Compliance Week, April 14, 2009
Weekly Newsletter On Corporate Governance, Risk And Compliance
Meaningful, Effective Say-on-Pay Plans
Davis and Jon Lukomnik, Compliance Week Columnists — April 14,
corporate executives and board members: Please help us restore some
rationality into the executive compensation debate.
M. Davis is widely considered a pioneer in the field of
international corporate governance. A founder of the Global
Shareholder Service at the Investor Responsibility Research
Center, Davis also co-founded the International Corporate
Governance Network, which represents the interests of
institutional shareowners with $10 trillion in assets around the
A Pulitzer-nominated author
who has published seminal books and studies on shareholder
rights, Davis also writes a regular column for The Financial
Times, and sits on the editorial boards of several
governance newsletters in the United Kingdom and Eastern Europe.
He is currently the president
of Davis Global Advisors—which consults to institutional
investors, government bodies and others—and is a member of
numerous governance institutes, panels, and working groups in
the United Kingdom, Japan, Australia, Russia, and elsewhere in
the EU. His firm publishes a weekly newsletter called “Global
Proxy Watch,” as well as prominent studies like the annual
Leading Corporate Governance Indicators report.
Stephen Davis can be reached
Jon Lukomnik was previously
the deputy comptroller for the City of New York, where he was
investment advisor for the city’s treasury, and for defined
benefit plans totaling $80 billion in assets. In that role,
Lukomnik gained a reputation for forward thinking on governance
issues, overhauling the city’s corporate governance program, and
earning election to position of chairman of the Council of
Institutional Investors’ Executive Committee.
A former governor of the
International Corporate Governance Network and member of the
World Bank/International Finance Corporation’s Investor Task
Force, Lukomnik not only serves on numerous international
advisory boards, but has had a role in changing the national
regulatory and legislative framework. He was one of two investor
representatives who successfully negotiated changes in the proxy
voting processes, and his testimony before Congress on the
predecessor bill to the Securities Litigation Reform Act helped
identify the issues that were ultimately included in that law.
A former hedge fund managing
director, Lukomnik is currently managing partner of Sinclair
Capital, which provides consultative services for institutional
investors, the investment management industry, and numerous
multinational corporations including Coca-Cola, Pfizer,
WorldCom, Korea Telecom, and others.
He can be
The recent feeding frenzy about the AIG bonuses was much more about
melodrama than installing a capital market fix. The only items missing
were pitchforks and tar on the side of the rampaging masses, and some
CEO dropping a Marie Antoinette-like saying such as “let them eat stock
options” on the other. Rational discussion was drowned by the din.
Into this emotional maelstrom is born the United States version of “say
on pay” (SOP). Nearly 400 public companies must have advisory votes on
executive compensation this year, with a condition of receiving taxpayer
money through the various government emergency relief programs. A
handful of others have voluntarily adopted say on pay. Scores of other
companies have SOP proposals on their proxies, and the probability of
legislated say on pay for all public companies—perhaps as soon as the
2010 proxy season—is high.
After studying SOP outside the United States, and even after
understanding the strong differences between other capital markets and
ours, we believed say on pay would increase communication among owners,
managements, and boards, leading to more nuanced conversations. We
thought say on pay would prevent exactly the type of shouting past each
other that has been a staple of the evening news for the past few
months. We still believe that.
didn’t, however, anticipate the advisory vote being forced into the
current proxy season, leaving neither owners nor companies adequate time
to prepare, and starting amidst a white-hot national emotional
background. As a result, the core objective of the advisory
vote—improved communications between boards and owners—is at risk, at
least in the short term.
Colin Diamond, a partner in the capital markets practice of law firm
White & Case, has noted, installing an advisory vote into the system
should be a process that enhances dialogue, not a way for one
side or the other to scream “gotcha!” Unfortunately, the imposition of
an advisory vote for nearly 400 companies participating in the
government bailout has caught both the companies and their owners by
surprise. We and Diamond both, however, remain optimistic that the
United States can emerge from the short term with a workable advisory
vote system for the long term.
make ‘say on pay’ constructive at your company, here is a roadmap you
can adopt. We suggest you follow the “Five Ps” rule: preparation,
philosophy, personnel, process, and planning.
prepared. Assume you will have to place an advisory vote on
compensation on your proxy in 2010, whether you are a bailout recipient
or not. Don’t think you can parachute in with the right answers next
year; the preparation will take six or nine months to do well. Consider
carefully the philosophical, personnel, process, and performance link
recommendations below. If you are a bailout recipient, your job
is harder; you have to deal with all the following while under the gun.
Do the best you can with these recommendations as guides, then evaluate
and plan for next year.
the right philosophy for dealing with SOP. Above all, we strongly
suggest viewing say on pay as a process, not as an isolated vote.
Companies taking that approach in other markets have made it work well.
