General Electric's decision to revamp Chief Executive Officer Jeff Immelt's pay plan two weeks before its annual meeting, fearing that shareholders would vote against it after Institutional Shareholder Services gave a negative recommendation, certainly hasn't gone unnoticed by either companies or shareholders.
The move seems to prove once more that the new say-on-pay rule, implemented by the Securities and Exchange Commission under a provision of the Dodd-Frank Act, is changing the power dynamics between companies and shareholders in terms of executive pay plans. So far this proxy season, shareholders have voted against compensation plans at eight companies, including Hewlett-Packard and Stanley Black & Decker.
“When say-on-pay was introduced in the United States, many observers were skeptical it would make much of a difference, but GE's move to embed new vesting hurdles in Immelt's stock option plan, apparently to avoid losing a say-on-pay vote, suggests that investors have started to use say-on-pay to better tie CEO pay to the CEO's long-term performance,” says Jesse Fried, a law professor at Harvard University who focuses on executive compensation.
As a result of the high-profile case, ISS and institutional investors will see that they are able to make a difference in compensation decisions and will therefore become more likely to push for reforms at other companies, says Fried. He also expects them to move to other executive compensation issues, besides tying option pay to performance.
The GE case could also strengthen the hand of compensation committees that are interested in improving executive pay arrangements, he says. “The comp committee can go to the CEO and say, ‘It's not that we want to put all these shackles on you, but if we don't do it, we're going to get a negative recommendation from ISS and it's going to be very embarrassing—so we need to put some restrictive conditions on your option and stock plans,'” Fried says. “This is going to weaken the ability of executives to determine the parameters of their own compensation, which is a very important thing, because executives have had too much power for too long over how they get paid.”
It's also likely that with say-on-pay in place, pay arrangements will became much more sensitive to performance, because boards do not want to lose the vote, Fried says. “There are a number of studies that have documented this effect in other countries where say-on-pay has been implemented, like the U.K. and I fully expect that we'll see the same thing in the U.S.,” he says.
In fact, a study completed by ClearBridge Compensation Group in February found that in a review of the first 100 proxy filings by Fortune 500 companies, that boards are minimizing non-performance based pay and increasing their disclosures.
Disney is another company that made changes to its executive compensation plan after ISS recommended that shareholders vote against it. The company removed an agreement that it would pay the excise tax on benefits in the event that an executive was ousted during a change in control. “Several hundred companies will end up with a ‘no' vote recommendation from ISS, but only around 20 percent of those ISS-against will actually fail,” says Ira Kay, a managing partner at Pay Governance.
Shareholders at approximately 5,000 companies are voting on compensation plans this spring, says Kay. Of the several hundred companies that have held votes so far, the average support level is 92 percent, he says.
“Several hundred companies will end up with a 'no' vote recommendation from ISS, but only around 20 percent of those ISS-against will actually fail.”
—Ira Kay,
Managing Partner,
Pay Governance
Change is definitely underway, says Kay. “In anticipation of the say-on-pay vote, companies are putting in more performance-based plans and they are reducing the use of items that irritate shareholders: that is, excessive severance, perquisites, federal income tax payments, and pensions,” he says. “The disclosures have finally improved, and that's because historically, attorneys advised companies to keep their proxy disclosure fairly legalistic—and that didn't work—so now there are providing much more executive summaries and using plain language.”
In the GE case the compensation committee used far from best practices in making a special, huge options grant at the time when the stock was considerably less than what investors had paid for it over the last few years, says Jack Lederer, founder of CursioWeb, which advises compensation committees on selection of pay consultants. “With no consideration of investors who bought stock at a higher price, the compensation committee gave the CEO a lot of options at a lower price with no shareholder protection features, like they eventually had to put in—it was definitely questionable,” he says.
The best practice today is to align equity programs very directly and transparently with expected performance, says Lederer. “The GE problem was that the option grants were not really aligned with performance, other than the company's stock,” he says. “Given this example, other companies will be more and more diligent about their plans and make sure that they are consistent with shareholder expectations.”
DETAILS ON GE CEO COMP
The following chart from ISS explains the changes to GE Chief Executive Officer Jeffrey Immelt's executive compensation package:
Source: ISS Recommendation on GE Initial Proxy Proposal.
Not all companies are walking the ISS line, as some are taking their chances with shareholders without making changes to their plans, even after ISS gives them a thumbs down. A negative ISS vote recommendation may still yield a positive vote from shareholders, as the recent examples of Johnson & Johnson and Pfizer show, says Holly Gregory, partner at the law firm Weil, Gotshal & Manges. “In both instances, ISS issued a negative vote recommendation, yet positive outcomes were achieved— without the companies announcing adjustments— albeit with a far narrower margin than at other large public companies,” she says.
Still, there is no doubt that a negative vote recommendation on executive compensation has an impact on the vote, says Gregory. “That is why we are seeing companies undertake concerted efforts to inform their shareholders of their disagreements with negative ISS recommendations, through letters to their shareholders filed as additional proxy materials, and some companies have subsequently announced changes to their practices to garner shareholder and ISS support,” she says.
“ISS has developed fairly rigid policies about executive compensation, which may be necessary internally in order for ISS to address the volume of vote recommendations they are required to issue in a relatively short time,” Gregory says. “As a result, ISS' analysis tends to undervalue the unique circumstances facing the company that the board had to consider.”
As to the protocol for revising an executive compensation plan, there isn't a predetermined set of rules. “That's where the compensation committee comes in: they often will redo a program as the business needs change, and as the need for attracting, or rewarding, or retaining key executives evolves,” Lederer says. Typically, the compensation committee discusses the new plan with the entire board, which then approves it. There are accounting considerations in revising a pay plan: for example, the stock options are an expense. So are restricted stock units, but they just come in different amounts at different times.
“Companies are really trying to find the right kinds of short- and long-term incentive plans that really are transparent and aligned with shareholder interest—that's the triangle of company performance, the right plan, and making sure of shareholder interest and expectations,” Lederer says.
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