Activist investors are gearing up for another busy proxy season, and as usual executive compensation will attract more attention than other issues. “It will be a major focus of our work,” confirms Brandon Rees, research analyst for the AFL-CIO Office of Investment. “It is always the single most focus of resolutions.”

Rees recently told Compliance Week that the AFL-CIO will file about a dozen proposals aimed at curbing pay, or more closely tying it to corporate performance or specific objectives. Ed Durkin of the United Brotherhood of Carpenters also confirmed to Compliance Week that his trade union has targeted about 30 companies for executive compensation issues. The Amalgamated Bank of New York’s Labor Oriented Long View Collective Investment Fund has also confirmed to Compliance Week that it has submitted about 10 proposals so far. And the American Federation of State, County and Municipal Employees has announced that it has submitted a dozen proposals related to some sort of executive compensation issue.

According to Georgeson Shareholder, there were 133 executive compensation proposals at the 2005 annual meetings, more than any other category for the third straight year, accounting for more than 35 percent of the total. However, this was actually down from 167 the prior year and a record 179 in 2003, when executive compensation accounted for about 42 percent of all proposals.

According to industry observers, the recent falloff is due to the steep decline in measures calling on companies to expense the value of stock options. Since the Financial Accounting Standards Board adopted its stock option expensing rule, most companies were able to omit these proposals from their proxies, arguing in effect that they had “substantially implemented” the request.

So while the total number of comp.-related proposal has decreased, activists have actually become more vocal about pay-related issues. The most popular proposals in 2006 will likely be related to pay-for-performance, excessive severance payments, and a demand for compensation committee reports to be included in proxies.

And the most likely sponsors of these measures figure to be unions, which accounted for 159 of the 375 governance proposals in 2005, led by the AFL-CIO, AFSCME and the Amalgamated Bank. Individual shareholders accounted for 158 proposals last year.

“We believe that excessive and nonperformance based executive pay is the best indicator of boards that are not accountable to shareholders,” asserts Richard Ferlauto, director of pension and benefit policy at AFSCME.

Below is a rundown of the key executive compensation issues that will likely emerge during the 2006 annual meetings:

Performance-Based Compensation

Drake

This is one of the "hot buttons" of the past few years. As Compliance Week has covered extensively, activists and other governance advocates are calling for a more direct link between certain executive pay such as restricted stock and options and performance. “Proponents are stepping up the pressure on performance—based pay,” asserts David Drake, senior managing director with Georgeson.

According to experts, institutional investors want to see either peer benchmarking, premium-priced options, performance vesting or indexed options as part of the compensation mix, whereby executives must perform in line with industry peers. “This also needs to be more precisely calibrated,” adds Durkin of the United Brotherhood of Carpenters.

Of the 30 compensation–related proposals planned for 2006, 20 to 22 of them will be related to this linkage between pay and performance, says Durkin. Among the companies he is targeting: Black & Decker, Weyerhaeuser, DuPont, ITT Industries, Abbott Laboratories and PepsiCo. Amalgamated Bank has submitted proposals at Merck, Citigroup and Novellus seeking a stronger link between pay and performance.

The AFSCME Plan submitted proposals at Bristol-Myers Squibb, JP Morgan Chase, and Time Warner, asking them to add performance-based vesting measures to restricted stock. This proposal is designed to make restricted stock awards contingent upon objective performance criteria, instead of simply based on the length of time served, known as “pay for pulse,” it asserts in a press release.

Drake says that in 2005 there were 25 performance-based proposals, and they received, on average, 34 percent support. “This is a very strong message to management,” he adds.

Limits On Executive Severance

Hodgson

Governance experts anticipate a number of resolutions urging boards of directors to seek shareholder approval for executive severance agreements that provide at least three times an executive’s base pay plus bonus. “I expect severance payments to be high on the agenda,” asserts Paul Hodgson, compensation expert with The Corporate Library. “Some severance packages paid this year were spectacular and raised the profile [of the issue] even more.”

Amalgamated Bank, for example, is submitting fresh proposals at Morgan Stanley, SPX and Allied Waste Industries. Julie Gozan, director of corporate governance at Amalgamated Bank, says her group singled out Morgan Stanley because it awarded extremely large severance packages to a number of former executives. The other two companies “currently have contracts for potentially outsized” payments without shareholder review. The bank is also resubmitting proposals at Halliburton and Republic Services after similar measures it submitted last year received support from a majority of votes cast, but then were not enacted by the company, according to Gozan.

She also said a similar proposal at United Rentals never came to a vote because the company never held a meeting.

The AFSCME Plan has filed proposals at Emerson Electric and Raytheon, which limit the amount of compensation a senior executives can receive in the event of a change-in-control and/or involuntary termination. Drake says in 2005, 20 golden parachutes proposals received, on average, 54 percent support from the total votes cast.