Second, remember that say on pay is designed to increase
communication—which is a two-way street. Decide what you want to
communicate, to whom, and through what mechanisms. Start with your
existing Compensation Discussion & Analysis. Are the incentive
performance targets clear and explicit? Can an average investor read the
CD&A, and just the CD&A, and understand what are the key drivers of
corporate performance? Are those drivers aligned with the performance
targets? Are there any ways in which executive compensation creates
unintended risk motivations? But then be prepared (be eager, in fact) to
listen to how your principal shareowners see those plans. Your default
approach should be discussion, not defensiveness.
a simple, replicable communication process that includes the nature of
communications you will be making, the target audience, and a timeline.
Start by carefully considering the one document that all shareowners
will read: the proxy statement. What type of resolution will you put on
the proxy? While there might be a temptation to write the narrowest
possible resolution—for example, asking for approval only of the summary
compensation table—less is definitely not more. The trend, and the
likely legislation, is for approval of both the amounts and the
compensation philosophy as evidenced in the CD&A. Some companies are
considering placing two resolutions on the ballot, one to approve the
amounts paid in compensation and one to approve the CD&A. (RiskMetrics
Group, the parent of proxy adviser ISS, actually includes a third,
asking for approval of the upcoming year’s plan.) Then decide on how
much outreach you will make to investors and their representatives. Will
you hold a meeting with the largest owners? How will you select them?
Will you meet telephonically with the proxy advisory firms? Will you
answer one-off questions from investors? (Assuming they don’t create
Regulation FD issues.) Or will you simply release the proxy and consider
it self-explanatory? Should management or the board compensation
committee run the talks? While the level of communications program will
depend on individual circumstance such as your investor base, market
capitalization and perceptions of your compensation program, the point
is that you should decide on that level in advance.
the right personnel. To whom should you talk? And who should
represent the company? These would seem to be simple decisions. But from
our experience, they are the most misunderstood practical aspects of
virtually all corporate governance communications between companies and
investors. First, when selecting investors with whom to talk, don’t make
the mistake of automatically assuming that your investor relations unit
is best placed to make those choices. IR is often best acclimated to
dealing with analysts who want to know, for trading purposes, what will
happen in the next quarter. The result is that a company can be
surprised come the annual general meeting, when a corporate governance
issue surfaces that never cropped up in the quarterly analyst calls.
That helps nobody. Many companies understand this; it’s one reason they
assign the corporate secretary responsibility for the proxy. You could
make the corporate secretary responsible for staffing the communications
plan as well. Or you could restructure your IR department to communicate
with the governance professionals, not just the analysts, at investment
houses. As a generality, the larger the institutional investor and the
more quantitative, the more likely it is to have specific corporate
governance experts assigned to decide on how to vote a proxy who are not
portfolio managers or analysts. That is particularly true of index funds
such as Barclays Global or State Street. It is also true of the largest
public pension funds (think CalPERS or New York State Common Retirement
Fund). That situation often does not hold for smaller investors where
the portfolio managers and analysts usually make voting decisions.
Exceptions abound, however, and the proxy voting advisory firms add
another layer of complexity. There is no substitute for simply knowing
how your top shareowners manage their ownership responsibilities;
someone needs to be accountable for gathering that information and
keeping it current. Second, in picking who represents the company, don’t
assume that management should take the lead. Outside the United States,
it is the independent chair of the board compensation committee who has
that job. That’s what investors may often prefer, since they view
directors as their agents—especially when it comes to setting
compensation frameworks. So make use of that channel.
your vote count, and start planning for the next year. If you
receive a high proportion of no votes, don’t rely on the fact that the
vote is “advisory.” It is, but should a material number of votes be cast
against the report, take action immediately. As Richard Ferlauto of the
American Federation of State, Municipal, and County Employees and one of
the most active proponents of SOP testified before Congress, a negative
advisory vote should be regarded as a warning. Absent changes in
policies, the next stage will almost certainly be a vote against
director(s). So, if you receive any material no vote, seek out your
largest holders and find out what aspect of your compensation plan was
problematic. That engagement cycle has served Britain well. When
shareowners of GlaxoSmithKline voted against its compensation report in
2003, the company immediately responded with a series of changes, and
instituted biannual shareowner roundtables. The other British companies
learned the lesson as well; most now build routine outreach to investors
into their annual calendar of preparations for the annual meeting. And
since 2003, only eight companies have suffered negative advisory votes,
or less than two a year. Finally, make sure you stay current on the
state of the art; the National Association of Corporate Directors, the
National Investor Relations Institute, and the Society of Corporate
Secretaries and Governance Professionals all have resources on the
current state of SOP, and are likely to continue to update them.
Simply put, your investors want a voice. If you treat the advisory vote
as a true, two-way communications process, you likely won’t ever have a
majority negative vote, you’ll know more about how your investor base
regards your compensation policies, and your investors will know more
about your company. Everyone wins all around. Done right, SOP will help
get the mob to put down its pitchforks, rather than fanning the flames.
So relax. The market reality is that with
more than 10,000 public companies in the United States, the chances of
your being made into one of the poster children for executive
compensation abuse is low, particularly if your company is not in
financial services, is performing well, and your compensation policies
are mainstream. The trick, of course, is to make sure you don’t become a
headline in the future. That’s what the Five-P structure is designed to
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