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ISS Governance Weekly, June 23, 2011 article


ISS | Governance Weekly

June 23, 2011

Feature Story



2011 U.S. Season Review: 'Say on Pay'

During the first year of advisory votes on executive compensation under the Dodd-Frank Act, investors have overwhelmingly endorsed companies' pay programs, providing 91.2 percent support on average (based on "for" and "against" votes).

This support exceeds the 89.6 percent average approval in 2010, when "say on pay" votes were mandated only at U.S. government-supported financial firms. While the median total compensation for CEOs at S&P 500 firms increased by more than 33 percent last year, those pay increases haven't translated into more shareholder opposition, in part because of greater engagement by issuers. Dozens of companies have released supplemental proxy materials to address investor concerns or made late changes to their pay practices to win shareholder support.

So far this season, S&P 500 companies have averaged 88.6 percent support, which is slightly less than the 91.8 percent approval for issuers in the Russell 3000 index, according to ISS data as of June 14. At the sector level, large-cap industrial companies had the lowest average support of 87.1 percent, while large consumer retail firms received the highest approval at 90.7 percent. Large financial firms, which traditionally have received more scrutiny over pay, had the second-highest approval average of 89.7 percent. Within the Russell 3000 index, the energy sector received the lowest level of average support (88.8 percent), while consumer retail firms again received the highest average approval (92.8 percent).

Failed Votes

So far this year, shareholders have voted down management "say on pay" proposals at 36 companies, or just 1.7 percent of the almost 2,200 companies in the Russell 3000 index that have reported vote results. Eleven of these firms received less than 40 percent of the votes cast "for" and "against." Overall, eight S&P 500 companies and 28 Russell 3000 firms have failed to receive the required vote for approval of their executive pay programs. Among the latest issuers to report failed votes are Freeport McMoRan Copper & Gold, Monolithic Power Systems, and Premiere Global Services.

The primary driver of these failed votes appears to be pay-for-performance concerns, which were identified at 26 of these companies. Investors appear to have voted their pocketbooks this season. Almost half all of the failed-vote firms have reported double-digit negative three-year total share returns. Also contributing to investor dissent were such issues as tax gross-ups, discretionary bonuses, inappropriate peer benchmarking, excessive pay, and failure to address significant opposition to compensation committee members in the past.

The greatest number of failed advisory votes--about 25 percent--have occurred in the energy sector, where companies such as Helix Energy Solutions, Cadiz, Superior Energy Services, and Constellation Energy received some of the lowest levels of shareholder support. At Constellation, shareholder support was only 38.6 percent, which appears to be due to pay-for-performance concerns at the company. CEO Mayo Shattuck's total compensation increased 137 percent, from $6.7 million in 2009 to almost $16 million in 2010. Meanwhile, the company's one- and three-year total shareholder returns were negative 10.3 percent and negative 30.6 percent, respectively. Shattuck's total pay increase was due to a significant increase in his deferred compensation and pension value, and in the value of stock options granted to him.

Consumer retail companies also saw a greater share of dissent, with 20 percent of the total failed votes in this sector. Shareholders expressed significant opposition at homebuilders NVR, Beazer Homes USA, and M.D.C. Holdings, as well at Shuffle Master, Nutrisystem, and Talbots. At M.D.C. Holdings, concern over pay-for-performance issues resulted in shareholder support of just 33.9 percent.

The health care sector had the lowest percentage of failed pay votes, with only one company's proposal failing to pass. At Cutera Inc., it appears that investors had concerns over pay-for-performance issues and the board's responsiveness to shareholders. Cutera's CEO received a total pay increase of 33.4 percent in 2010, due to an increase in the value of non-performance-based equity granted to him. In addition, the company conducted a stock option exchange without shareholder approval, despite the fact that shareholders voted not to approve an option exchange program in 2009.

Other well-known companies with failed "say on pay" votes this year include: Stanley Black & Decker (outsized time-based and guaranteed equity award, and failure to address low voting support for two compensation committee members in 2010); Nabors Industries (pay-for-performance concerns, coupled with pay significantly above the peer median); Hewlett-Packard (concerns over the new CEO's hire package in conjunction with a track record of generous severance payments for departing executives, and the CEO's participation in selecting new board members); Janus Capital Group (outsized sign-on bonus for the new CEO, despite lagging shareholder returns); Jacobs Engineering Group (pay-for-performance concerns), Masco (pay-for-performance); and Freeport-McMoRan (concerns regarding the CEO's incentive pay structure and excessive compensation).

