Companies Revising Pay Programs in Response to Say-on-Pay Results

Not many companies have failed shareholder advisory votes on executive pay plans, but that doesn't mean the votes aren't having a significant effect on pay practices.

Recent analysis from executive compensation advisory firm Towers Watson finds that 48 companies failed “say-on-pay” votes this year out of 1,941 Russell 3000 companies that reported their voting results before June 28. Many more garnered positive votes, with more than 50 percent approving their plans, but were not in the comfortable range above 80 or 90 percent.

Those companies aren't taking any chances with their compensation plans and are likely to make changes to improve say-on-pay results in the coming year. Indeed, among companies that received less than 80 percent shareholder support last proxy season, 68 percent said they made changes to their compensation programs in response, according to Towers Watson.

The improvements resulted in higher support rates among shareholders for many companies. According to analysis conducted by executive compensation advisory firm Farient Advisors, over 60 companies across multiple industries experienced a dramatic shift in shareholder support.

“A lot of companies are trying to answer investor concerns,” says Robin Ferracone, chief executive officer of Farient Advisors.

The top three changes companies made to their pay programs in response to low support during say-on-pay votes include using more rigorous incentive plan metrics (23 percent); adjusting the compensation mix, including an adjustment in the equity portion of pay (23 percent); and granting new long-term performance awards (21 percent), finds a Towers Watson analysis of the 166 S&P 500 companies that received less than 80 percent support for say-on-pay in 2011 or 2012.

Shareholder Engagement

One major step many of these companies are taking is that they are engaging more directly with their shareholders. Johnson & Johnson, for example, squeaked by last year with only 57 percent of votes cast in favor of its executive compensation program. “These results were below what we deem satisfactory,” J&J stated in this year's proxy.

Following those results, J&J's compensation and benefits committee chair and presiding director, along with senior management, met with a diverse group of institutional investors and proxy advisory firms first “to discuss our executive compensation program in an effort to better understand the underlying reasons for our say-on-pay results,” J&J stated.

J&J has made two significant changes to its compensation practices as a result of the discussions. First, the committee no longer targets total direct compensation for an executive officer to a specific percentile of the executive's peer group, but rather “will consider the individual's performance and alignment with our values, our internal bonus and long-term incentives as a percent of salary, the individual's roles and responsibilities, and his or her experience in those roles.”

In addition, J&J said it has eliminated all non-relocation related tax reimbursements for its executive officers. As a result of these efforts, J&J received a 94 percent shareholder support level during its say-on-pay vote this proxy season.

“We're going to continue to see companies making efforts to ensure their pay plans are in line with shareholder expectations. Sometimes these things just take a while.”

—Aaron Boyd,

Director of Governance Research,

Equilar

Companies are increasingly reaching out to shareholders to identify potential concerns with compensation plans ahead of time, says James Kroll, a senior consultant in Towers Watson's executive compensation practice. And they are doing it whether they have experienced a failed say-on-pay vote in the past or not.  

Not all shareholder engagement outcomes necessarily have to result in changes to executive pay plans either, Kroll adds. In some cases, they can simply provide an opportunity to converse with shareholders to flesh out any parts of the proxy statement that may need further clarification, he says. In many cases, companies are able to communicate their intentions for how they have structured a plan or clear up misunderstandings on how the plan works.

Through this engagement process, the company can clarify any ambiguities and bridge that communication gap in the next proxy. “It's one of the benefits that can come from the engagement process,” says Kroll.

Chesapeake's Turnaround

Other companies have boosted investor support by making significant enhancements to their corporate governance practices that may or may not be directly related to compensation. For example, Chesapeake Energy, which failed a say-on-pay vote last proxy season with just 20 percent of the votes in approval of the plan, passed its say-on-pay this proxy season with 84 percent support.

Some of the changes the company made to achieve these results include:

CHANGES TO J&J'S COMPENSATION PRACTICES

The following excerpt from Johnson & Johnson's 2013 proxy statement explains the changes the company has made to its executive compensation practices.

Key Compensation Highlights:

Provided appropriate compensation for a new CEO;

Reduced planned annual performance bonuses for all named executive officers by 10 percent;

Eliminated above median targeting for our executive officers;

Eliminated all non-relocation related tax reimbursements for our executive officers;

Implemented a new long-term incentive program and granted performance share units with payouts contingent on the achievement of specific financial goals;

Revised stock ownership guidelines to increase the amount of company stock our CEO must own to six times base pay and to add share retention requirements; and

Adopted principles for a compensation recoupment policy in the event of material violations of company policy.

