Nays on Pay: The Story
Behind the Votes
Third Quarter 2011
Corporate Board Member
by Charlie Deitch
for inaugural say-on-pay votes at the two public companies he chairs was
an anxious time for Philip Odeen and his fellow directors. Odeen serves as
independent chairman of the board for both customer relationship
management firm Convergys and power company AES. As if that weren’t
enough, he also serves on both companies’ compensation committees. So, in
one way or another, he was involved in structuring or approving pay plans
for the two executive teams.
And now, thanks to changes brought about by
last year’s Dodd-Frank Act, the companies’ shareholders were about to tell
him what they thought about those compensation packages. “The looming
say-on-pay vote caused us to work a whole lot harder on our CD&A to make
sure we did a good job describing our comp systems,” Odeen says. “In
particular, we wanted to spend the time to make sure we explained how our
compensation packages were very much performance based.
“It’s not that we didn’t describe it
before,” he continues, “but say on pay was the impetus to be even more
careful and more forthcoming in how we presented our compensation
For Odeen and his colleagues, say on pay
was a bit stressful, to be sure.
But at the end of the day, shareholders
agreed with both boards’ presentations. Convergys’s comp plan passed with
an 85% approval rating, while AES racked up an impressive 97% approval.
However, not all companies felt the same
relief this proxy season. On Feb. 1 more than 50% of shareholders voted
negatively on executive compensation at Jacobs Engineering. It would be
the first of 39 companies [as of this article’s press time] to lose
advisory votes on compensation. In fact, Jacob’s 54% disapproval rating
would pale in comparison to the 66% negative ratings posted later in the
spring by companies like M.D.C. Holdings, Helix Energy Solutions Group,
and Cincinnati Bell.
So what do these defeats really mean–both
now and for a failing company’s future? Are 39 losses really that big of a
deal? For some, maybe not, but for those on the receiving end of the
shareholder derivative suits filed so far, the answer is clearly yes.
“I don’t think a lot of companies really,
fully thought out the implications of say on pay and how serious it [would
be],” says New York-based compensation consultant Steven E. Hall, managing
director of the eponymous firm. “And that’s a strange thing for me to be
saying, because we’ve talked about it and we’ve known it’s out there.”
Donald G. Kalfen, partner and senior
consultant at Meridian Compensation Partners, says that since “the idea of
say on pay began percolating,” his firm has been stressing to clients the
importance of using the CD&A to very clearly lay out a company’s
compensation plan in detail. “It’s absolutely critical to use the CD&A to
tell an effective story to the shareholders that describes why executive
pay is what it is and why the decisions have been made the way they have
been,” Kalfen says. “The stakes are higher now because of say on pay, and
your CD&A is an important tool.”
But not all companies have used this tool
in the most effective manner. “Some companies have done a better job with
their CD&As,” Hall notes, “but with regard to shareholder outreach—getting
out and telling their stories to shareholders and listening to what they
had to say—I think a lot of companies fell short.”
A look at the landscape
In 2010 Congress answered the country’s financial meltdown by passing the
Dodd-Frank Wall Street Reform and Consumer Protection Act. The bill was
meant to bring sweeping changes to the way government regulates Wall
Street and publicly traded corporations.
And although say on pay was a very small
part of the act, it has in the past several months gotten what some might
term a disproportionate amount of attention from companies, shareholders,
and analysts. The shareholder vote on compensation—required for large and
mid-cap publicly traded companies—is nonbinding or “advisory,” meaning a
company is not statutorily obligated to do anything before or after the
vote, regardless of the outcome.
But as votes began rapidly approaching and
proxy information was sent out to investors, it became obvious that
advisory or not, companies were not going to be able to relax and do
nothing to secure an affirmative vote.
“You can’t just sit back and expect people
to love you and say nice things about you,” observes Hall.
It wasn’t just shareholders with the
occasional unkind word or criticism. Companies also had to deal with
say-on-pay recommendations from proxy advisory firms, most notably
Institutional Shareholder Services. Of the roughly 3,000 or so say-on-pay
votes scheduled, ISS issued negative recommendations on about 11% of those
companies, according to Carol Bowie, head of compensation research
development at ISS. The 39 companies receiving negative votes so far,
Bowie says, represent a very small rate of negative votes.
