Say-on-Pay Losses Catch HP, Others Off Guard

When the Securities and Exchange Commission finalized a proposal giving shareholders advisory votes on executive compensation, corporate governance analysts didn't think it was a big deal. The companies with executive compensation problems had already dealt with “say-on-pay” votes through the proxy-resolution process, they reasoned. They were wrong.

This proxy season, five companies have already lost advisory votes on executive compensation: Ameron, Beazer Homes, Shuffle Master, Jacobs Engineering, and Hewlett-Packard. And more defeats are likely still to come. “In the U.S., we've already had more negative votes in one year than any of the foreign countries that have say-on-pay have had,” says Ronald Mueller, a partner at the law firm Gibson, Dunn & Crutcher. In Britain and some of the European countries, perhaps one or two companies a year lose the vote, he says.

Hewlett-Packard appeared to be caught off-guard when it lost its say-on-pay vote last month by a slim margin. At the company's March 23 annual meeting, HP stockholders voted 729 million for and 767 million against the company's proposed pay package, according to an 8-k form filed by HP on March 28.

“HP was almost certainly surprised,” says Robert Jackson, a professor at Columbia Law School.  “The vote was lost by less than 5 percent of the votes. It's very rare for management to lose a close vote like this. My guess is that HP thought they had the votes and they just turned out to be wrong.”

HP has had a bumpy ride since August, when its Chief Executive Officer Mark Hurd resigned after an investigation into sexual harassment allegations. The idea that the CEO would receive a nearly $13 million dollar severance package, when his departure was under such difficult circumstances, is something that shareholders might have found objectionable, says Jackson. However, it's not clear whether the shareholders are using the vote really to express their views on pay, or instead, if they're just using their vote to express their views that what happened in the boardroom last year was unfortunate, he says.

“The HP example might get directors to think a little harder about when an executive leaves under difficult circumstances, whether they should pay severance in that amount,” Jackson says. “Severance packages, at least of this size are generally designed to encourage CEOs to do acquisitions that make sense for shareholders, but it's not obvious at all how it makes sense for shareholders to pay a severance package of this size under circumstances like these.”

HP did all the right things in terms of reaching out to shareholders, but there's only so much you can do when you've made a decision to pay this big a severance package, says Jackson. “Companies are going to have to rely on their compliance personnel to know who their shareholders are and to get a clear and accurate count of who they are and how they're going to vote,” he says.

Winners and Losers

One notable case that went in the other direction is that of Monsanto's successful say-on-pay proxy vote, which countered the negative recommendation from the corporate governance advisory Institutional Shareholder Services. “It is interesting to see companies, really for the first time, begin to challenge proxy advisory recommendations and their pay policy methodologies head-on, either in their proxies or letters to shareholders,” says James Barrall, a partner in the law firm Latham & Watkins.

“The HP example might get directors to think a little harder about when an executive leaves under difficult circumstances, whether they should pay severance in that amount.”

—Robert Jackson,

Professor,

Columbia Law School

Some corporate governance lawyers don't think that five losses is a substantial number. “While it is still early in the 2011 proxy season, the most striking features from the 300 or so Dodd-Frank Act-reported say-on-pay advisory votes are that only five proposals have failed—how many proposals have passed with overwhelming approval votes and how many proposals have passed notwithstanding negative recommendations from proxy advisers such as ISS and Glass Lewis?” asks Barrall.

Furthermore, the importance of the HP case may be overblown, since this trend was already apparent before the defeat. “It was already clear from the several companies that lost say-on-pay votes in 2010 that large and prominent companies with histories of shareholder issues can lose say-on-pay votes,” says Barrall. 

It is also possible that Hewlett-Packard's defeat was too tied to the specifics of that case to signal anything significant for most companies, says Peter Fetzer, a partner at Foley & Lardner. “Most companies have acceptable pay practices and will be able to paint a positive picture for their shareholders, resulting in a favorable vote,” he says.

ISS ON HP

The following excerpts are from Institutional Shareholder Services' report on Hewlett-Packard's annual meeting, March 2, 2011:

Discussion - CEO Resignation

On Aug. 6, 2010, Mark Hurd resigned as chairman, president, and CEO of HP, following sexual harassment accusations. While an investigation found that he had not violated sexual harassment policies, it did find that he had misreported expenses and had violated HP's standards of business conduct, prompting his departure. Per his separation agreement, Hurd received approximately $24 million in compensation, including approximately $12.2 million in cash as part of his severance package, and approximately $9.9 million in stock awards.

