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RiskMetrics (f/k/a Institutional Shareholder Services - "ISS"), January 30, 2008 blog














Wednesday, January 30, 2008


2008 Preview: Pay Proposals
Submitted by: Subodh Mishra, Publications


Investor calls for advisory votes on pay and other measures to reform executive compensation will resonate in 2008 as U.S. capital markets slide in the face of recession.

A network of investors, led by Boston-based Walden Asset Management and the American Federation of State, County and Municipal Employees, has so far filed more than 90 proposals calling for an advisory vote on pay, compared with 44 such resolutions at this time last year.

The network’s membership--which ranges from retail shareholders to pension fund giants including the California Public Employees’ Retirement System--also has grown from 2007. Nearly 75 investors have come together this year to file the measure at primarily large and medium-sized companies.

“Companies receiving the proposal include those where shareholders believe there has been non-performance, options backdating, and other major issues that shareowners need to address,” Timothy Smith, senior vice president at Walden Asset Management, told Risk & Governance Weekly. Abbott Laboratories, Capital One, Lexmark and Wells Fargo are among those targeted.

Spokeswomen at Capital One and Wells Fargo declined to comment on the filings, while officials are Abbott Laboratories and Lexmark did not immediately respond to requests for comment.

The proposal, dubbed “say on pay,” also will be filed at companies such as General Electric that are generally viewed positively by shareholders with respect to executive compensation and other facets of governance, according to Smith. “We believe [such companies] should provide leadership in adopting an advisory vote” on pay, said Smith, who also noted that dialogue on the issue has increased this year.

Governance watchers have in recent months called for increased communication between issuers and shareholders on a range of issues including compensation. “Improved communication and dialogue … may provide compensation committees with a broader perspective and balance in relation to the views provided by management,” wrote Weil, Gotshal & Manges attorneys Ira M. Millstein, Holly J. Gregory, and Rebecca C. Grapsas in a memo to clients earlier this month. “It may also lessen the push for an advisory vote on executive compensation.”

Last year, 20 companies and investors came together to form the “Working Group on the Advisory Vote on Executive Compensation” to study the issue.

Three companies--Par Pharmaceuticals, Verizon Communications, and Aflac—have so far taken steps to allow for advisory votes on pay following shareholder proposal filings in 2007 calling for the right. Aflac, the Georgia-based insurer, will be the first to give shareholders the vote when it holds its annual meeting on May 5. The company originally planned to allow for the vote in 2009.

Concerns over compensation in 2008 will not be limited to calls for advisory votes on pay, though. Novel proposals will include demands for companies to adopt a policy on the use of so-called 10b5-1 stock-selling plans, and those seeking to limit or bar tax gross-ups for senior executives. Another resolution seeks to place limits on executive employment agreements.

First year proposals generally do not fare as well as those in their second and third year, though this year may prove an exception.

“As the market declines, there’ll be more support for compensation reform,” notes Charles Elson, director of the University of Delaware’s Weinberg Center for Corporate Governance. “The downturn will only fuel the efforts of shareholders.”

Reports of record Wall Street bonuses at financial firms that sustained considerable losses in 2007 as a result of exposures to mortgage-related investments are likely to stimulate broad support for proposals tied to executive pay. Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns together awarded roughly $39 billion in year-end bonuses, exceeding the $36 billion distributed in 2006 when the industry reported all-time high profits, Bloomberg News reported.

CEOs at Morgan Stanley and Bear Stearns forfeited bonuses in light of bad bets on subprime mortgage-backed securities. That may mollify shareholders who are expected to vote on a range of proposals including those calling for strengthened links between pay and performance. Labor funds, led by the United Brotherhood of Carpenters’ and Joiners of America, have so far filed more than 50 such resolutions at spring annual meetings.

More than three-dozen proposals requesting a pay-for-performance link received average support of nearly 30 percent in 2007, while roughly two dozen similar resolutions received more than 36 percent support in 2006.

This year’s proposals typically call for compensation committees to adopt a pay-for-superior-performance principle by establishing compensation plans that set strict criteria for achieving payout targets. For example, measures call for the establishment of performance targets for each plan financial metric relative to the performance of peer companies, as well as delivery of a majority of the plan’s target long-term compensation through performance-vested equity awards rather than time-vested awards.

Bear Stearns is one company that is challenging the proposal at the Securities and Exchange Commission. The firm is seeking permission from the SEC to omit the proposals on the grounds it has been “substantially implemented,” arguing its compensation committee “has historically followed the long-held principle that the executive officers should be rewarded based on both the [c]ompany’s and their own individual performance.”