Shareholder Outreach and Compensation Program Changes

In 2012, we held an annual advisory vote to approve named executive officer compensation, commonly known as “Say on Pay”. Approximately 57 percent of the votes cast voted in favor of our executive compensation program as disclosed in our 2012 Proxy Statement. While representing majority support for the named executive officer compensation, these results were below what we deem satisfactory.

Following our 2012 Say on Pay result, our Compensation & Benefits Committee Chair and Presiding Director, along with senior members of management, met with a diverse mix of our institutional investors and with leading proxy advisory services to discuss our executive compensation program in an effort to better understand the underlying reasons for our Say on Pay results. The feedback from our outreach in 2012 showed that shareholders and other key stakeholders appreciated the changes to the long-term incentive program that we made. They also understood that it would take several years to see the impact of those changes reflected in our Summary Compensation Table since legacy cash-based awards will continue to vest for several years while awards are being made under the new program. We received some criticism on our past philosophy of targeting total direct compensation above median for our named executive officers. While most praised the direction in which our executive compensation program was heading, there was, nonetheless, a sense among many stakeholders that their 2012 Say on Pay vote expressed their judgment on a retrospective basis on the company's 2011 named executive officer compensation as disclosed in the Summary Compensation Table, as opposed to expressing judgment on a prospective basis on changes we made to our compensation program design.

In response to key stakeholder feedback in 2012, we made two important changes to our executive compensation program:

We no longer target total direct compensation for our executive officers between the 50th and 75th percentile of our Executive Peer Group. The Committee will continue to review market data to understand how our target pay levels compare to benchmark positions, but we will not target total direct compensation to a specific percentile of the Executive Peer Group. In deciding on compensation for individual named executive officers, the Committee will consider the individual's performance and alignment with our Credo values, our internal bonus and long-term incentives as a percent of salary, the individual's roles and responsibilities, and his or her experience in those roles.

We eliminated all tax reimbursements for our executive officers that are not provided pursuant to our standard relocation practices.

Source: Johnson & Johnson.

Appointing an independent non-executive chairman and six other new independent directors;

Hiring a new chief executive officer and president to fill the post vacated by co-founder Aubrey McClendon in April;

Pursuing a compensation philosophy that emphasizes pay-for-performance and targets median peer compensation levels; and  

Significantly reducing perks, such as personal use of the corporate jet, for executive officers.

Quest Diagnostics also dramatically turned around its say-on-pay results, jumping from a 64 percent “for” vote last proxy season to a 96 percent vote this proxy season. In its 2013 proxy, Quest said it changed the allocation of its long-term equity awards for executive officers to enhance pay and performance alignment, adopted new performance metrics, eliminated tax gross-ups, and made other changes to align executive and shareholder interests.

Another way that companies have won shareholder support is by enhancing the Compensation Discussion and Analysis portion of their proxies by adding additional details and being more transparent about their pay practices.

Even companies with healthy shareholder support levels on pay practices are providing more details. “Across all companies, we're seeing ongoing transformation of the CD&A,” says Kroll. Whether that has meant adding more details, clarifying some sections, or becoming more transparent, the “CD&A is evolving,” he says.

As companies revise their CD&A, however, Kroll warns against moving toward a “one size fits all” approach of executive pay programs. “The CD&A should be very clear on telling that company's own story and to avoid a homogenous look and feel,” he says.

What's Next?

For a while, tax gross-ups, excessive perks, and other lavish compensation practices used to earn the ire of shareholders, but most companies have reined-in abusive practices in those areas and addressed problem perks. “We've largely seen that wave finish,” she says.

The newest wave shareholders are pursuing, however, is pay-for-performance. “That's an area where we will continue to see more attention going forward,” says Kroll.

Investors increasingly are asking companies to disclose more about their thinking on, and the integrity of, their performance goals, “so we're seeing more scrutiny there as well,” says Ferracone. “This all adds up to better pay-for-performance alignment,” she says.

“Some companies are learning that, just because they passed the first or second year, doesn't mean they'll definitely pass the third year,” adds Aaron Boyd, director of governance research at Equilar, a firm that tracks executive compensation trends.

As companies continue to review their pay plans and engage with shareholders, “We're going to continue to see companies making an effort to ensure their pay plans are in line with shareholder expectations,” Boyd adds. “Sometimes these things just take awhile.”