One month following Hurd's departure from HP, Oracle Corp., a rival competitor of HP, hired Hurd as a co-president. The day following Hurd's appointment at Oracle (Sept. 7, 2010), HP filed a civil complaint for alleged breach of contract and threatened misappropriation of trade secrets in connection with his employment at Oracle. The litigation was resolved on Sept. 20, 2010, and per the settlement, Hurd agreed to waive his rights to 330,177 performance-based RSUs granted on Jan. 17, 2008, and 15,853 time-based RSUs granted on Dec. 11, 2009.

Following Hurd's resignation, the board appointed Catherine A. Lesjak, HP's current executive vice president and chief financial officer, to serve as the company's interim CEO. On Sept. 30, 2010, the board announced it had elected Léo Apotheker as president and CEO, and Raymond J. Lane as non-executive chairman, effective on Nov. 1, 2010.

Item 15. Advisory Vote to Ratify Named Executive Officers' Compensation Vote Recommendation

A vote AGAINST is warranted in light of the new CEO's lucrative hire package in conjunction with a subjective "for-cause" severance definition (coupled with a track record of CEO departures under "without cause" circumstances), and the CEO's inappropriate participation in the selection of five new board members.

Discussion - Incentive Programs—Short-Term

Comment: We note that the company paid substantial discretionary awards and does not disclose goals for the key metrics that drive payouts under its annual and long-term plans, even retrospectively. Without complete disclosure, shareholders cannot ascertain the rigor of the goals relative to payouts.

Incentive Programs—Long-Term

While many companies are reluctant to disclose forward-looking incentive plan goals, most S&P companies disclose complete information about retrospective goals, such as the cash-flow metrics underlying the short-term plan and recently paid long-term awards. Without that information, it is difficult for shareholders to gauge the rigor of the company's incentive programs relative to the awards delivered.

Apotheker Agreement

Leo Apotheker was not an NEO in fiscal 2010 (ended Oct. 31) but was hired to be the company's president and CEO (on Sept. 29, 2010), effective Nov. 1, 2010, and his compensation is discussed in the CD&A. We therefore consider the terms relevant to this resolution.

The new hire package for Mr. Apotheker does not appear to protect the company from potentially costly settlements in a "pay for failure" scenario, which is concerning in light of the departures of predecessor CEOs Mark Hurd and Carly Fiorina.

Conclusion

At this point, shareholders are left with a rich CEO contract at a company with a poor track record on CEO exits. A negative say-on-pay vote serves as a signal to the board that shareholders are monitoring the situation closely and expect directors to exercise the utmost objectivity in pay decisions going forward.

Source: Institutional Shareholder Services.

“With the early results including a number of lost say-on-pay votes and say-on-pay votes approved but approved with a relatively low percentage, I think it is clear that shareholders are taking this seriously and are more than willing to signal their displeasure,” Fetzer says. This trend will push companies to ensure they effectively communicate to their shareholders that the company's pay practices properly incentivize the company's executives and do not reward poor performance, he says.

There are many reasons for the greater frequency of defeats in the United States, says Mueller. First, there's a much more widely dispersed shareholder base in the United States than in other economies. “There's the joke that in the United Kingdom, companies would spend a day in a cab driving around London visiting their shareholders, whereas here in the United States, it's two weeks in airplanes flying coast to coast, and overseas,” he says. Second, there is a greater variety of compensation practices in the United States. Third, it's become apparent that even if you did not have a say-on-pay vote this year, if the ISS has concerns about a company's compensation program, they'll recommend a vote against its directors who serve on the compensation committee. And finally, some shareholders that would have been reluctant to vote ‘no' on the directors, are not as reluctant to vote ‘no' on the say-on-pay vote, Mueller says.

For companies hoping to fare better than HP, however, there are, unfortunately, some things beyond their control. “One of the best ways to have a good vote is to have a strong stock price,” Mueller says. “Short of that, talking to your shareholders in advance of the proxy being filed, knowing who your shareholders are and what concerns they have, is helpful.”

“What's changing on the internal processes is a greater need for internal communication,” says Mueller. “It's less common, but you still find situations where people who are working on the proxy are not directly in contact with members of the compensation committee.” Therefore, people at the company who work with the compensation committee should be sure that compensation decisions get made all year long, in order to ensure that the thought and rationale behind those decisions get clearly articulated so that it can be accurately described in the proxy statements, he says.

“There is a little bit of a transition here,” says Mueller. “One would expect the number of no votes to go down next year, because companies will be responding to what the votes are this year.”