In their Dec. 21 letter to the SEC, lawyers for the New York-based financial firm note that the commission has in the past stated that exclusion may be appropriate “…even if company practice does not mirror the proposal exactly.”

Thirty-two percent of Bear Stearns’ shares present and represented, including abstentions, voted in favor of a Carpenters’ pay-for-performance proposal at last year’s annual meeting.

The Carpenters have so far filed pay-for-superior-performance proposals at 33 companies, including Best Buy, Honeywell International, WellPoint, and Northern Trust, according to RiskMetrics records.

New Concerns Spotlighted
Troubled by the potential for executives to abuse certain benefits, labor pension funds are filing two new proposals in 2008.

AFSCME plans to submit proposals calling on companies to adopt tighter controls on executive stock sales under “Rule 10b5-1” plans. That SEC rule, enacted in 2000, was meant to provide flexibility to insiders who may not trade on information that is not available to outsiders by allowing them to set up automatic trading protocols that operate regardless of insider trading “windows.”

However, critics of the rule contend that loopholes allow executives to cancel trades when nonpublic information would indicate, for example, that a sale may not be beneficial. A September 2007 study by Stanford University researcher Alan D. Jagolinzer found that the rule “appears to enable strategic trade[s],” and SEC officials have warned that the study suggests the possibility of abuses, which they are investigating.

AFSCME's 10b5-1 proposal, filed so far at Safeway and SanDisk, seeks to close potential loopholes by tightening disclosure requirements and putting in place stronger controls. The resolution calls on boards to adopt principles to help ensure that 10b5-1 plans are not abused. For instance, one principle would limit amendments, or the early termination of plans. Another would require the broker handling 10b5-1 plan trades not to handle other trades for an executive in order to minimize the likelihood that the executive will inadvertently communicate material nonpublic information to the broker.

The proposal also calls for a 90-day gap between adoption or amendment of a 10b5-1 plan and initial trading under the plan, barring executives from trading in company stock outside plans, and a requirement to identify plan transactions on Form 4 reports, which are corporate filings on trades by insiders.

“We believe that 10b5-1 plans, with proper safeguards, can serve a useful function,” AFSCME notes in the proposal's supporting statement. “The disclosure-related principles aim to increase transparency regarding 10b5-1 plans.”

AFSCME also is submitting a new compensation-related proposal that seeks to limit the use of tax gross-ups, whereby companies cover the tax liability of executives, often following a change in control. Such payments have received widespread coverage in recent years as use of perks has proliferated and new SEC compensation disclosure rules make it easier for investors to identify such potential payments.

AFSCME’s proposal calls on companies to refrain from making or promising to make gross-up payments to its senior executives, except those “provided pursuant to a plan, policy or arrangement applicable to management employees” generally, such as those related to relocation or expatriate tax-equalization policies.

The proposal defines a gross-up as “any payment to or on behalf of the senior executive whose amount is calculated by reference to an actual or estimated tax liability of the senior executive.” The definition is designed to focus on the often large payments made in conjunction with severance packages awarded after takeovers.

“Gross-ups highlight the dubious effects of privilege that allow CEOs to avoid taxation, while ordinary Americans cannot,” said Richard Ferlauto, director of pension and benefit policy at AFSCME. Proposals have so far been filed at Nabors, American Express, Textron, CVS Caremark, Northrop Grumman and Clear Channel Communications.

Connecticut Retirement Plans and Trust Funds is seeking to bridge the gap between CEO pay and that of the next highest-paid named executive officer, or NEO. So far, the pension fund is calling on two companies--Abercrombie & Fitch and SUPERVALU--to adopt an internal pay equity policy. Under the proposal, compensation committees would be charged with conducting peer group and other analyses and then disclosing to shareholders “the role of internal pay equity considerations in the process of setting compensation for the CEO and other NEOs.”

We “believe that large CEO to NEO pay ratios may indicate inadequate succession planning, since large disparities may be seen as reflecting significant differences in contribution and ability,” fund officials wrote in the proposal.

Meanwhile, the AFL-CIO is submitting a new resolution that seeks to curb employment contracts for named executive officers. The limits include capping such agreements at three years, barring evergreen clauses that allow for renewal without shareholder approval, and barring the accelerated vesting of stock-based awards and the use of excise tax gross-ups.


Copyright © 2007 RiskMetrics Group




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