Recently, we conducted a study that finds the executive compensation practices at more than 1,000 companies – a third of the Russell 3000 – fail a common test that will likely subject them to enhanced scrutiny at annual shareholder meetings. These findings are based on a survey of each company’s recent total shareholder returns compared to industry medians. This screening test is used by some institutional investors and proxy advisory firms to find potential disconnects between executive pay and performance.
With say-on-pay votes on the annual meeting agendas of all U.S. companies this year, investors and proxy advisors will be scrutinizing pay practices and looking for indications of pay-for-performance alignment. Each interested group, including shareholders, institutional investors and proxy advisors, have their own separate criteria for evaluating pay for performance alignment – and each has its own ‘hot button’ issues.
Using total shareholder return as a gauge of company performance, we identified more than 1,000 companies whose one- and three-year total shareholder returns trailed that of other companies in their industry. Of those, 40 percent – about 400 companies – also have negative total shareholder returns over the past three-year period. If early 2011 proxy voting results are indicative of a developing trend, companies fitting this profile should expect reduced levels of shareholder support on advisory “say on pay” votes.
In addition, these companies also must develop a clear understanding of the perspective of proxy advisory services that analyze company practices and advise institutional investors on the voting of their shares. ISS uses a detailed set of factors to assess companies’ executive pay practices. These criteria include:
– The long-term relationship between CEO pay and total shareholder return
– The portion of total compensation delivered via performance-based vehicles
– The use, type and disclosure of performance measures and goals
– The existence of “poor” pay policies and practices.
Shareholders will scrutinize upcoming disclosures, looking for indications of how compensation programs support pay for performance and whether disclosed compensation figures demonstrate this alignment. Many companies already recognize the challenge of demonstrating this alignment under today’s disclosure rules. A growing number of companies’ disclosures contain specific references to historical pay for performance analysis, using both company and industry data, and supplemental disclosure tables.
Our independent research evaluating realizable pay for performance demonstrates that, at most companies, executive pay is truly aligned with performance. In today’s environment, it’s crucial that companies use their CD&As to demonstrate how well they meet this criteria. They must be able to show that compensation programs truly align an executive’s interests with those of shareholders.
Here’s something that I kept putting off blogging about until someone else wrote about it – but no one ever has. In our “Airplane Use” Practice Area, I have posted final guidance that the FAA issued on December 30th about its reconsideration of the “Schwab” interpretation regarding executives not being allowed to reimburse for corporate aircraft use under certain circumstances (here’s my blog about the FAA’s proposal).
Here’s one member’s reaction to this guidance:
It is a another example of bureaucrats standing in the way of common sense and sound policy. If an executive wants to pay for personal use of corporate aircraft, there is no reason the FAA should stand in the way.
Based on my reading of the policy, the FAA would allow CEO to fully reimburse XYZ for the personal use of corporate aircraft, but only if it is possible he could be called back on company business or forced to cancel his trip ( i.e., a normal vacation). On the other hand, if he is going to a wedding or funeral, FAA has declared it would not be reasonable to assume the company would – or could – force him to alter his plans. Thus, if he uses the plane for a wedding, he could only reimburse a limited amount of the expense under FAA guidelines ( i.e., fuel and landing fees), whereas he could pay all the incremental costs associated with a normal vacation.
If his wife or kids used the plane when CEO was not present, you could read the guidelines to limit the reimbursement to the limited FAA guideline level. If the company wants to establish a written policy that makes reimbursement of personal use of corporate aircraft mandatory, the policy will have to include a caveat that any reimbursement must comply with FAA restrictions.
To help keep track of the Form 8-Ks filed under Item 5.07 to report voting results on say-on-pay and say-when-on-pay, I’ve created this chart that I intend to periodically update. A few interesting observations based on the identified companies thus far:
1. With respect to “Say-on-Pay,” the average “for” vote percentage for the identified companies (90.3%) indicates that these proposals are faring well overall; however, as you noted in Broc’s blog, two companies have already failed to receive a majority vote – Jacobs Engineering and Beazer Homes – and five companies have received “for” vote percentages in the 60s.
