Engel: Say on Pay: One Year Later - Are We Better Off?
New SEC rules requiring companies to obtain an advisory shareholder vote approving executive compensation went into effect one year ago as part of the corporate governance reform measures under the Dodd-Frank Wall Street Reform Act of 2010.
Today, executive compensation remains a hot button issue and companies and investors alike are anxious to gauge the impact of the new rules and predict what the coming proxy season holds.
Before setting expectations for proxy season 2012, let’s take a look back at 2011 and assess how the SEC’s new rules may already be changing behavior.
In the first year under Dodd-Frank, the SEC required two votes. The first was the Say on Pay vote, giving shareholders the opportunity to endorse (or oppose) a given company’s executive compensation program. Most companies received strong support for their pay programs. Among the S&P 500, the median vote on Say on Paywas 93 percent in favor of executive compensation programs. All the hype over highly-paid executives was not born out in shareholder voting.
But while a high percentage of companies’ compensation programs passed muster with shareholders, levels of support varied. Companies that performed better tended to get better votes. The average total shareholder return of companies where ISS, the proxy advisory firm, recommended a “Yes” vote on Say on Pay was 24 percent, compared to 10 percent for companies where a “No” vote was recommended.
The second new vote required by the SEC was a frequency vote asking shareholders to decide whether a Say on Pay vote should occur annually, every other year or every three years. Shareholders responded vigorously, expressing an overwhelming preference for annual voting. Even when Say on Pay proposals passed handily, shareholders did not support proposals for less frequent voting at most companies. Among the S&P500, 26 percent of companies proposed biennial or triennial voting, but 80 percent of these proposals failed to gain support.
With the first year of Say on Pay voting now in the rear view mirror, what should we expect to see this year? Boards of directors and management teams must heed two key lessons learned as they approach this proxy season.
Lesson #1: Companies with low pass rates will face the possibility of a recommendation to vote against directors on the Compensation Committee unless there is evidence of changing pay practices in 2012. Only eight companies in the S&P 500 actually failed the first round of Say on Pay votes, obtaining less than 50 percent of votes cast in favor of their executive compensation programs. Companies that did not fail Say on Pay, but passed with low levels of support – less than70 percent to 80 percent in support – should expect to face additional scrutiny in the 2012 proxy season. A simple majority on this vote is not the same as a passing grade, since low support exposes the Company and its Compensation Committee to pressure from shareholders.
The proxy advisory firms are looking for evidence that boards have taken the Say on Pay vote to heart by demonstrating efforts to reach out to and engage in dialog with shareholders. ISS is also looking for evidence that the pay practices that may have caused the poor vote result in 2011 have been modified to address the issues creating opposition.
Lesson #2: Clear, succinct disclosure will be critical in 2012. Companies with low support need to lay out their response front and center in the proxy statement. Effective communication with shareholders is important and the use of executive summaries, charts or other call outs that clarify and simplify the proxy statement will be well-received. Some companies are adding a fifth conference call with analysts, supplementing calls held to discuss quarterly earnings with a call to discuss the proxy statement and executive compensation.
Companies that fail Say on Pay face serious consequences. It creates reputational risk and exposure to derivative shareholder suits. Critics have argued that Say on Pay is a blunt instrument, but nevertheless it has helped to effect change. Expect to see more action on this front in 2012.
Margaret Engel is a Partner in Compensation Advisory Partners in New York. She has provided boards and management teams with executive compensation consulting services for over 20 years. Margaret has broad experience, with particular experience in retail, consumer products and telecom industries. She has consulted in all aspects of executive compensation and program design, including IPOs, mergers, spin-offs and other corporate transactions.