So are there any common threads? While
there’s not one blanket to cover all of the negative votes, there does
seem to be an underlying theme within the companies that failed.
“Am I seeing any trends?” asks Hall. “Yeah,
their stock prices were [in the toilet].”
Underperforming companies definitely seemed
to take the brunt of shareholder dissatisfaction. Combine that with what
investors saw as high compensation compared to that performance, and it
became a recipe for failed votes.
Take, for example, Colorado-based
homebuilder M.D.C. Holdings. While CEO Larry Mizel only saw a 2% increase
in compensation, ISS noted that Mizel’s total comp package of $9.6 million
was well above the median $2.4 million paid out across the industry.
“The Board of Directors believes the
Company’s compensation programs are tailored to retain and motivate key
executives in alignment with maintaining and creating long term value for
our shareowners,” M.D.C. wrote in its proxy. Investors disagreed, however,
and smacked the company with a 66% negative vote.
Another company, Constellation Energy
Group, posted nearly $1 billion in losses in 2010 while its CEO, Mayo
Shattuck III, made $15.7 million, according to the company’s April 15
proxy statement. Attempts to contact many of the companies that received
negative say-on-pay votes went unanswered. However some, while reporting
the loss in their required form 8-K, did indicate how they were handling
the negative votes and how they would deal with their say-on-pay losses.
Portland-based bank Umpqua Holdings
received a massive 62% negative vote.
In an April 8-K following the annual
meeting, the company writes, “Our board of directors takes the results of
this vote seriously and is considering ways to address this concern.” A
subsequent 8-K filing in June noted: “Our Compensation Committee has taken
action to more closely link executive compensation to stock price and
Umpqua’s filing also sheds some light on
where at least some companies might have been thinking things went wrong.
The bank is quick to point the finger at ISS and its negative
recommendation, saying, “We believe that the vote against the ‘say on pay’
resolution was primarily the result of votes cast by institutional
investors that followed the recommendation of [ISS]. The ISS report found
a ‘disconnect’ between our CEO’s compensation in 2010 and the company’s
total shareholder return.
“Our board and management fully support the
pay for performance principle advocated by ISS and that principle is a
cornerstone of our executive compensation program. Our board and
management are fully committed to increasing earnings per share as we
recover from the recession and thereby positioning Umpqua to increase
dividends in the future and create an environment for improved shareholder
Umpqua says ISS used a “formulaic” approach
to reach its recommendation and did not take into account the company’s
2010 performance as it attempted to emerge from the recession. Last year
the company reported earnings of $16.1 million, compared to losses the
year before of more than $163 million.
One size does not fit all
In fact, it is just such an approach, as well as the proxy advisory firms’
reaction to it, that has many critics of say on pay up in arms. There are
many nuances to a company’s executive compensation program—such as what it
takes to hire leadership that will elevate a company that has been a
laggard performer in the past or, in some cases, to hire someone with the
talent to help a company outperform its peers, especially during a
downturn. In other words, there is often not a straight correlation
between performance and pay. The important thing, many critics say, is not
to evaluate executive compensation in a vacuum, or simply relative to a
ratio of employee salary.
How many people are there in the entire
world, for instance, who can come in and head a company like
Hewlett-Packard? In some cases, companies have to pay superstars for the
jobs they legitimately do, although the optics of paying superstar CEOs
may cause critics and investors to flinch.
For her part, Bowie says it’s not
reasonable to lay a company’s defeat on ISS. The firm conducts its
research, does its analysis, and makes a recommendation based on those
facts. To give ISS that much credit, she says, just wouldn’t be fair.
“Investors weren’t just listening to ISS,”
Bowie says. “If that were the case, I think there would have been a lot
more negative votes.”
Others are not convinced by this argument.