2. With respect to “Say-When-on-Pay,” the sample size is only 55 companies as of 2/11/11, but here are some interesting trends:
– The shareholders of 20 of the identified companies have not followed the board of directors recommendation on the frequency of the “Say on Pay” vote (shareholders of 29 of the identified companies followed the board’s recommendation, and the boards of the six remaining identified companies did not make a recommendation);
– With respect to the 12 companies whose boards recommended an annual vote, the shareholders of each of those companies approved that recommendation (all of the approval percentages were 81% or greater);
– With respect to the 7 companies whose boards recommended a biennial vote, the shareholders of three of those companies approved that recommendation (the shareholders of the other four companies voted for an annual vote); and
– With respect to the 30 companies whose boards recommended a triennial vote, the shareholders of 14 of those companies approved that recommendation (the shareholders of the remaining 16 companies voted for an annual vote).
In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 231 companies filing their proxies, 58% triennial; 6% biennial; 31% annual; and 5% no recommendation. And in the “Dodd-Frank Blog,” Steve Quinlivan discusses the reasons for the “against” vote at Beazer Homes as well as the results reported in the 54 Item 5.07 Form 8-Ks filed so far this proxy season.
We just posted the Spring 2011 issue of the Compensation Standards newsletter, in which Dave Lynn has drafted model say-on-pay disclosures to help you prepare your upcoming proxy statement. It includes a model executive summary, say-on-pay resolution and say-on-frequency resolution. We have also posted a Word version of the newsletter so that you can cut and paste as a starting point for your proxy disclosures.
Last week, we saw “Say on Pay”/”Say on When” votes at four companies – Air Products, Monsanto, Woodward and Jacobs Engineering – where board recommendations for triennial Say on Pay were defeated by shareholders supported by ISS’ recommendation for an annual advisory vote on compensation. While the pushback from shareholders for an annual vote on executive compensation was expected there remains a certain amount of shock amongst governance experts, the business media and issuers about what looks like a developing trend toward annual SOP votes. The real story here however, may be the low level of support for Monsanto’s SOP request and the defeat of the Jacobs’ SOP vote.
A vote of 65% of the share voted in favor of a company’s SOP request is worrying, but it is still quite different from a losing vote. With that said, let’s examine the Jacobs results (according to the company’s recent 8K filing and making some assumptions) and do some Monday morning quarterbacking in line with what we (and other advisors) have been recommending to our clients.
ISS Influence among the Top Holders
We begin by taking a quick look at Jacobs’ top twenty-five institutions – we noticed that 18.9% of the shares outstanding appear to be strongly influenced by ISS and would be encouraged to vote in accordance with their recommendation. If that is indeed the case, the company would need to garner voting support for its SOP among its other investors. Had this issue been flagged as a serious challenge to the company’s SOP vote strategy?
Had the company made a determination, by indentifying and engaging with its shareholders, that it had the votes needed for passage? The company had engaged with ISS (according to the ISS’ published analysis) and had not been able to persuade the proxy advisor on pay for performance and/or compensation committee discretion in the award of a non-performance grant of restricted shares. Clearly 54% of the company’s investor base agreed, but could Jacobs have taken any action that would have spared them a defeat?
Going It Alone – Not A Viable Option
In reviewing the firm’s previous proxy statements, going back as far as 2007, it appeared that Jacobs has not used a proxy solicitor. The lack of a proxy solicitor is usually not critical to the success of a routine annual meeting, however 2011, the first year of mandatory Say on Pay, is not a routine year. In reviewing the company’s 8K filing and making some educated assumptions, we identified some key factors that might have made a difference in both the strategies that could have been employed and the ultimate outcome of the advisory compensation vote.
For example:
– We estimate the ISS influence level at approximately 18.9% of the outstanding.
– 36. 2 million shares were not voted – according to the 8K filing 16.2 million shares were held by brokers in street name accounts; and the remaining 20 million shares were likely held by a combination of registered holders, insiders and employees.
– Brokers are no longer allowed to vote shares, per the amendments to NYSE Rule 452, in 2009 by the SEC and further amendments resulting from passage of Dodd-Frank.
