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Corporate Board Member, Third Quarter 2011 article


Nays on Pay: The Story Behind the Votes

Third Quarter 2011
Corporate Board Member
by Charlie Deitch

thumbsPreparing 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 packages.”

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 dividend performance.”

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 returns.”

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 award …”

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 award changed.”

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 shareholders.

“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 plan.”

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’s RealMoney.

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,” Hall adds.

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 compensation.”

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.”

Proactive Planning

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 your shareholders.”

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






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