At Home And Abroad, Say-On-Pay Takes Root

Ready or not, “say on pay” could rapidly become a reality in the United States.

Like the majority election of board directors that swept Corporate America in 2005 and 2006, shareholder advisory votes on executive compensation may be the next big governance trend, observers say. Interest in the votes has “caught on like wildfire,” says Elizabeth McGeveran, vice president of governance and sustainable investment at F&C Management Ltd.

“While majority voting seemed far-fetched a couple of years ago, it’s arguably now the new template in the U.S.,” says Stephen Deane, director of the Center for Corporate Governance at Institutional Shareholder Services. “I can foresee the same thing happening with say-on-pay.”

Say-on-pay shareholder resolutions debuted last year, with seven proposals that averaged about 40 percent support. Companies have been bombarded with more than 60 such resolutions this year. At 14 companies where votes have occurred, the proposals averaged 42 percent support, according to ISS. Earlier this month, 57 percent of shareholders at video rental chain Blockbuster voted in favor of an advisory vote on executive pay, the first U.S. company to see majority support for the measure. Verizon Communications also confirmed last week that after lengthy tabulation, 50.1 percent of shareholders voted for a say-on-pay proposal there as well. Earlier this year, insurer Aflac voluntarily adopted an advisory vote.

And even if say-on-pay does not sweep to success at annual meetings, Congress is moving to make such votes mandatory anyway; the House has already approved a bill in favor of the votes, and the Senate is likely to act on it later this year.

Simpson

“U.S. shareholders are basically stuck with the tradition of, `Sell your shares if you don’t like it or sue the company,’” says Anne Simpson, executive director of the International Corporate Governance Network. “An advisory vote is about saying, `Let’s have a more grown-up relationship where shareholders are consulted.’”

In countries such as the United Kingdom and Australia, where advisory votes are already the norm, supporters say they have improved the dialogue between investors and boards, strengthened the link between pay and performance, and greatly reduced the spectacle of “pay for failure”—such as Robert Nardelli’s $210 million severance package when he left Home Depot earlier this year.

Deane, author of a whitepaper on the effect of advisory votes overseas, says a “sea change in the quality of dialogue between investors and the board” occurred after say-on-pay votes were adopted in Great Britain in 2003.

What’s more, the vote has prompted a reduction in the severance awarded to British CEOs. Previously, severance packages typically provided for two years’ salary or more. Today, Deane says, the norm is only one year’s salary.

The advent of the vote also virtually eliminated “retesting,” formerly a common practice where boards granted executives another year’s extension (or longer) if they failed to meet their performance goals within the originally allotted time. Annual bonuses are smaller, and companies have shifted from granting stock options to giving restricted stock awards, Simpson says.

Prodding Compensation Conversations

Bess Joffe, manager of the Americas region for London-based Hermes Equity Ownership Services, agrees that advisory votes link pay to performance in “a very concrete way.” Investors and companies in the United States already spar over such links informally, but say-on-pay votes would “formalize the process,” she says.

“Companies say they’re already engaging with their top shareholders on executive compensation and explaining the process their compensation committee undertakes,” she says. “My thought is, if they’re already doing it, what’s the problem with putting in an advisory vote?”

PAY RATES

A comparison of median total CEO pay in the United States, Great Britain and Australia; all figures are adjusted into U.S. dollars with foreign exchange rates effective May 9, 2007. Great Britain and Australia have say-on-pay shareholder advisory votes in effect.

Year

United States

Great Britain

Australia

2002

$500,000

$292,419

$282,131

2003

$949,100

$282,952

$329,997

2004

$1,145,800

$300,875

$334,148

2005

$1,325,000

$282,510

$342,697

2006

$1,246,400

$299,591

$377,681

Change

59.9 %

2.4 %

25.3 %

Compliance Week Analysis Of CEO Pay By Nation, 2002 to 2006 (Data Courtesy Watson Wyatt Worldwide, May 9, 2007)

Hermes filed its first and only shareholder proposal this season seeking an advisory vote on executive compensation at UnitedHealth Group, which became the poster child for abuse of backdated stock options last year. Shareholders will vote on the proposal on May 29.

McGeveran says advisory votes also can give compensation committees more leverage. When battling with powerful CEOs seeking outsized pay packages, the committees could use the shareholder advisory vote as a weapon, she says. “They can point to it and say, `Shareholders think it’s important.’”

Even with the SEC’s new rules for disclosure of executive compensation, which went into effect this spring, McGeveran and others say the process is “still really a one-way street,” where investors can get data about the CEO’s pay, but they cannot communicate their sentiments back to the CEO. The usual recourse for a shareholder is to withhold a vote at an annual meeting, but that act doesn’t necessarily reveal why the shareholder is doing so.

Advisory votes could reduce withhold votes for individual directors by providing “a clear channel for shareholders to communicate specifically on compensation matters,” McGeveran says.

Schacht

Members of the CFA Centre For Financial Market Integrity in Great Britain and Australia feel the votes are “working quite effectively,” managing director Kurt Schacht says. “Both groups say the advisory vote has focused management specifically on describing their thinking and their policies on executive compensation in terms investors can understand.”

Schacht says the votes are viewed as a way to accomplish “a better understanding of how the compensation process is put in place … The compensation discussion and analysis doesn’t seem to be fitting that bill.”

And what about Congress? Deane hopes that U.S. companies won’t need a mandate from Washington. “Whether or not it becomes law, the legislation could spur the players to have a market solution,” he says.

Others, however, say some companies may need a legislative push. “Ideally, companies should voluntarily elect to do it,” Schacht says. “But I’m not sure there will be a wholesale movement to adopt this on a voluntary basis until we see the outcome of the effort by Congress.”

While market-leading companies are likely to adopt the practice on their own, “There are many others that won’t,” Joffe says. “It’s those companies where [legislation] is probably needed.” A legislative approach “might be faster and would allay the concerns that companies may be at competitive disadvantage by having a vote when others don’t.”

Schacht also warns that a legislative mandate could bring litigation about whether a say-on-pay law is a state issue, since states control much of how companies incorporate and conduct their governance practices.

While proponents cite the benefits of advisory votes, McGeveran and others caution that they’re “not a magic bullet for all of the ills of executive compensation.” They stress that advisory votes aren’t intended to lower or cap CEO compensation—although total CEO pay in Great Britain and Australia grew 2.4 percent and 25.3 percent, respectively, from 2002 through 2006, while pay in the United States soared 59.9 percent in the same period.

The goal of advisory votes in Great Britain, Deane says, is “to look at the structure of pay and make sure you’re not rewarding executives for failure. It’s not for shareholders to micromanage the company or to vote on the absolute amount of pay of individual executives.”

McGeveran says that the process requires both companies and investors to do some additional work. “It takes more disclosure by the board, more consultation, and more time to be a thorough investor,” she says. “We think it’s worth it if it means incentive packages are clearly tied to performance.”