According to Investor Responsibility Research Center, funds affiliated with the International Union of Bricklayers and Allied Craftworkers have filed proposals at Wachovia, Chevron, Charles Schwab, Progress Energy and McDonald’s.

The International Brotherhood of Electrical Workers funds have also filed golden parachute proposals at Citizens Communications, Comcast, Duke Energy, Exelon, FirstEnergy, FPL Group, The Ryland Group, and Sprint Nextel, while The Teamsters have announced that they have thus far filed two golden parachute proposals, at Coca-Cola and Coca-Cola Enterprises, according to IRRC.

Claw-Backs

The Amalgamated Bank has submitted proposals at Eastman Kodak and Mercury Interactive, requesting that they adopt a policy whereby executives return bonuses based on misreported results if the company subsequently restates its financials. “In a nutshell, if they didn’t earn it, they should return it,” says Gozan. The Bank submitted similar proposals to Dynegy in 2005 and Computer Associates in 2004.

Add-On Pension Plans

This is the only other compensation-related issue that the United Brotherhood of Carpenters has singled out, submitting about eight to 10 resolutions seeking more information about Supplemental Employment Retirement Plans. “Disclosure is very poor [in general],” Durkin asserts. “We want to flesh out this issue.” His proposals are calling on companies to disclose nine aspects of their plans.

Advisory Votes On Executive Pay

This is a new proposal from AFSCME. The proposal urges boards to establish an annual shareholder advisory vote to approve or reject the company’s compensation committee report. A shareholder vote on the compensation report is already required of companies in the United Kingdom and Australia, it points out. “One criticism we hear is that these reports include boiler-plate discussions on how compensation is set,” says Drake, who expects this to become a bigger battle front over the next year or so. “Activists are finding the report is less than helpful.”

Frank

In fact, in November Congressman Barney Frank, the Ranking Democratic Member of the Financial Services Committee, introduced “The Protection Against Executive Compensation Abuse Act,” which would require that public companies include in their annual report and proxy a comprehensive Executive Compensation Plan. “It would provide an opportunity for shareholders to voice their opinion on a company’s compensation policy or compensation award,” says Hodgson.

AFSCME has submitted proposals at US Bancorp, Merrill Lynch, Bank of America, Home Depot and Countrywide Financial. “Our proposal for an up or down advisory vote on executive pay reports will allow shareholders to express clearly their dissatisfaction to boards if they believe that the CEO's pay is too high or that compensation disclosure is incomplete,” says Ferlauto, adding that the policy in the UK has done of a good job of restraining pay in that country.

Drake says historically these measures are voted down, but “they are a very strong message to the board and management.”

Equity Compensation Holding Policy

AFSCME has submitted proposals at FMC Technologies and Amgen that executives must maintain a percentage of after-tax shares provided to them under the company’s equity compensation plan, so that an executive who exercises stock options also increases their overall share ownership.

Tally Sheets

Drake at Georgeson Shareholder is looking for a strong push for companies to publish very detailed descriptions of executive pay and perquisites. IRRC reported that The Connecticut Retirement Plans & Trust Funds has filed a Tally Sheet-like proposal at Pfizer, urging the drug maker’s compensation committee report to include disclosure in tabular form of all relevant compensation information with regard to the five highest-paid executives of the company.

IRRC says the disclosure “would provide estimated market value of all perks and personal benefits, including such items as the actuarial present value of retirement benefits; the delineation of post retirement health and other benefits, including perks, and the estimated dollar value of severance agreements, including any change of control agreements and tax gross-ups.”

Institutional Shareholder Services recently announced for the 2006 proxy season it is strongly encouraging companies to provide better and more transparent disclosure related to CEO pay. “For those companies that do not meet a minimum standard of tally sheet disclosure, ISS will note the deficiency and provide cautionary language in its analysis,” it added.

It also said that in the absence of poor disclosure that would necessitate a higher level of scrutiny, it generally will not withhold from the compensation committee for providing rules-based disclosure and boilerplate language in the compensation committee report.

However, for 2007, ISS said it will consider recommending withhold votes from the compensation committee and potentially recommending votes against proposed or amended equity plans if compensation disclosure is not improved and enhanced proxy disclosure in the form of a tally sheet is not provided.

Poor Compensation Practices

ISS has also said it is adopting a formal policy to recommend withholding votes from compensation committee members if the company has poor compensation practices. Poor compensation practices include egregious employment contracts including excessive severance provisions; excessive perks that dominate compensation; huge bonus payouts without justifiable performance linkage; performance metrics that are changed during the performance period; egregious SERP payouts; new CEO with overly generous new hire package; internal pay disparity; other excessive compensation payouts or poor pay practices at the company.

ISS also said if there is an equity plan proposal on the ballot and the plan is a vehicle for poor pay practices, then it may recommend a vote against the proposal.

Extensive coverage of executive compensation and related resources can be found in the box above, right.