Say-on-pay has renewed the focus of directors and senior management on striking the right balance between designing an effective executive compensation program that supports the company’s strategic business objectives and one that is sensitive to shareholder perspectives. An analysis of the first 100 proxies filed by Fortune 500 companies (“First 100”) subject to shareholder advisory votes under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) demonstrates some of the real effects say on pay has had on executive compensation. A key finding from this analysis indicates that companies that successfully demonstrate a strong pay-and-performance linkage are more likely to win shareholder votes.
Yonat Assayag
With the 2011 proxy season behind us, we examine what influence the pay-and-performance relationship has had on say-on-pay votes and consider what we have learned as we look ahead to 2012 compensation decision-making.
Say-on-Pay Voting Results Among the First 100
Among the First 100, all but two companies – Jacobs Engineering and Hewlett-Packard – garnered a majority of shareholder votes in favor of their executive compensation program. On average, 89 percent of shareholders voted in support of executive compensation programs, and 66 of the 100 companies received support from more than 90 percent of shareholders.
Results for the First 100 are very consistent with voting results in the broader market. As of Aug. 12, 2011, approximately 2,600 companies held say-on-pay votes; 37 companies (including Jacobs Engineering and Hewlett-Packard) failed to win majority shareholder support – less than two percent. A study of Russell 3000® companies indicates that almost 75 percent of companies passed say-on-pay votes with more than 90 percent shareholder approval.
Influence of Performance on Say-on-Pay Votes
Performance, as measured by total shareholder return (TSR), has a significant influence on the shareholder vote. As shown in Table 1, companies with stronger TSR on a one- and three-year basis were more likely to get “for” votes from shareholders on their executive compensation programs.
Russell Miller
Not surprisingly, as shown in Table 2, average TSR among those companies that failed to win majority shareholder support for their say-on-pay votes was significantly below the broad market (based on the S&P 500), further supporting the conclusion that performance matters.
Influence of the Pay-and-Performance Relationship on Say-on-Pay Votes
The results of the first say-on-pay votes send a clear message that performance matters, and that pay that is disproportionate with performance can result in a negative vote, particularly if pay is high and performance is low.
An analysis of CEO total compensation and TSR for the First 100 finds a relationship between CEO pay, company performance and say-on-pay votes. Companies that paid their CEO in the top quartile of all companies in the First 100, but had one-year TSR that was in the bottom quartile (i.e., the companies that paid high and performed low), on average, had the lowest level of shareholder support for their executive compensation program. Also noteworthy, First 100 companies in the top quartile for TSR received, on average, more than 90 percent shareholder approval on say on pay regardless of how the CEO was paid. Conversely, companies in the bottom quartile for TSR performance received, on average, less than 90 percent shareholder approval, regardless of CEO pay.
Alignment between pay and performance appears to have influenced votes for the 37 failed say-on-pay companies as well. For most of these companies, the rationale for failing to receive majority shareholder support for their executive compensation programs was due to:
- A perceived pay-and-performance disconnect (e.g., CEO pay increased in a period where TSR was negative or below the median of a comparator group), or
- Significant concern among shareholders about non-performance based pay (e.g., large severance packages, excise tax gross-ups or tax gross-ups on perquisites).
Influence of Program Design on Say-on-Pay Votes
Institutional investors and shareholder advisory groups are paying considerable attention to ensuring that companies limit non-performance-based pay elements and enhance shareholder alignment (e.g., eliminating executive perquisites and increasing stock ownership guidelines). In a study conducted by ClearBridge Compensation Group earlier this year, we noted many First 100 companies made changes to their compensation program aimed at enhancing the relationship between pay and performance in preparation for their first say-on-pay votes.
Despite this focus, there is little evidence, based on the results of the First 100 say-on-pay votes, that any one compensation practice had any significant influence on the outcome of the shareholder votes. A study of four compensation practices that are often a focal point by shareholders and advisory groups – excise tax gross-ups, perquisites, stock ownership guidelines and clawbacks – indicates that say-on-pay votes for companies with those pay practices did not significantly differ from companies without them. While these practices individually do not seem to influence the say-on-pay vote, when combined with other shareholder concerns (such as a pay and performance disconnect), there is the potential for these practices to swing the vote.
Another effect of say on pay has been an increased level of engagement with shareholders. Early in the proxy season, companies recognized the importance of knowing their shareholder base and understanding fully their perspectives on compensation and governance issues.
Determining when and how often to reach out to investors is a strategic decision companies should make each year. During this proxy season, a significant number of companies determined that engagement with shareholders following an “against” vote recommendation from proxy advisory firms (e.g., ISS and Glass Lewis) was critical to overcoming the negative recommendation. Among the First 100, seven companies, including Disney, Hewlett-Packard and J.C. Penney, filed supplemental materials following ISS’s negative recommendation, in large part to defend their pay-for-performance orientation. This approach proved successful in swaying shareholder votes for many companies, providing further evidence that effective communication of the pay-for-performance story can influence shareholder votes.
Influence of Disclosure on Say-on-Pay Votes
Effective disclosure had a clear impact on the say-on-pay votes. Companies that used a “layered” approach with an executive summary – highlighting key program design features and pay/performance alignment early in their CD&A, with supporting detail provided in later sections – enjoyed higher say-on-pay results as compared with those companies that did not. Seventy-one percent of First 100 companies that used executive summaries received “for” votes from 90 percent+ of shareholders. In contrast, of the companies without executive summaries, only 57 percent received FOR votes from 90 percent+ of shareholders.
A Look Ahead to 2012
Much can be learned from the 2011 proxy season and can be incorporated into compensation decision-making for 2012. A design that fully supports the business, aligns with shareholder interests, and is sensitive to shareholder perspectives is critical to the success of any executive compensation program. Companies should consider the following with respect to their compensation programs:
- Establish a transparent link between pay and performance. Successfully demonstrating the pay/performance linkage is critical to gaining majority support of the executive compensation program. In particular, companies should:
- Identify the key measures of the company’s success;
- Determine how to assess actual performance (for example, should performance be compared to budget, relative to peers or some combination of both?); and
- Determine how to assess pay (for example, should it reflect grant values or realizable gains?) and understand what influences pay.
- Aim to minimize non-performance-based pay and enhance shareholder alignment. While doing so may not be the primary driver for say-on-pay vote outcomes, it can signal to institutional shareholders and advisory firms that the company takes pay for performance and shareholder alignment seriously.
- Engage with Shareholders. Proactive outreach to shareholders heavily influenced SOP voting outcomes this proxy season. Talk with top investors early in the season to gain insights on their compensation governance policies and their views of the company’s pay practices. Pay attention to proxy advisory firms’ influence, but also know that an “against” recommendation often does not translate into a failed say-on-pay vote.
- Use proxy disclosure to your advantage. Companies that use proxy disclosure to tell their story and incorporate user-friendly formats such as executive summaries and charts can provide clear understanding of their compensation decisions and effectively demonstrate the pay and performance relationship.
Applying what has been learned from the first year of say on pay and making informed decisions on the executive compensation program going forward will result in effective compensation programs and positive say on pay outcomes in 2012 and beyond.
Yonat Assayag and Russell Miller are partners at ClearBridge Compensation Group, an independent executive compensation consulting firm based in New York City. They can be reached at yassayag@clearbridgecomp.com, and rmiller@clearbridgecomp.com.
Your articles fails to highlight those successful companies that took a teir approach to disclosure to present their story of their compensation arrangement. Can you offer any quidance in this regard. thank you, Alan