Activists Rally the Troops for Say-on-Pay

Shareholder votes on executive compensation packages hit a plateau this year, after a stunning ascendancy in 2006 and 2007. Corporate America, however, should brace itself for another resurgence in 2009.

Virtually everyone who follows the topic expects shareholder advisory votes on compensation to become the law of the land sometime next year, possibly within months of the Obama Administration settling into office. At that point, the question of how to handle the popular yet pointed say-on-pay shareholder proposals will become moot.

Ferlauto

“Conditions are ripe for passing say on pay fairly quickly,” says Rich Ferlauto, director of corporate governance and pension investment for the American Federation of State, County, and Municipal Employees. He predicts that say on pay will be legislated “some time early in the next administration, probably in the first quarter.”

Ferlauto made his remarks during a Nov. 12 Webcast on the topic held by RiskMetrics, which tracks shareholder proposals.

An import from the United Kingdom, shareholder proposals calling for advisory votes on compensation burst on the U.S. governance scene in 2006. In their first year stateside, such proposals averaged an impressive 40 percent support at the seven companies where they went to a vote. In 2007, the number of proposals increased and voting support edged somewhat higher to 43 percent, according to Carol Bowie of RiskMetrics Governance Institute.

Earlier this year, however, the measure seemed to lose steam. Shareholder support among more than 75 proposals that have come to vote this year have averaged about 42 percent support, Bowie said. “Support is still robust but there was an unexpected drop at some financial firms hard hit by the credit crisis,” she said.

All that changed in September, when the credit crisis sparked Washington’s massive intervention in the financial sector. The initial draft of the federal bailout bill called for all companies receiving government cash to allow say-on-pay votes. That provision was deleted from the final bill Congress passed into law, but resurrected say on pay’s popularity. At Sun Microsystems, for example, a recent say-on-pay proposal received support from 67 percent of shareholders who voted.

Say on pay has been also been a legislative priority for U.S. Rep. Barney Frank (D-Mass.), chairman of the powerful House Financial Services Committee. He sponsored legislation last year to require say-on-pay votes, which the full House passed overwhelmingly. A companion Senate bill was introduced by then-Sen. Barack Obama. The measure was also part of an omnibus pay reform bill sponsored by Sen. Hillary Clinton (D-N.Y.)

The Can of Worms

Despite its political support, most issuers haven’t embraced the advisory vote concept. Few companies have adopted say-on-pay votes voluntarily, and Bowie said progress from a 2007 working group comprised of investors and issuers to address the issue “has been slow.” Say-on-pay proposals have only received majority support at 11 companies.

“When the government finally steps in to create rules and penalties for companies that fail to self-police, we don’t usually end up with the best solution.”

— Christianna Wood,

Board Member,

H&R Block

Bowie

“Compensation seems to be such a lightning rod issue, companies are wary of opening it up to a shareholder vote,” she said.

At Aflac, the first major U.S. company to allow a say-on-pay vote, the company’s compensation policies and procedures were approved by 93 percent of shareholders who voted at its annual meeting this year. And drug-maker Schering Plough recently announced that it would survey investors on its compensation practices in 2009; the survey will be sent with the company’s proxy materials.

Opponents of say on pay, including Charles Tharp, executive vice president for policy at the Center on Executive Compensation, fear that putting pay practices to a shareholder vote could lead to “cookie cutter” approaches to compensation by companies worried about a negative vote.

“We don’t think it’s necessary, and we think to the extent that it may erode the centrality of the board in managing pay, that it really isn’t good for shareholders and will lead to some unintended consequences,” Tharp said at the RiskMetrics Webcast.

NO VOTES ON PAY

Below is a statement from the Center on Executive Compensation supporting “say on pay,” while rejecting the idea of “votes on pay.”

These latest efforts go beyond providing a say on pay to providing a vote on pay. The distinction is important. “Say on Pay” practices already exist, are serving shareholder interests and should continue to be embraced by companies. Conversely, the “Votes on Pay” proposals, as they really should be labeled, will in effect turn publicly held corporations into entities run by shareholder referenda with unintended consequence detrimental to shareholders and the very companies they count on to drive results and deliver value. For the benefit of shareholders, these “Votes on Pay” proposals should be rejected.

Despite the impression left by a few high-profile pay scandals that the checks and balances embedded in our corporate governance system have run amok, the facts tell a different story. More stringent and transparent disclosure rules, improved corporate governance practices and greater communications between companies and their shareholders are taking hold. As a result, the vast majority of some 12,000 publicly traded companies in the U.S. are being held accountable for strong performance-based pay practices without diluting the trillions of dollars in total market capitalization and the benefits to shareholders they provide.

Today, the vast majority of Boards are overwhelmingly independent, resulting in greater CEO accountability and shareholder responsiveness. The proof: with low tolerance for poor performance and high demand for pay linked to results, studies show that in the last decade the number of CEOs dismissed by Boards has increased four-fold, and the amount of total direct compensation of poor performing CEOs has dropped significantly compared to their high-performing counterparts.

