Governance Center Blog
Corporate America has weathered (with mixed results) two years of annual
“Say on Pay” votes and is gearing up for a third. One theme which emerged
during 2012 is that companies should not view the annual vote as a 60-90
day event that needs to be managed as best as possible given the hand the
company has been dealt (or, in some senses, the hand it has dealt for
itself). Rather, companies need to view Say on Pay as a year-round
exercise in which the outcome of the annual vote can be positively
affected if the company “engages” successfully with its investors on the
topic of executive pay.
However, the meaning of the term “engagement” in this context is by no
means obvious. And, while a number of companies have implemented sound
engagement programs based on an accurate assessment of corporate
governance dynamics, too many common prescriptions for engagement are
based more on myth than reality.
Myth Number 1: Engagement means effective communication
with portfolio managers and buy-side analysts about a company’s strategy
and the linkage of its executive compensation programs to that strategy.
Reality: Portfolio managers and equity analysts are
largely, sometimes entirely, divorced from voting decisions on Say on Pay
at most large institutions. Traditional IR communication channels and
traditional IR communication strategies are at best of marginal utility in
the world of Say on Pay. Say on Pay voting (along with all other
shareholder votes on governance matters) at most large institutional
investors is vested in a wholly separate group of corporate governance
specialists, who typically answer to the general counsel or another senior
administrative officer, not to the chief investment officer. While
portfolio managers may have ability on paper to debate a proposed vote on
a governance matter within the organization, most often the portfolio
manager is put in the position of explaining why the institution’s voting
policies should be overridden. Needless to say, a portfolio manager has to
care an awful lot about a governance vote to take on this burden. Most
Myth Number 2: Engagement with corporate governance
activists is like engagement with portfolio managers. The lingua franca
boils down to corporate performance.
Reality: Not so, for many reasons.
Say on Pay is truly about pay, not
performance. It was not an isolated provision in Dodd-Frank, but rather
one of several that were intended to reduce the size of executive pay in
the US, including mandated disclosure rules for so-called “pay
equity”—the relationship of CEO aggregate pay to that of the average pay
for all world-wide full and part time employees.
Corporate governance specialists are not
trained investment professionals. Their discipline is not measuring
company performance, but rather advancing corporate governance in
accordance with their view of best practices. They assert that good
corporate governance, on the whole, promotes good company performance.
Accordingly, their mission is to insist on good corporate governance,
not to determine whether a company is producing good or bad performance.
In any event, corporate governance
specialists in any institution are too few in number to deal with
sophisticated, fact-specific measures of company performance across an
institutional portfolio. They not only lack the skill set to judge the
quality of performance, they lack the manpower to do so on a company
specific basis. To the extent that performance is relevant to their
decisions, they rely on simple one-size-fits-all metrics–such as Total
Shareholder Return (TSR)– as the sole performance measure relevant to
Say on Pay voting.
Communicating to corporate governance
specialists requires using their language and points of reference. Their
world is one of corporate governance, not relative or absolute company
performance. Communicating to them in the same terms as portfolio
managers and equity analysts would be like speaking Swahili to an Inuit.
Successful engagement in the realm of Say on Pay requires communicating
about issues the governance specialist cares about in terminology the
specialist can understand, not the issues a portfolio manager cares
about in the terminology the portfolio manager can understand.
Myth Number 3: Say on Pay can be successfully dealt with
by utilizing internal resources, except in a crisis situation, such as a
negative proxy advisory recommendation.
Reality: Say on Pay is not an occasional crisis brought
on by a specific failure to meet the metrics of the proxy advisors and
corporate governance specialists. It is an annual recurring event that can
all too easily threaten core relationships between a CEO and his/her board
as well as among board members. There have been a number of instances
where CEOs and/or Non-Executive Chairs have been severely embarrassed or
forced to step down over failed Say on Pay votes, and far more instances
where directors have been seriously embarrassed.
Every Say on Pay vote at every public
company should be viewed as a potential proxy contest and treated with
the same degree of attention and expertise. As a matter of prudence,
that means the company should consult with experienced outside counsel,
proxy solicitors and corporate communication specialists.
