not really much difference between 2011 and so far in 2012 except smaller percentage of “failures.”
Here’s an interesting fact – almost all companies who failed in 2011 made substantial efforts since then – as we expected – to both reach out to investors and change pay practices. All so far have gotten majority support in 2012 (egs. Beazer Homes, Jacobs Engineering and H-P). Pat also stated that “a lot of companies” who received “no” votes in the 20-40% range last season seem to have not reached out in a meaningful way.
Pat noted 3 big communication themes:
– Disclosure is much improved in 2012
– Direct engagement with investors is being done more, and being done better, when warranted
– Directors saying “No to exec perqs and big severance deals” more so every year
Also, Pat said a lot of people misunderstand ISS’s methodology regarding CEO pay disconnect – the financial screens are just the start, not the end. If a company fails the quantitative tests, then ISS goes thru a qualitative review -so his stats were – about 25% of companies fail the quantitative tests but only 23% of those companies get a “no” recommendation.
Also, ISS is looking more to 3- and 5-year TSR; they use 3-year (and also 1-year – but they are looking less at 1 year) for relative TSR and 5-year for absolute TSR.
Here’s news from this Towers Watson blog (remember that Netherlands, Norway and Sweden already have binding votes):
On March 14, the Department of Business, Innovation and Skills published a detailed consultation document on enhanced voting rights for U.K. shareholders, including the proposal to require binding say-on-pay votes in the U.K., pursuant to Vince Cable’s policy announcements in January. The main components covered in the consultation document are:
– An annual binding vote on future remuneration policy (If a company fails the vote, it will have to revert to the last approved policy and cannot implement any proposed policy changes, whether contentious or not.)
– Increasing the level of support required on votes on future remuneration policy from 50% up to 75% (or a level in between)
– An annual advisory vote on how remuneration policy has been implemented in the previous year
– A binding vote on individual directors’ exit payments over and above an amount equivalent to one year’s salary (regardless of the circumstance of termination and including any amounts in respect of in-cycle incentive payments, benefits and pension).
Comments on the consultation document are being accepted until April 27, 2012, and the government expects to publish draft legislation on this and the narrative reporting requirements over the next few months. The new voting regime, as finalized, is due to come into effect for reporting years ending on or after October 2013.
Early Bird Rates – Act by End of this Friday, April 13th: For the special early bird discount rate – both of the Conferences are bundled together with a single price – register by the end of this Friday, April 13th.
As noted in this press release, in a Sarbanes-Oxley Section 304 clawback action, the SEC sued both the former CEO and CFO of ArthroCare last week to recover bonus compensation and stock sale profits they received during an accounting fraud at the company. The two former officers had not been personally charged in connection with fraudulent financial statements; two other former officers were charged for that last year. This jibes with the District Court of Arizona holding in SEC v. Jenkins – that disgorgement of compensation and profit under Section 304 does not require personal misconduct.
By my loose count, the SEC has used Section 304 at least seven or eight times since its birth in 2002 – see the list of links to SEC clawback actions in our “Clawbacks” Practice Area.
Two weeks ago, a majority of Disney shareholders re-elected their Board of Directors and approved the company’s executive compensation program. Ordinarily this would have been a non-newsworthy event of concern only to Disney’s holders, senior management and directors. However, in the post-Dodd-Frank world of Say on Pay where “fear” of ISS (and Glass Lewis) vote recommendations hold sway, it has become a bellwether for public companies concerned with the passage of their own compensation plans and the potential for shareholder backlash against directors on various corporate governance issues where companies are deemed not to be following proscribed best practice.
Let’s discuss this year’s Disney vote both in immediate context of what it means for the company and for what it tells us about the broader influence of the proxy advisory firms on institutional investors. Last year, Disney was a among a number of mega cap S&P 500 companies to make changes to the pay arrangements of the CEO and senior team in response to concerns raised by proxy advisor ISS. The market presumed from the fact that Disney acceded to ISS pay concerns that the company passage of Disney’s SOP was in danger of failure. There was also a question of how the company would manage its board leadership structure and whether it would maintain a dual board leadership structure with an independent chairman or would recombine the roles under Mr. Iger.
