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.
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
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.
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 don’t.
Engagement with corporate governance activists is like
engagement with portfolio managers. The lingua franca boils down to
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.
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
» 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
Say on Pay can be successfully dealt with by utilizing
internal resources, except in a crisis situation, such as a negative proxy
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
» 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.
Engagement amounts to a “schmooze” session or two, with a
premium on a “feel good” outcome.
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.
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.
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.
Say on Pay will become more routine over time, and in due
course Corporate America will weather this storm relatively “unscathed”.
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 circumstances.
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 details.
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
everywhere 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 equity”.
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.
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.
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