Moreover, Equilar, an independent executive compensation data provider, found in its analysis of 2007 proxy data for 233 S&P 500 companies that the pay for performance linkage continues to be strong. Yes, company performance was mixed, as median annual revenues increased by 7.5 percent between 2006 and 2007, while net income increased by 1.3 percent. As a result, the median value of performance-based bonuses for CEOs fell by 4.5 percent and the prevalence of CEOs receiving such bonuses dropped from 85.5 percent to 78.2 percent. While the value of discretionary bonuses increased by 1.8 percent, only 18.7 percent of CEOs received such a bonus. In view of the mixed results, the median aggregate value of bonus compensation still dropped by 4.9 percent.

It’s clear that existing “Say on Pay” mechanisms, including the multiple means of direct communications with the company, are having an impact. And they are getting more robust. On the heels of requiring companies to provide even more details about the total potential earnings of its top executives and how its compensation will help drive results, the SEC buttressed its new disclosure requirements with a call for companies to beef up their shareholder communications.

Many now are communicating directly and often through forums and other avenues, inspiring a leading critic of CEO pay to laud 2007 as “the Year of Engagement.” This heightened level of engagement resulted in over one-fourth of the some 1,150 proposals to be successfully resolved last year, prompting shareholders to withdraw over 20 percent of all pay for performance resolutions, over 50 percent of majority voting proposals, and roughly one-third of proposals requesting a nonbinding shareholder vote, according to ISS Governance Services.

It is precisely this type of active engagement, rather than mandated whole-sale votes, that should be fostered because it enables shareholders to satisfactorily address specific concerns without abdicating their influence to proxy services, diluting the Board’s responsibility to set corporate strategy, or compromising confidential information critical to a corporation’s ability to compete and deliver results.

Finally, it is important to recognize that shareholders have different agendas, ranging from risk-takers seeking quick returns to more risk-adverse, long-term investors to those seeking social change. Boards are charged as fiduciaries to maximize the value for all of their shareholders. “Votes on Pay” runs the risk of retooling the corporate governance system in a way that could allow certain shareholder groups to promote their own agendas at the expense of the broader body of shareholders—a disastrous outcome. This is but one reason why the Board should retain its responsibility for setting strategy and related issues such as compensation. Meanwhile, shareholders should retain the authority over directors by being able to vote them out—the ultimate “say on pay” in our carefully balanced, effective corporate governance system that produced $256 billion in dividends to shareholders of S&P 500 companies in 2007.

Source

Center on Executive Compensation (May 8, 2008).

He argued that corporate pay practices are becoming much more performance-based, and that companies are engaging their largest shareholders.

“Companies have to reach out to their major shareholders,” Tharp said. “I don’t think you need a thumbs up, thumbs down shareholder vote to make that happen. In fact, I’m not sure that doesn’t get in the way of that.”

Wood

Christianna Wood, a board member at H&R Block and chief executive of Capital Z Asset Management, disagreed. She said there’s “good anecdotal evidence in the U.K. that there were appropriate consequences, and it was a mechanism for shareholders to be heard.”

Wood, a former investment officer for the California Public Employees Retirement System, pointed to British pharmaceutical giant GlaxoSmithKline, which saw 51 percent of GSK shareowners vote against the company’s remuneration report in 2003, in part due to backlash over the CEO’s golden parachute package. “That got a substantial message to the board and the board responded by reigning in CEO pay,” she said.

Calling say on pay “a rather blunt instrument,” Wood said: “If you’re sitting in a directors’ seat and you get a withhold or no vote, it’s not that easy to figure out what the message is.”

Still, Wood said she’d rather see companies voluntarily adopt advisory votes than have them mandated by Congress.

“I think it’s unfortunate we’re at a place where this is going to be legislated,” she said. “When the government finally steps in to create rules and penalties for companies that fail to self-police, we don’t usually end up with the best solution.”

“I like say on pay, but I think directors need to do more on all levels of communication,” she said.

If say on pay is passed into law, companies that have “efficient and well-developed mechanisms for getting input” from shareholders should be exempt, Tharp argued. “The problem with any of these laws is they’re too broad-brushed,” he said. “If a company is doing a great job … that should be something you get an exemption for.”

Ferlauto, who believes a Congressional mandate is a foregone conclusion, said the question now is whether reform will end simply with say-on-pay votes, or continue with more far-reaching measures. He cited the Treasury Department’s Troubled Asset Relief Program, which requires participants to have clawbacks, limits on golden parachutes, and limits on incentives that promote undue risk.

Ferlauto expects to see 90 to 100 shareholder proposals on say on pay filed this fall. In addition, he says AFSCME will also file numerous proposals calling for “substantial amounts” of equity awards to be held for two years beyond tenure or retirement from the company (so departed executives feel the same pain investors do for mistakes uncovered after they leave), as well as proposals that would put bonuses in escrow for a period of years before they’re paid out.