David F. Larcker, the James Irvin Miller Professor of Accounting at
Stanford University’s Graduate School of Business and Rock Center for
Governance, finds it interesting that all the say-on-pay defeats also had
an “against” recommendation from ISS. Of course, he points out, this does
not mean that ISS alone caused the defeat.
“Based on our research, we find that ISS
can influence somewhere around 30% of the votes for a typical company,”
Larcker says. “However, the fundamental unresolved question is whether the
approach used by ISS in developing [its] voting recommendations can
actually identify firms with flawed compensation practices and bad
governance. I am not sure that it makes sense to base most of the voting
recommendation on comparisons involving relative total shareholder return
and change in compensation levels over one or three years. Is there any
real evidence that these recommendations are correct?”
Susan O’Donnell, a managing director at
executive compensation consultant Pearl Meyer & Partners, agrees that
there are a lot of gray areas when it comes to making a judgment call
against a company’s compensation plan. “There’s a lot of ire against ISS
right now, and it’s frustrating for a lot of companies,” she says, noting
that some ISS opponents are calling for more regulation from the SEC. ISS,
she explains, has no authority, but “a huge amount of power and
influence,” so given that, directors have to understand its rules.
No matter what dynamics influence the
casting of votes, the fact is, the power of a potential negative vote is
pervasive. Some companies, as a result of recommendations from companies
like ISS, made pre-vote changes to their compensation packages and filed
additional proxy information to alert investors to the changes.
The most prominent examples of this were at
General Electric and the Walt Disney Co. At GE, many thought the company
was headed toward a sure-fire negative vote based on nonperformance
related to stock options given to CEO Jeffrey Immelt in March 2010.
“Some shareowners have expressed the view
that additional performance conditions should be applied to Mr. Immelt’s
2010 stock option award,” GE wrote in its 2011 proxy supplement. “After
taking into account these views, the MDCC [management development and
compensation committee], with Mr. Immelt’s full support, has modified that
According to the new conditions, “50% of
the options would vest only if GE’s cumulative industrial cash flow from
operating activities … is at least $55 billion over the four-year
performance period beginning on January 1, 2011 … and 50% would vest only
if GE’s total shareowner return meets or exceeds that of the S&P 500 over
the same period.” GE went on to score a nearly 80% affirmative vote.
At Disney, the main point of contention was
a policy, pointed out by ISS, that allowed the company to pay the excise
taxes on the severance packages of departing company executives. Disney
took the GE approach and publicly addressed the policy, saying that the
board of directors voted to discontinue the practice on future contracts.
Then, days before the vote, the company made the new rule effective for
its current executives as well. Disney’s say-on-pay measure passed with
77% of the ballots cast.
Compensation expert Paul Hodgson, chief
communications officer for GovernanceMetrics International, a governance
rating and research firm, says the actions by GE and Disney may be the
best example of why say on pay is necessary and why it works.
“It was very interesting to see two
household-name companies [react] with speed and alacrity to the
possibility of a negative vote,” Hodgson says. “And to be honest, I think
that this is exactly what say on pay is all about.
“I can’t sit here and say that the
directors of GE, for example, weren’t acting in good faith when they made
that stock award; I’m sure they were,” Hodgson says. “But without say on
pay, it would have been much more difficult for shareholders to get that
Handling the fallout
Not all companies, however, made the necessary changes to secure an
affirmative say-on-pay vote. Although the vote is technically nonbinding,
that doesn’t mean there aren’t consequences. Thirty- nine companies (and
possibly one or two others whose “yes” votes are in dispute) must now
figure out exactly what this advisory vote means and how they can avoid
failing a second time.
The aforementioned Umpqua Holdings, for
example, is one of a handful of companies (six in 2011; two in 2010) hit
with a shareholder lawsuit. In Umpqua’s case, the resolution did not pass
with a majority, yet the company upheld its compensation committee’s
recommendation, stating it believed the vote was a result of institutional
investors who followed the ISS’s “formulaic” recommendation. According to
the company’s April proxy statement, Umpqua CEO Ray Davis earned $3.7
million in 2010, a 61% increase over 2009. While published reports
indicate that the company plans to fight the lawsuit, in a June 20 SEC
filing, the company stated it was taking action to “more closely link
executive compensation to stock price and dividend performance.”