– Of the 36.2 million shares unvoted some portion of those shareholders would have been NOBOs and could have been reached via a calling campaign aimed at both registered owners and at brokerage clients (asking them to contact their broker and instructing them to vote for management).
– The lack of an annual-NOBO, a suggestion made to the SEC and included in their concept release, but not acted upon, might have allowed the company an opportunity to reach a greater number of shareholders.
– 10 million additional shares in support of management would likely have made a difference in the outcome of the SOP vote (less than 1/3 of the unvoted shares) – this is where a retail shareholder outreach campaign could have made a difference as well.
– The ability of a quality solicitor/governance advisor to reach out and contact the staff responsible for proxy voting at many institutions might have made some difference in turning around a negative vote.
Could a proxy solicitor/corporate governance advisor made a difference in this instance? It is, in our opinion, hard for experienced proxy hands to look at the numbers and conclude otherwise. While no firm, neither us nor our competitors, could offer a guarantee of a victory, the retention of a top-flight solicitor/governance advisor might have brought the company closer or helped tip the balance in management’s favor.
The lesson here is not about ISS’ influence or governance advocates or the margin of defeat of management’s frequency proposal. It is about the now limited range of options for a compensation committee, board and senior management that will be absolutely needed to “win” next year’s SOP vote or face the prospect of negative recommendations from the proxy advisory firms and potential Vote-No campaigns from public pension and union funds. In the new normal of the post-Dodd-Frank world, issuers need to create their own luck and develop scenarios for winning their SOP vote if even by razor thin margins – so as to provide their directors with the time and flexibility to deal with shareholders displeased with their executive compensation programs – and hiring quality proxy/governance advisors is a key way to do it.
Broc’s note: After I posted this, I realized that according to Jacobs Engineering’s SEC filings, they did hire Innisfree to conduct some type of solicitation for them, as referenced in their subsequent filings.
Yesterday, Beazer Homes USA filed this Item 5.07 Form 8-K which revealed that it has become the second company to fail to receive majority support for its say-on-pay, with 54% voting “against.” As I blogged before, Jacobs Engineering became the first last week. That’s two failed votes out of roughly 30 SOPs voted upon so far – nearly a 7% rate.
In my poll last week – in which folks guessed how many failed votes there would be this year – zero picked 1-2 failures; 4% predicted 3-4 failures; 18% predicted 5-10 failures and 75% predicted more than 10 failures (5% said “what me worry?”). At the current 7% rate of failure, it looks like the smart money will have pegged it.
I’ve been amused by some who have recently reported that only 1 out of 20 have failed so far – as if a 5% failure rate was a good thing – and that’s not even counting the companies who have garnered a significant “against” vote like Monsanto and Johnson Controls. If you apply that failure rate to the number of companies that will hold SOP votes soon enough, the image is scary.
As Paul Hodgson blogged last year, 500 nays-on-pay would be the result extrapolating from the 3 failures last year out of the 60 companies that voluntarily had say-on-pay on their ballot. And as Paul noted, “Can you imagine what might happen if shareholders got organized? [FX: Long, slow, whistle on descending note….]”
Interestingly, a member brought three smaller companies to my attention that filed proxy materials after the effective date of Dodd-Frank’s SOP provision – but before the SEC postponed the applicability of SOP to smaller reporting companies. Given that the SEC hadn’t signaled the postponement beforehand, they certainly got lucky! Of course, given that they didn’t even know that SOP had applied to them, they likely don’t even know they are lucky…
As perhaps can be expected given it’s a new ballot item for most companies, the first batch of companies reporting voting results regarding say-when-on-pay have led many members to send questions about how to properly count votes. As an example of the confusion, Steve Quinlivan notes a voting ambiguity at the end of this blog. And in his “California Corporate & Securities Law” Blog, Keith Bishop also blogs about the confusion of counting say-on-frequency votes – here is Keith’s follow-up blog too.
