Thirty-seven companies in the Russell 3000 had less than majority shareholder support in their Dodd-Frank mandated Say on Pay advisory vote in 2011. As of June 2012, 26 of these companies became second time “winners,” with an average Say on Pay voting support of 39 percentage points over their 2011 ignominy. Unfortunately, four of 2011's Say on Pay losing companies and 48 new firms have had shareholders reject their 2012 proposals. We think Say on Pay winners and losers should examine the factors behind the tremendous turnaround in support from 2012's 26 second time winners so far. First, here are the facts:
Viewpoint on Executive Compensation* 2012 proxy not filed as of June 2012** Say on Pay results not available for 2012 due to acquisition activity Pay Governance worked with compensation committees and management from a number of these companies to achieve their 2012 turnaround Say on Pay success. Armed with this direct experience, and supplemented by interviews and CD&A disclosures, a fairly consistent pathway was developed that presents Say on Pay proposals in a winning light.
While much of this pathway involves outreach to real shareholders rather than proxy advisory firms, the market-moving power of Institutional Shareholder Services (ISS) and Glass Lewis voting recommendations cannot be minimized (see our June 2012 “Say On Pay Soul Searching Required at Proxy Advisory Firms” for additional commentary).
In 2012, ISS processes resulted in “For” vote recommendations for 20 of the 30 companies that lost their 2011 advisory votes (seven companies had not held their 2012 SOP vote at the time this article was written). All 20 of these companies earned a “Low” or “Medium” concern rating following ISS's alphabet soup of “RDA”, “MOM” and “PTA” quantitative tests and its qualitative reviews of the companies' pay programs. That's an extraordinary stroke of luck, as ISS ignores CD&A-disclosed peers and selects its own group of “peers” for applying its relative pay/performance mathematics. Nevertheless, while it's certainly better to be assigned a “Low” or a “Medium” concern rating than a “High” one, every 2011 Say on Pay losing company underwent ISS's qualitative assessment. And it is here where the concerted efforts of committees, management, and advisors made all the difference to winning 2012's Say on Pay referendum.
With planning and execution strategy that would make the Pentagon proud, the most common actions taken in response to 2011 failed Say on Pay votes include:
1. Shareholder Outreach
Ninety percent of companies indicated that they conducted a shareholder outreach program in an effort to understand investor concerns over their pay program. Some of this outreach occurred just before 2011's proxy vote but most companies took the time to meet with major shareholders to understand their concerns in more detail, and later, when program changes were made, to proudly present them via meetings, webcasts, and website postings.
- Intersil (DEF14A 3/13/2012): “We met with many of our largest shareholders [We] met with individuals responsible for the proxy voting as well as other analysts in each of these organizations.
- Jacobs Engineering Group (DEF14A 12/16/2011): “During fiscal 2011, the equity component of the Company's pay programs was reevaluated, taking into account discussions with major institutional shareholders.”
2. Proxy Advisor Outreach
Prior to 2011, ISS seemed to welcome summer and fall pilgrimages to its offices in Rockville, Md., whereas Glass Lewis prided itself on not permitting any forms of influence. Both firms appear to have changed their policies ISS now limiting meetings to those who lost their Say on Pay vote, and Glass Lewis now showing receptivity to face-to-face meetings. Who should attend? Our experience is that groups including the committee chair, the lead director or non-executive chairman of the board, the head of HR or other HR executive with detailed knowledge of programs, and the General Counsel are an effective team to communicate the shareholder message had been received and positive responses have been made.
- Umpqua Holdings (DEF14A 2/27/2012): “As a result of productive discussions with ISS, Glass Lewis and our shareholders, the Committee worked to more closely align incentive compensation earned in a given year or period with the returns realized by our shareholders over that same period. “
- Nutrisystem (DEF14A 4/23/2012): “ [W]e contacted Institutional Shareholder Services (ISS) to discuss and evaluate the issues ISS raised in its recommendation to our stockholders ”
3. Actual or Target Pay or Benefit Reductions
Some companies have taken actions to reduce executive pay as a means of “sharing the pain” during periods of lagging shareholder returns. Although this can be a difficult measure to take, doing so can show the Committee's commitment to aligning executive compensation with company returns, and is viewed favorably by proxy advisory firms.
- Curtiss-Wright (DEF14A 3/22/2012): “ [T]he Company addressed stockholder concerns by implementing the following changes: (i) modified its compensation philosophy to target the 50th percentile in compensation and performance, (ii) reduced target award levels ”
- Freeport-McMoRan Copper & Gold (DEF14A 4/27/2012): “No participant in the [Annual Incentive Program (AIP)] may receive an award under the plan having an aggregate value in excess of six times his or her salary (reduced from the eight times limit in the plan). In addition, the total value of the cash award under the AIP may not exceed three times the executive's salary (reduced from the four times in the plan). These changes reduce the magnitude of each executive's potential awards under the plan.”