Wayne R. Guay, a compensation expert and
Yageo Professor of Accounting at the University of Pennsylvania’s Wharton
School, says it appears that the handful of lawsuits filed have tended to
be against companies that lost on say on pay and then stood by their
original compensation committee’s recommendation. As the lawsuits move
through the courts, Guay predicts it will be an uphill battle for
“This is going to be a tricky legal matter
to navigate,” Guay says. “It’s going to be very difficult [for
shareholders] to win a lawsuit like this because you’re going to have to
show damages of some kind and show that directors weren’t living up to
their fiduciary responsibilities by enacting this particular compensation
Michael S. Melbinger, chair of the employee
benefits and executive compensation practice at Winston & Strawn, says,
even more than that, such suits are clearly designed with one aim in
mind—big settlements. “Based on my extensive experience and work in this
area, I believe that these lawsuits are an attempt to draw a quick cash
settlement out of the companies sued so far. The ‘business judgment rule’
imposes a very significant barrier to lawsuits like these that attempt to
second-guess the decision of the board or compensation committee.
Additionally, the lawsuits were filed before any of the companies even had
an opportunity to react—or make changes in response—to the majority
‘against’ vote,” Melbinger states. The Umpqua case falls into that
category. “I can only imagine that some creative and overly optimistic
plaintiffs’ lawyers thought that the new shareholder say-on-pay vote gave
them an excuse to file suits that would have been immediately dismissed
previously,” he continues.
Regardless of the true aim or likelihood of
winning such a lawsuit, compensation expert Hodgson says it doesn’t
surprise him that some firms are testing the water. “There are clearly
some law firms that are looking at this issue and determining if there is
an opportunity for them to facilitate reform,” says Hodgson. “At this
point, I think it’s way too early to tell how companies are going to react
to this advisory vote. So, if there’s something here that needs to be
reformed in terms of executive compensation, this is just another way to
maybe help figure that out. But I think that this is just a testing ground
at this point.”
O’Donnell says the rising number of
say-on-pay no-votes are increasing the chances of litigation. Beyond the
lawsuits already filed, she says, “I suspect there will be more. Even if
the litigation doesn’t stick, you don’t want to have that on your
shoulders, because it’s a huge additional expense and a waste of time.”
Lawsuits aside, there could be other
concerns for directors who decide to ignore or downplay the significance
of say-on-pay votes. In some parts of the world, negative votes on say on
pay have had pretty serious consequences.
“In Australia, if a board receives two
consecutive [negative] votes on say on pay,” Hodgson explains, “then the
entire board has to stand down. The Australians don’t mess about.” Hodgson
says he can’t imagine a similar law being passed in the United States, but
that doesn’t mean directors won’t come under serious fire.
Damien Park, managing partner of
Philadelphia-based Hedge Fund Solutions, works both with activist
directors seeking board seats and companies trying to repel such a move.
He is also the co-chairman of The Conference Board’s expert committee on
shareholder activism and is a regular commentator on the subject for
Park says this year’s negative say-on-pay
votes might not be too worrisome yet; however, it does put companies at
risk because while a second negative vote next year definitely puts a
target on your back.
“Nonbinding votes don’t worry me too much,
especially in their initial year,” says Park. “It’s what’s going to happen
next year if … these companies that either received a negative vote or
even a negative recommendation from ISS don’t change their practice[s] or
their polic[ies]; they’re going to be sitting ducks for an activist
investor next year.
“That’s what we’re following—which of these
companies don’t make fundamental changes to their policies because that
says to me that they’re not listening to their shareholders. The loss of
one nonbinding vote is one thing, but two … that’s the sort of thing that
matters in my world,” Park says.
What the vote really means
With so much hanging in the balance, how can a company be sure that simply
engaging shareholders or making comp package changes will solve the
problem? In other words, is a negative vote on say on pay really always a
vote against a company’s current compensation package?
