McGurn: We’re going to go through a couple of straight frames now on compensation-related issues.
The first one is the growing focus on compensation risk. This was obviously a huge issue at some of the financial services firms who were required by TARP to make voluminous disclosures last year. The SEC has now brought this requirement to the larger corporate community, and in particular, has spread it beyond just looking at pay for the named executive officers to include looking at other potentially significant risks created for employees downstream.
The tweaks that the SEC made in their final rules are going to have an impact this year. They did weaken the proposal a little bit when they changed the standard for disclosure to risks “reasonably likely to have a material adverse effect.” By making that change, the SEC scaled down the size of the disclosures that companies would have to make. In fact, we’re hearing a lot of advisers telling boards that after they go through this analysis they may end up disclosing little or nothing about riskiness in the system if they don’t find any material adverse effects.
From the investor perspective, we would hope that most boards would go well beyond that compliance notion, to provide more detail about the process they went through in looking at pay riskiness and also, very importantly, what sorts of provisions they have in place to mitigate excessive risk – things like a hold-till-retirement or through-retirement policy, strong clawback provisions, bonus banks or hold back provisions.
We’ve been asked how we will view silence on the part of issuers in the next season. From our perspective, we’re looking to provide our clients with some disclosure about what companies say about their compensation risk analysis process. To the extent that a company’s disclosures are non-existent, we’re going to have to say that the company didn’t say much of anything about this issue.
That’s why I advise issuers to provide at least some detail. If you say nothing, that’s the same disclosure as companies that did nothing. If you say nothing, I don’t think people are going to assume there was a robust process for determining that there was nothing material to disclose.
That information we provide to our clients is not necessarily going to become a determinant of the recommendation that we make for a particular board of directors. When we revamped our policy during the off season, we raised the profile of compensation risk issues. We are continuing to look at them, and we hope that the boards can help us in that process by having their own robust disclosure in that area.
So we’ll have to wait and see on how this issue plays out during the season. I think the best approach here is to provide as much transparency into the company’s processes as possible.
Romanek: From what I’ve heard, there is a wide variety of different advice being given by outside law firms to in-house folks. The warning, even for companies for whom the disclosure might feel like boilerplate, is that investors are going to be scrutinizing disclosure more closely than people would think.
McGurn: I have never been an advocate of the absolute statements that some of the TARP participants made last year that, “There’s no pay risk at our company whatsoever.” I know some issuers are fearful that making those sorts of broad generalizations could come back to haunt them at some future date.
But there’s a huge middle ground between avoiding making broad general statements that there are no risks and providing zero disclosure. I think you can provide a great deal of confidence to investors by detailing the process that the board went through and, as I mentioned before, pointing out what sort of mitigators that the company has baked into its compensation structure to provide that the risks don’t ripen into excessive risks at some point in the future.
Our second frame on compensation issues goes to poor pay practices and in particular, looking at the election of directors, which is going to be the battlefield for most companies when it comes to executive compensation this year.
Many of the issues that drove our negative recommendations and, in some instances, some high “no” votes against members of the board of directors last year, are back again this year. I’ve already seen a number of companies putting new gross-up provisions in place, excessive perquisites, large severance pay-for-failure packages, and the like. Even though there have been moves towards reform made by a number of boards over the last year or so, we are going to continue to see over the next couple of years companies that haven’t got the message yet coming forward.
As far as shareholder proposals go, we’re expecting to see repeats of the campaigns related to gross-ups, golden coffins, hold-till-retirement or through-retirement programs, and bonus banks. But we are going to see some new pay-related proposals this year as well.
One novel proposal basically asks companies to have no sitting CEOs on their pay panels. It will be interesting to see how that issue resonates with investors. I think the ban there may cost them some support in the long run. But it will be an interesting debate over membership on pay panels.
There are a couple of other interesting proposals. One looks to tie pay levels to succession planning at companies. Another looks to eliminate accelerated vesting under the various equity programs at firms. There’s also a resolution that seeks to prohibit hedging and pledging by senior executives of their shares. One new proposal that crossed over into the employment union realm is tying pay to pension funding.
Finally, there is a trio of proposal types, which I call the “TARPie Harpies,” that look to hold some of the companies that had gotten out from under the TARP program to the TARP structures, seeking limits on asymmetric pay practices by forcing disclosure of non-deductible pay, or seeking to force companies to have their award recipients hold the bulk of their variable pay for five years.
It will be fascinating to see if we continue to see more and more traction for pay-related “no” vote campaigns. They jumped from being almost a non-factor in a director election to an issue last year, when about 10% of the S&P 500 firms led to opposition of 10% or greater. So it is an issue that seems to getting a lot of traction these days.
The final pay issue is the 800-pound gorilla of “say on pay.” We’ve seen a delay in the federal mandate, but we still expect that legislation to be in place for 2011. I think for this year, we’re already seeing a substantial number of companies – most recently, Edison International – announce that they would voluntarily subject themselves to” say on pay” votes on the management side of the equation.
Before all is said and done, I’m guessing there will be well over 50 companies voluntarily putting it on the ballot this year, in addition to the several hundred TARP companies that aren’t out from under the TARP, who will have it on their ballot as well. So we will see a substantial number of “say on pay” resolutions on the management side.
But since the mandate isn’t in place yet, we’ll also see a bumper crop of shareholder resolutions on the topic. We’ve been hearing from proponents that upwards of 100 proposals, or about the same amount that have been offered in each of the last several years, would likely come through the hoppers at corporate offices this year. Again, we would expect some issuers to front run these proposals by putting their own management proposal in the ballot.
Looking at the “say on pay” world going forward, we asked our clients what their approach would be to the election of directors and management-proposed say on pay resolutions, if and when both items are on the ballot.
Pretty much a straight majority, 52% of the respondents, said they would adopt with what’s been called the “yellow card, red card” approach, borrowing the terminology from soccer. In the first year, if an MSOP resolution is on the ballot, investors would use that to raise the yellow card, that is to say, a caution, as a way of addressing those issues, rather than voting against members of compensation committees or board. Only if that yellow card was ignored would they, in the next year, play the red card, which would be a negative vote against members of compensation committees or full boards.
Interestingly about 42% of the respondents to our survey indicated they would consider votes against both MSOP and compensation committee members in the same year. I think this is probably largely reflective of the fact that there still are a lot of skeptics in the investor community to the whole concept of say on pay. They question whether it is as strong a statement as simply making a vote against members of boards of directors, which they see as having a greater impact. We’ll see how that debate plays out and, ultimately, whether issuers and investors embrace the “yellow card, red card” approach rather than simply doing it belt and suspenders.
The management proposals that were on the ballot in ’09 passed with overwhelming support, by and large; the typical resolution received about 90% of the votes cast in favor. Given the fact that broker votes are still in the mix on those management say on pay resolutions, we look for the vote support level to remain pretty high.
Will we see the first-ever majority “no” vote on a management-proposed say on pay in the U.S. market place? I think that’s an open question. If I had to guess right now, given the number and type of companies that have it on their ballot, it is probably unlikely, but it isn’t beyond the realm of possibility. We’ll keep an eye on that as the year goes on.