In addition to the failed votes, 34 companies received between 50 and 60 percent support for their pay practices, and most likely will face greater shareholder scrutiny next year. Among those firms were Chesapeake Energy, Safeway, Lazard, Amgen, Devon Energy, and Allstate.

'Vote No' Campaigns

The American Federation of State, County, and Municipal Employees (AFSCME), which has long been active on compensation issues, waged "vote no" campaigns against the pay practices at five S&P 500 companies: Pfizer, Johnson & Johnson, Alcoa, ConocoPhillips, and ExxonMobil. Four of the firms received significant opposition; support at Pfizer and ConocoPhillips was less than 60 percent, while Johnson & Johnson and Exxon Mobil received less than 70 percent approval. Alcoa, which made late changes to its pay practices to win investor support, received 84.2 percent approval, which came close to the 88.6 percent average for S&P 500 companies.

AFSCME primarily raised pay-for-performance concerns at several of the targeted companies, as well as other issues such as severance arrangements and pay magnitude concerns. At Pfizer, AFSCME argued that a $4.5 million exit payment for retiring CEO Jeffrey Kindler, despite lagging shareholder returns during his tenure, raised concerns regarding the company's adherence to a pay-for-performance philosophy. At ConocoPhillips, the company provided for the payment of excise tax gross-ups in severance arrangements with two new executives, and continued the practice of crediting certain executives with additional years of service under its supplemental retirement plan.

Frequency Votes

Also on this season's ballots were separate Dodd-Frank-mandated votes on the frequency of future "say on pay" votes. So far, shareholders have overwhelmingly supported an annual frequency. As of June 20, annual votes have garnered majority (or plurality) support at 1,658 companies, as compared to triennial votes, which won the greatest support at 378 companies, and biennial votes, which received the most support at just 15 firms.

Notably, management recommendations on pay vote frequency shifted throughout proxy season. In the early part of proxy season, from March to mid-April, management recommendations shifted away from triennial votes and toward annual votes, following early investor support for an annual frequency. Recommendations finally stabilized in late May, with approximately 53.3 percent of companies recommending annual votes, with 41.6 percent endorsing triennial votes. Recommendations for biennial votes decreased throughout proxy season, stabilizing at around 2.5 percent. However, these management preferences did not have much influence on the outcome of these frequency votes; investors have defied management recommendations for triennial votes at 515 of 850 companies so far, according to ISS data.

Greater Engagement

Because of "say on pay" and frequency votes, companies have done significantly more engagement on compensation issues this year. A number of companies made late changes to their compensation programs or filed additional proxy materials to win shareholder support, including Walt Disney Co., General Electric, Collective Brands, and Assured Guaranty Ltd. At least 50 issuers have made additional filings to address investor concerns and proxy advisers' recommendations. In most cases, the companies objected to the industry peer groups and option-valuation methods used by the proxy advisers.

In a June 10 speech to the Social Investment Forum, SEC Commissioner Luis Aguilar observed that advisory votes appear to be facilitating an increase in communication between issuers and shareholders, and has resulted in positive changes to many companies' executive pay practices.

"Many companies are putting in more performance-based compensation plans and they are addressing items that shareholders often criticized, such as: excessive severance; perks; federal income tax payments; and pensions. For example, approximately 40 of the Fortune 100 companies have eliminated policies that had the company pay certain tax liabilities of executives," said Aguilar, who also mentioned the positive changes by General Electric.

"There seems to be real evidence that say-on-pay is one catalyst to increasing shareholder engagement more broadly," Aguilar said.

ISS Recommendations

Overall, ISS has recommended against "say on pay" proposals at 11 percent of U.S. companies that have held advisory votes this year. Within the Russell 3000 index, ISS recommended against 12.6 percent of companies' compensation practices. For the S&P 500 index, ISS issued negative "say on pay" recommendations at 15 percent of the companies. --Jolene Dugan, U.S. Research

Edward Kamonjoh, ISS Specialty Research, contributed to this article.

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