Or is there more to it than that?
During the 2010 congressional elections,
for example, the move to oust Democratic legislators was seen as an
indictment of Obama and his policies and had little to do with how
congressmen from Kentucky, Pennsylvania, and Iowa were actually doing.
“The one question I’ve had about this from
the beginning is, is a say-on-pay vote really a say-on-pay vote?” asks
Hall, the compensation consultant. “Are they really upset about the
compensation package, or are they upset because of some other issues that
have been going on in the company and was this finally their chance to
say, ‘We aren’t happy with some of the things that you’ve done’?
“I think if you take a quick look around at
some of those negative votes, you can find some pretty easy examples,”
By the time Hewlett-Packard shareholders
settled in for their say-on-pay vote this year, the company had been
through a tumultuous 2010. First there was the abrupt departure of CEO
Mark Hurd, and then, shareholders found out that tough times were ahead,
thanks to leaked memos from current CEO Léo Apotheker indicating that
revenue forecasts were much lower than expected.
The company, valued at $100 billion the day
Hurd left, according to The Wall Street Journal, was now worth about $20
billion less. Hurd, a once-popular figure with HP shareholders who
credited him with reviving the company by slashing costs and diversifying
holdings, was admittedly not without baggage—he resigned after an internal
sexual harassment probe, only to become co-president of HP competitor
Oracle Corp. a month later.
HP received a negative recommendation from
ISS, but Bowie says it was for one reason only. “It was based solely on
the issue of pay, and I have no reason to believe that it was anything
but,” he says. “That said, I don’t think say on pay has to only be about
pay or pay magnitude. It’s about the level of performance compared to that
level of pay.
“When you get down to it,” Bowie adds,
“your average investor wants to pay whatever is necessary to get the
talent into the company that will create the greatest shareholder value.”
Hall doesn’t completely agree.
“Things happen all the time that can affect
a company and anger shareholders,” he says. “I just don’t think you’re
ever going to know for sure what a shareholder is really basing his vote
on, and that’s going to make it hard for a board of directors to make
changes to compensation if the reason for the vote isn’t based on
Hodgson says he gets asked that question
all the time. His answer is always the same and when you get right down to
it, is probably the best reason to hold say-on-pay votes—communication.
“Just ask the bloody shareholders,” he
says. “They’re right there. If they took the time to vote against your
compensation package, I’m sure they’re going to be more than willing to
tell you why.”
Adds the Wharton School’s Guay, “If what
comes out of these votes is that the company has to do a little bit more
talking, a little bit more explaining why they structured things the way
they did, I think [that’s] good. Anytime we can get the dialogue going
between companies and shareholders, it’s a good thing.”
Pearl Meyer & Partners’ Managing Director
Susan O’Donnell offers three cogent tips to help directors make sure
they’re prepared to face shareholders with their compensation plan.
Understand your shareholders.
“I’m not suggesting that companies don’t know who their shareholders are,
but [they need to] understand their perspective on compensation. Related
to that, if you have a lot of institutional shareholders, they [either]
already have their own thoughts and ideas on compensation or are depending
on services like ISS or Glass Lewis. You need to be very aware of what
their voting guidelines are. And you need to know where your no votes are
likely to come from.”
Pay close attention to your disclosure.
“Your disclosure is the end result of your year’s worth of decisions. You
have to clearly highlight for people what you want them to know, and you
have to make it easy for them to understand things.”
Look at your policies and processes.
“You really should review all of these things. Clean up those
policies—think about things like clawbacks, ownership guidelines, holding
requirements, and the design of your incentive plan. Think about your
decisions as you go along, and assess your pay-for-performance
relationship because that is the key item that will get you a no vote from
Proxy Access on Hold...
The U.S. Circuit Court of D.C.’s decision
on July 24 to vacate the SEC’s rule on proxy access gives corporate boards
more comfort about shareholders’ ability to influence their nomination
slate. While shareholder suits are still a looming shadow over say-on-pay
votes, shareholders’ ultimate weapon will be blunted by this decision. To
read more about this outcome, visit