In this instance, Disney’s pay plan once again raised concerns for ISS and the company’s plan to recombine the board leadership roles was also disconcerting to the proxy advisor and to many other shareholders. What appears to be different this year from last is that Disney was prepared and had engaged with its shareholders on compensation issues – whether they also held discussions with investors on dual board roles for Mr. Iger is unknown – the bottom line, the likely pre- and post-ISS recommendation engagement and Disney’s pushback was sufficient to provide Disney with passage of their executive compensation/SOP plan and to protect directors from ISS’ withhold vote recommendation for elevating Mr. Iger to Chairman of the Board.
Beyond the immediacy of the Disney case is the fact, as stated in previous columns, that institutional investors – beyond the governance advocates (public pension and Taft-Harley funds) – the majority are not advocates or drivers of corporate governance thought or practice. The other exceptions are the largest institutional investors: Blackrock (formerly Barclays), Fidelity, Vanguard, Capital Research, T-Rowe Price and State Street. These firms have made an investment of people and money in understanding and developing processes for voting the proxy assets of the funds they manage. The recent Disney vote coming in the wake of the Blackrock letter and comments from Vanguard have led some commentators to state that there is a new breath of freedom from proxy advisory firms blowing among institutional investors.
This is not really the case, but a slow trend in favor of developing internal corporate governance teams, having them make decisions on votes in conjunction with investment teams or committees is taking place. When Blackrock and Vanguard go “public” with their internal processes or ask companies to seek them out in advance of discussions with proxy advisory firms, that is not a sign of courage but an acknowledgement of standard operating practice. This is more a sign of issuer pressure on proxy advisory firms and the need of some investors to clarify to issuers how they arrive at determining their proxy voting guidelines – and the role proxy advisors play as aggregators of governance and compensation information – in helping them.
It is early yet in the 2012 proxy season. Out of the number of meetings held thus far ISS has made 166 “FOR” SOP recommendations and 27 “AGAINST” SOP recommendation. I would also guess, based on past statement made by the California State Teachers’ Retirement System (CalSTRS) as a proxy for other governance advocate funds that they might well have a higher number of rejections than ISS at this point. The large asset aggregators and mutual funds may well presently represent the balance between the proxy advisors and the governance advocates on pay and other governance issues, but those celebrating the “new found” independence of the institutions should keep in mind that the balance can swing both ways – pro-management today and pro-ISS or governance advocate tomorrow.
Proxy advisors – such as ISS and Glass Lewis – provide Say-on-Pay recommendations that guide institutional shareholders in their voting. The single most powerful determinant of whether their recommendations will be positive or negative is the overall alignment of CEO pay to company performance – measured primarily by Total Shareholder Return (TSR). Many large companies receive “high concern” or “medium concern” ratings for pay-for-performance alignment – and in more extreme cases, “against” recommendations for Say-on-Pay votes from Institutional Shareholder Services – despite the reality that, when properly measured, their pay programs exhibit true alignment. This may adversely affect the outcomes of Say-on-Pay votes.
Pay Governance found strong alignment of a company’s TSR with realizable CEO pay. Realizable pay is the sum of actual cash compensation earned, the aggregate value of in-the-money stock options the current value of restricted shares, actual payout from performance share or cash plans, plus the estimated value of outstanding performance share or performance contingent cash. The alignment between pay and performance found in these measurements is directly linked to the substantial amounts of stock-based incentives in these compensation packages. Other assessment methods cannot provide this clear linkage of pay and performance because the time period used to measure pay opportunity is usually not concurrent with the one used to measure performance. […]
Using both tests, approximately 86 percent of the companies exhibited the same levels of alignment versus misalignment of pay with performance. In more than 10 percent of the cases, however, the opportunity-based test found misalignment (high pay opportunity with low TSR) when pay was actually aligned with performance.
In this podcast, Jim Kroll of Towers Watson discusses the latest developments in using supplemental proxy materials for say-on-pay votes (here’s our ongoing list of supplemental materials), including:
– How many companies have filed them so far this year?
– Is the approach that companies are taking any different than last year?
– What are the pros and cons of using supplemental materials?