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IR Magazine | Inside Investor Relations, November 10, 2011 article


Inside Investor Relations


Say-on-pay not going away

Adam Piore 10 Nov 2011

Shareholder votes on US executive pay set to continue apace in 2012

With a flagging economy driving down earnings, investors are likely to more closely scrutinize rising pay, and may take a more confrontational stance than they did during the financially heady days of the 2011 proxy season, when a rising economic tide seemed set to lift all boats. They are also likely to be less tentative in casting ‘no’ votes simply because say on pay is now in its second year, a number of insiders predict.

Proxy access and campaign finance disclosure will also be hot topics in the coming months, thanks to the furious fund-raising of the 2012 US presidential election and two recent court decisions that are grabbing shareholder attention. In July a federal appeals court in Washington, DC struck down an SEC rule that would have required companies to list shareholder- nominated board candidates in their proxy materials.

But the legal decision did not prevent an SEC revision of another related regulation – Rule 14a-8 – from taking effect in September. Rule 14a-8 will, for the first time, allow shareholders to use company proxy materials to propose their own board election and nomination procedures, which could result in a number of activist initiatives aimed at filling the void left by the DC court decision.

There’s no guarantee those proposals will aim for the consensus ownership threshold set by the SEC proposal, which would have required nominating directors to own 3 percent of the company for three years. Some suggest the proposals could go as low as 2 percent or even 1 percent. ‘If people are frustrated, you could see situations where it would be management-unfriendly, which would be unfortunate,’ says Brad Robinson, managing director specializing in corporate governance at proxy firm Eagle Rock. ‘If companies believe they will be targeted and there might be enough support to pass a bylaw, they would be better off opening a dialogue and coming up with a bylaw they can live with.’

Political concerns
Meanwhile, the upcoming US presidential race will be the first since the Supreme Court struck down campaign contribution limits in the 2010 Citizens United case – and various observers expect activist investors to push for disclosure aimed at filling the void. ‘Senior executives right now have enormous discretion to dip into corporate treasuries and fund all manner of charitable and political activities – often with little oversight from boards – and disclosure is scattered among different regulatory agencies,’ says Amy Borrus, deputy director of the Council of Institutional Investors. ‘Shareowners have no idea whether their money is being spent in ways that contribute to shareholder value, or are contrary to companies’ own policies.’

Melissa Aguilar, a research associate at the Conference Board, says more than a quarter of social and environmental proposals filed in 2011 were related to political contributions; one proposal filed at Sprint-Nextel in 2011 garnered 53 percent of the vote. Many of the proposals were coordinated by the Center for Political Accountability, which has already telegraphed its agenda priority for the year by sending letters to more than 400 companies urging them to adopt some form of disclosure or oversight of political contributions.

Top of the list
Still, the first issue on all lips as people look toward the 2012 proxy season remains say on pay. ‘There are routine votes – like the annual ratification of auditors,’ notes Patrick Quick, a partner at Foley & Lardner who specializes in corporate governance and proxy statements. ‘While say on pay will be annual, I don’t think it will be routine in any way. Issuers will have to actively address it every year, and think early and often about how to do that.’

‘Proxy advisers tighten the screws on their voting policies annually,’ adds Jim Barrall, a partner in the Los Angeles office of Latham & Watkins who specializes in executive compensation. ‘So some things that didn’t trip the trigger in 2011 might do in 2012.’ Ron Schneider, senior vice president at Phoenix Advisory Partners, says this ‘enhanced scrutiny’ will apply especially to companies that got ‘less-than- sterling votes’. He notes that while only 40 companies failed say on pay in 2011, at least 200 more got less than 70 percent approval, while 600 companies got less than 80 percent. ‘Many of those companies are likely to receive closer scrutiny next year,’ Schneider says. ‘Certainly the same investors that voted against them this year will be looking to see what changes were made, if any. Others that may have given them an easy pass may take a harder look at them next time.’

Indeed, when ISS surveyed shareholders on what level of ‘no’ to say on pay is worthy of a response, the top answer was 20 percent or greater, says Pat McGurn, special counsel at ISS. The second most popular answer was 30 percent. Despite this, Robinson says many companies believe if they received a majority of votes they can safely assume investors are satisfied. ‘There is a disconnect there, and I think it’s one thing companies are going to have to be aware of,’ he notes.

ISS has indicated it intends to operate a ‘yellow card, red card’ system, drawing its analogy from the penalty system used in soccer. Failing a say-on-pay vote is a warning, or yellow card. Failing to address a failed say-on-pay vote is a red card, which may well result in ISS recommending a ‘no’ vote against members of the corporate compensation committee.

Getting into gear
How companies likely to be in the crosshairs next year will prepare for the upcoming season is difficult to say. Many have not returned calls seeking comment, or say it is too early to discuss the issue. Some grew agitated at the mere mention of proxy season. ‘I don’t want to be quoted and I don’t want to talk about it,’ barked John Prosser, executive vice president of finance and administration and treasurer of Jacobs Engineering, which was the first to see its say-on-pay plan voted down last year.

At Exxon, which faced a campaign against its compensation package by union pension funds and a ‘no’ recommendation from ISS, and garnered just 67 percent approval for its pay packages, a spokesperson says the company wouldn’t ‘speculate’ or discuss the way it planned to prepare, or how it planned to respond to the 33 percent that voted against it.

But proxy advisory firms and attorneys who work with corporate clients have plenty of suggestions. Current SEC rules, notes Barrall, require every company to disclose in its proxy after a say-on-pay vote whether it has taken the say-on-pay vote into account in designing its pay plans and, if so, how. ‘The 38 companies that failed the vote are going to have to say more,’ Barrall adds. ‘If they don’t make significant changes, they risk having ISS make recommendations against the reelection of members of the compensation committee, possibly the entire board, for failing to be responsive to shareholders.’

There’s another reason to address pay and performance disparities: investors are likely to be far more irate at some meetings due to the sagging stock market. ‘Unless the market really recovers, we’re likely to have a lot of companies where performance is down and pay is either up or flat,’ says McGurn. ‘That will be a disclosure challenge for many firms and they will have to address it in a fairly straightforward fashion in order to convince investors there is a long-term link between pay and performance.’

The real deal
The consequences of failing a say- on-pay vote go beyond reputational issues; some 11 companies have been sued by individual shareholders and pension funds. The outcome of these cases is still unclear. Several have been settled, one has been dismissed, and one survived a motion to dismiss. ‘If people haven’t already figured out that this is the real deal and they have to address it, now is the time to learn the lessons from year one, both from their own company’s experience and the experience of other companies,’ says Quick.

Delivering the vote ‘will depend in part on good disclosure’ from both the compensation policies and the thinking of the compensation committee behind the policies. ‘Companies should also talk to shareholders – get a dialogue going and work to understand shareholder concerns,’ Quick says.


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