How To Stop Investors Staging A Coup When It Comes
To Compensation Season
The 2013 proxy season may seem
a long way away, but we are already seeing signs of some activists and
companies alike making preparations.
Companies are lining up compensation consultants, legal advisors and proxy
solicitors (and PR firms) to help them defend against governance
challenges, from activist/dissident investors – primarily say-on-pay proxy
Say-on-pay contests don’t affect many companies, but when they do
happen, companies sometimes lose, and even a narrow win can lead to
have the best chance of clear victory, it makes sense to ensure early on
that the company’s compensation plans are defensible, that the surrounding
governance is appropriate, and that vote-getting machinery is in place if
Good idea, but not enough. Say-on-pay isn’t just about pay. Say-on-pay
isn’t just about governance. Say-on-pay is usually about performance.
More specifically, it is about investor dissatisfaction about performance.
Ask your dozen largest
shareholders these questions:
• What is our
• How will that strategy create value for you?
• How do you like the strategy?
• How are we doing at executing the strategy?
This means that a large part of preventing a bad-odds say-on-pay fight is
preventing, identifying and addressing investor dissatisfaction.
What’s needed here, even before a say-on-pay challenge surfaces, is a kind
of old school investor relations expectation management. More on this in a
moment. But first, how do you feel about executive compensation?
If a company’s stock is going through the roof, investors usually
have no problem with management getting rich. Wall Street’s generally
comfortable with the original hedge fund formula: “If I make money for
you, I share in the profits. If I make nothing for you, I take nothing.”
If a company’s stock is performing in line with expectations, or
if a company is executing well against a widely-understood and approved
strategy, investors are usually content to see management paid well, in
line with managements in general.
If the stock is lagging, if the performance is mediocre, and/or
the strategy is unknown or unliked, investors will likely want
management to get no more than a living wage (by C-suite standards), and
to be shown the door if things don’t get better.
Say-on-pay contests happen most often in the third category. But the issue
isn’t that the pay is too high. It’s that the pay is too high for the
performance actually delivered. A company challenged on pay has to make a
credible case for its compensation program. A company that wants to avoid
being challenged on pay has to make a credible case for its performance.
Both cases matter.
Before say-on-pay, an investor unhappy with a company’s performance had
the choice between very small actions and very large actions.
Very small action was a letter, phone call or personal visit to
management. Only the very largest shareholders really got
management’s attention. Mere communication rarely affected corporate
strategy or capital management.
Very large action was selling one’s investment. That erased the
downside of future underperformance. It also erased the upside that
persuaded investors to buy in the first place. And it didn’t send a
clear message to management.
Very large action was also mounting a proxy fight to unseat board
members. This was very expensive. It usually didn’t succeed. And even
success wasn’t sure to send the stock upward. But the message to
management was certainly clear.
Say-on-pay’s inclusion in Dodd-Frank gave shareholders a mid-size tool to
show dissatisfaction – and to get management and board attention when they
did. Effectively, say-on-pay is now a referendum on whether management
earned its pay package – a referendum on performance. It requires
nothing from investors or managements or boards. But it is a painfully
visible statement of disapproval.
company that loses a say-on-pay vote would be mad not to bring the pay
package into line with investor acceptability. For those that don’t: The
following year, activists now run withhold campaigns to unseat or
discredit members of compensation committees who don’t respond to
The scorecard: There are more than 6000 public companies. Last
year, 2,186 reported say-on-pay votes. Only 53 of those votes failed to
get a majority in favor of the company’s comp program. Overall, about 90
percent of all votes cast anywhere were in favor of their company’s
programs. Focus just on S&P 500: Out of 406 votes, only 12 got no majority
for the company program.
Now add ISS to the mix. ISS, the proxy advisor, recommended against
278 comp plans (57 of the S&P). Of these, 176 got less that 70% of the
vote. ISS (and some others) believe 70% is a better measure of shareholder
acceptability than a 51% legal majority. ISS is reported to control or
strongly influence up to 30% of all share voted.
ISS recommendations correlate pretty closely with activist-shareholder
say-on-pay campaigns. ISS is more likely to take an interest if investors
are vocally unhappy. Shareholders are more likely to go to war if the most
prominent arbiter is on the case. So: Campaign + negative ISS = a
worrisome chance of outright defeat, plus a pretty likely under-70%
a proxy fight begins, companies often complain that ISS has too much
influence or a conflict of interest. Activists often complain that their
target’s compensation plan doesn’t inflict enough financial pain when
performance sours or the stock price tanks. Maybe true, maybe false, but
neither argument is going to decide the outcome of the vote. The decisive
issue is going to be: How do we, the shareholders, feel about the job our
management is doing for us?
let’s return to that thought from above: If a company’s stock is
performing in line with expectations, or if a company is executing well
against a widely-understood and approved strategy…. See the four questions
in the box above. Almost without exception, companies that try this quiz
are astonished at the degree of strategic misunderstanding and consequent
dissatisfaction among the investors who should know them best.
Memo to management: Tell investors where you’re going. Tell them
what’s in it for them. Give them some milestones that show you’re getting
there. And, last but absolutely not least, ask them how they feel about
your direction and your progress before they conclude they have to send
you a message.
Sounds simple. Distressing how rarely it actually happens. Too many
strategic statements are mush (does anyone not want to increase ROI?) Too
many boards don’t consider how the strategies they approve create
shareholder value. Too many companies do not connect their results to
their strategies. And too many don’t ever really take their shareholders’
We recommend that boards of directors reach a clear understanding
about how they intend to create shareholder value. Sometimes this is
explicitly communicated; sometimes not. Either way, it is the foundation
for so much of the shareholder communications that follows, and
therefore it needs to be reviewed and refreshed constantly. In our
experience, this is uncommon.
We recommend that managements put forth strategic statements that
specify goals, plans and rationales clearly enough for rational
external analysis. In our experience, these statements are more common,
but too often they’re so vague or legalistic that they fail their
We recommend that managements provide externally-visible milestones
that show progress (or lack thereof) toward strategic goals.
SEC-mandated data are pretty good about today; they’re not much help
We recommend that corporate executives who speak to investors never stop
imitating New York’s legendary mayor Ed Koch: Incessantly ask “How’m
I doing?” If you ask and listen, you’ll have a better shot at
avoiding a needless, expensive and disruptive battle over say-on-pay.”
Doing these things won’t
eliminate the need to put together a say-on-pay fight team, just in case.
Every year, we help a bunch of clients in say-on-pay fights, with good
results. We’d rather help them implement these four steps – they might
save the team from having to go into battle.
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