4. Enhanced Detail on Incentive Plan Goals and Outcomes
Increasing the transparency of the goal-setting processes and outcomes of incentive plans has become critical for demonstrating pay-for-performance linkage in executive pay programs. Shareholders and proxy advisory firms are looking for a clear explanation of the metrics used and how actual performance translates into award payouts.
- Penn Virginia (DEF14A 4/2/2012) “Following our negative Say on Pay vote in 2011 .the Committee took the following actions: Established Purely Quantitative Bonus Pool Funding Metrics. The Incentive Award Guidelines provide for the establishment of a cash bonus pool based on several financial and operational performance metrics.”
- BioMed Realty Trust (DEF14A 4/16/2012): Creation of formulaic annual bonus program effective for 2011:
- An executive's annual bonus is tied to five financial, operating and individual/strategic measures, with “threshold,” “target” and “maximum” performance levels corresponding to the executive's bonus payout levels
- Performance goals are determined in advance and actual performance relative to those goals determines the bonuses earned, limiting the use of discretion in annual bonus decisions. The five measures utilized for 2011 were: Funds from operations per diluted share, Leasing volume (square footage), New investments (aggregate capital investment), Leverage ratio (debt/total assets), Strategic and individual measures
5. Long-term Incentive (LTI) Program Modifications
Two-thirds (20 of 30) of companies disclosed changes made to their LTI programs, with almost all of the changes involving the use of performance-based awards going forward.
- Navigant Consulting (DEF14A 4/3/2012): “ The compensation committee added performance-based vesting conditions linked to the Company's relative annual total shareholder return to a portion of the restricted stock awards granted to our [named executive officers] in March 2011;”
- Monolithic Power Systems (DEF14A 4/30/2012): “Beginning in 2012, 50% of the equity compensation payable to our NEOs will be based on the Company's long-term financial performance, as set from time to time by the Board, and the relative alignment to the performance as measured by total stockholder return.”
6. Enhanced Stock Ownership Policies
Fifty percent of companies (15 of 30) have either implemented or increased stock ownership guidelines for their CEOs and other NEOs.
- Stanley Black & Decker (DEF14A 3/9/2012): “Minimum stock ownership requirements for executive officers have been significantly increased. The Company's new stock ownership policy also includes a requirement that executive officers hold the net after tax shares received upon vesting of RSUs or the exercise of stock options for a period of one year from the date of vesting or exercise, as applicable.”
- Stewart Information Systems (DEF14A 3/26/2012): “In April 2011, the Compensation Committee approved the implementation of stock ownership guidelines that require executive officers to acquire a meaningful level of stock ownership in the Company.”
7. Writing CD&As Transparently and Compellingly
Even companies that take pride in their CD&As need to be sure shareholders and proxy advisors can easily recognize the program changes made following the Say on Pay loss. Some companies used separate letters right up front in their proxy statements to highlight changes. Others addressed changes in the opening paragraphs of their CD&As and provided additional detail in the pages that followed.
- Blackbaud (DEF14A 4/27/2012): “We took the following actions, as more fully discussed in the accompanying Proxy Statement: We amended [the CEO's] employment agreement to eliminate its automatic renewal feature, eliminate the tax gross-up for penalties imposed by Section 409(A) of the Internal Revenue Code of 1986, as amended, and implement a clawback of [the CEO's] incentive-based compensation in certain circumstances; We eliminated [the CEO's] annual equity award payable in time-based [stock appreciation rights] as provided in his former employment agreement and replaced it with a potential grant of performance-?based restricted stock units to reinforce our commitment to pay-for-performance compensation and increase the amount of (the CEO's) “at risk” compensation; and We granted performance-based restricted stock units to all our named executive officers to reinforce our commitment to pay-for-performance.”
- Hewlett-Packard (DEF14A 2/3/2012): “Changes to Executive Compensation Program in Fiscal 2011 Targeted the compensation of our executives within a competitive range of the market median Restructured our incentive compensation programs to limit the use of discretion Redesigned our annual incentive plan to reinforce linkage between pay and performance Disclosing more detailed information about historical performance targets, actual performance against targets, and payouts under our annual incentive plan Changed structure and design of CEO compensation Eliminated tax gross-ups for Section 16 officers except with respect to relocation benefits as to which gross-ups are generally available to most employees Amended our severance plan for executive officers to be consistent with current market practice and to reduce the need for individual agreements and the use of discretion in determining plan benefits.”
“Second time winner” is a well-deserved outcome after suffering the ignominy of a Say on Pay defeat. But the real “win” is not losing the first time. Regardless of a company's total shareholder return (TSR) against its own or ISS-assigned peers, a campaign involving shareholder outreach, enhanced disclosure on how pay and performance are implemented, well-designed operating metrics or relative TSR long-term incentive plans, strong equity ownership levels, and transparent CD&As represent the best forms of offense in successful Say on Pay advisory votes.