The bottom line is that whether a majority preferred a triennial vote depends on how “abstentions” are treated – which means that the same numbers could wind up with entirely different results for two different companies. Personally, I don’t see how abstentions wouldn’t be counted, but it seems like a matter of state law – not my area of strength. But I do note that the SEC’s adopting release in discussing the Rule 14a-8 exclusion states at footnote 151:
“Specifically, as adopted, the note to Rule 14a-8(i)(10) will permit exclusion of such a shareholder proposal if, in the most recent shareholder vote on frequency of say-on-pay votes, a single frequency (i.e., one, two or three years) received the support of a majority of the votes cast and the issuer has adopted a policy on the frequency of say-on-pay votes that is consistent with that choice. FN151
Footnote 151 – For purposes of this analysis, an abstention would not count as a vote cast. We are prescribing this voting standard solely for purposes of determining the scope of the exclusion under the note to Rule 14a-8(i)(10), and not for the purpose of determining whether a particular voting frequency should be considered to have been adopted or approved by shareholder vote as a matter of state law.”
One might ask whether the difference matters. There are some consequences. One is determining whether a specific frequency preference received a “majority of the votes cast” for purposes of the Rule 14(a)-8(i)(10) exclusion – so it matters for purposes of the shareholder proposal rule (I guess it also could have an impact on which preference received a plurality of the votes cast, but this situation isn’t likely to come up too often – and doesn’t seem have any legal consequences). Perhaps the biggest factor to consider is one that isn’t driven by regulation: the optics of how you report your voting results. In other words, how will it be received by shareholders and the media in general.
I expect that companies will want to disclose the potential voting implications “right” at the outset in their proxy materials – it doesn’t look good to file a corrective disclosure. So it’s something to figure out now and not when it comes time to report the voting results in a Form 8-K…
In his “Proxy Disclosure Blog,” Mark Borges gives us the latest say-when-on-pay stats: with 218 companies filing their proxies, 58% triennial; 6% biennial; 30% annual; and 6% no recommendation.
Recently, the CSA (Canadian securities administrators) proposed changes to executive compensation disclosure that would not take effect until the 2012 proxy season. Check out this Torys’ memo for more.
In addition, here is something from ISS’s Debra Sisti about how Ontario regulators are seeking input on “say-on-pay” and majority voting:
In keeping with its 2010-2011 Statement of Priorities, the Ontario Securities Commission recently issued a notice, in which the OSC indicated that it was considering future regulations on slate voting and majority voting in uncontested director elections, as well as “say on pay” advisory votes on executive compensation.
Following a comprehensive look at proxy voting mechanics in Canada, the law firm of Davies Ward Phillips and Vineberg released a paper by senior partner Carol Hansell, entitled, “The Quality of the Shareholder Vote in Canada,” which makes a number of recommendations for improvement beginning with a regulatory review of the proxy voting system. The OSC has included a review of the effectiveness of the proxy voting system in Canada as the third item on its “shareholder democracy” agenda for this year. Institutional investors in Canada have pushed back on slate voting, which provides a bundled director ballot and prohibits shareholders from registering individual votes for director nominees. From 2009 to 2010, the percentage of TSX companies with slate director elections fell from 46 percent to 28 percent, and declined from 28 percent to 17 percent at S&P/TSX Composite Index companies, according to ISS data.
Majority voting in the form of a director resignation policy had been voluntarily adopted by 146 companies by end of the 2010 proxy season; 130 of those are Composite Index companies and accounted for 53 percent of the index as of Dec. 31. As a result of shareholder engagement and letter-writing campaigns, a handful of other companies have publicly committed to adopt majority voting in the coming year.
Much like majority voting, “say on pay” has been voluntarily adopted by some of Canada’s largest companies in response to shareholder engagement and shareholder proposals. As of June 30, 2010, ISS had identified 28 issuers with management “say on pay” resolutions on their proxy ballots. And another 10 companies have announced they will follow suit this year.
While the tenor of shareholder engagement in Canada to date has been quietly conservative and has garnered substantial results, there has been some indication from larger shareholder coalitions that if engagement activity is not sufficient to make further gains on these issues, they will file shareholder proposals to prod unresponsive boards. The results of these efforts and the investor support for these proposals will be closely watched by regulators in contemplation of future regulation. In the interim, the OSC is asking stakeholders to submit their comments on the appropriateness of such regulation by March 31.