The team should be assembled well before the
annual meeting and should be actively involved in the compensation
committee’s and board’s deliberations on the executive compensation
package for the forthcoming year.
The team should also go through the standard
proxy contest drill of obtaining the best available information
concerning current institutional ownership, voting records and
methodologies of those institutions on Say on Pay and governance matters
and assessing, in advance, the pros and cons of the compensation
decisions being considered by the compensation committee and the board.
Say on Pay communication programs and
outreach should not be reserved for the crisis of a negative Say on Pay
recommendation by a proxy advisory firm. Rather, they should be viewed
as part of a year-round, year after year program of successfully dealing
with the separate universe of corporate governance specialists. This is
what “engagement” means and what successful “engagement” requires.
Myth Number 4: Engagement amounts to a “schmooze” session
or two, with a premium on a “feel good” outcome.
Reality: Engagement must be substantive and sustained to
be successful. The point of the exercise is two-fold:
First, to educate the company’s corporate
governance constituency about the positive aspects of the company’s
corporate governance, including in no small part the rationale for its
executive compensation program and its relationship to the company’s
business strategies and priorities.
Second, to listen and to respond to the
reasonable concerns of the corporate governance constituency and, where
possible, to foster a constructive dialogue and mutual understanding.
Obviously, a great deal of the engagement process depends on thoughtful
and consistent messaging in terms the corporate governance community can
understand and relate to. Beyond the fundamentals, however, a good
corporate governance communications program should help frame the issues
in terms most favorable to the company and, over time, it should challenge
and, optimally, change the corporate governance community’s appreciation
of the company’s commitment to effective corporate governance and its
steps to achieve that goal.
Myth Number 5: Say on Pay will become more routine over
time, and in due course Corporate America will weather this storm
Reality: Say on Pay will not become easier to deal with
over time. On the contrary, it is likely to continue to adversely impact
much of the public company universe each year. Like it or not, every year
every public company will have to face the critical issue of whether to
tailor its executive compensation program to meet the latest and greatest
Say on Pay metrics of the proxy advisory and activist governance community
or to do what its board thinks “is right” under its particular
Moreover, Say on Pay is not the only executive compensation hurdle
companies will have to face in the future. Corporate governance activists
won other significant victories in the Dodd-Frank legislation, which await
SEC rule making for implementation but which are likely to increase the
level of scrutiny surrounding executive pay. Today’s annual Say on Pay
campaigns are the tip of a much larger iceberg.
One new provision requires the SEC to adopt
rules requiring annual disclosure by every public company of the
relationship of executive pay and company performance. While the SEC has
yet to propose these pay for performance rules, few observers believe
they will be favorable to public companies in their definitions and
Dodd-Frank also requires the SEC to issue
rules for mandatory disclosure of the relationship of the CEO’s
compensation to that of the average worker at the company, taking into
account full and part time employees every where in the world. Aside
from the huge burden companies will inevitably face in collecting
world-wide compensation data, the outcome can hardly be viewed as a
positive for current CEO pay levels. This rule is very plainly designed
to embarrass CEOs and boards and to lead to investor and political
pressure drastically to reduce CEO compensation in the name of “pay
The stark reality is that Corporate America is facing a long-term
challenge to its existing governance models, most particularly in the
realm of executive pay. Companies cannot afford to deal with this
fundamental challenge through one-off proxy-like contests on those
occasions when their CEO compensation runs afoul of the proxy advisory
metrics of the day.
Rather, public companies need to recognize that Say on Pay is just the
beginning, not the end. To deal with this challenge requires a long-term
view and a long-term communications program aimed at a fundamental
reshaping of the thinking and voting of their institutional investors. The
goal is to wean investors away from the simplistic one-size-fits-all
metrics of the proxy advisory services or their own internal voting
policies and to get the voting decision makers (corporate governance
specialists and/or portfolio managers and analysts) to base their Say on
Pay voting a more nuanced and fact specific understanding of each
company’s strategy goals and executive pay policies and practices.
This post first appeared as the November 28, 2012 RLM Finsbury
Commentaries on Corporate Governance Series client memo.