Second Largest Public Pension Fund Targets CEO Pay

The pension fund that serves California's teachers is sending letters to 122 companies expressing its dissatisfaction with their compensation practices.

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"We want them to take the message seriously", said Anne Sheehan, CalSTRS Director of Corporate Governance.

The message CalSTRS is sending is why it voted "no" during the 2011 proxy season on the companies' pay proposals.

With the new rules granting shareholders a "say on pay" companies must now give a mandatory advisory vote to shareholders that allows them to approve or disapprove of a company's pay plan for top executives.

Among the companies receiving these letters, the retailer Abercrombie & Fitch and the oil and gas driller Nabors Industries . Twenty two letters have been sent out so far with CalSTRS expecting to send the rest in the coming months. CalSTRS said it has yet to hear back from any of the companies that have been sent letters.

CalSTRS hopes the letters will initiate discussions with the companies about the pension fund's concerns ahead of the 2012 proxy season. If the firms do not make satsifactory adjustments to their pay plans, Sheehan said CalSTRS would likely vote to reject the plans again, and would consider engaging in a withhold vote campaign against a company's directors who serve on the compensation committee.

Abercrombie and Fitch sign
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Abercrombie and Fitch sign

"The real end game here is get them to modify their pay practices," Sheehan said of the campaign, the first of its kind by CalSTRS. "By highlighting the worst offenders it can be informative to others to see the concerns we have about pay structures."

Companies have reason to pay attention, CalSTRS manages $146 billion in pension money for over 850,000 retired and current teachers in the Golden State. It has holdings in close to 7,000 companies around the world of which 3,500 to 3,600 are headquartered here in the United States.

Sheehan points out CalSTRS' concerns are company specific which is why individual, rather than form letters are being sent out. Still, she points out CalSTRS disapproves of many of the companies' pay practices for similar reasons, including a disconnect between executives' pay and a company's performance and a CEO's compensation being well above the other pay of other named officers of a company.

On average a CEO makes two or three times more than the other executives. CalSTRS said a wider gap between the pay of the CEO and the next level of management puts too much emphasis on the value of a single employee and can undermine the confidence of a group of executives the company should be grooming to someday be CEO. As a long term investor, CalSTRS said it's concerned about proper succession planning, something it feels may be compromised if the upcoming layer of management feels undervalued.

Sheehan said CalSTRS concerns about how a company determines pay for performance encompass a wide range of issues. For example CalSTRS may engage a company if it gives a greater reward to a CEO for an outstanding one year performance even if the company's three and five year performance is mediocre. It might also question a pay plan if it gives a compensation committee so much discretion in determining pay, it is difficult for a shareholder to understand what measurements the directors are using to determine an executive's compensation.

With regards to Abercrombie & Fitch, whose pay plan was approved by a narrow margin last year, CalSTRS questions why the firm agreed to an employment agreement with CEO Michael Jeffries, when his sixteen year tenure at the firm essentially makes him one of the company's founders. While some CEOs have employment agreements in the first years of service, most serve with no agreement, at the pleasure of the board. CalSTRS also questions elements of the agreement such as the semi annual stock grants given to Jeffries if the stock appreciates during a six month period, a short term incentive that can be at odds with long term shareholders. CalSTRS also takes issue with the $23.2 million Jeffries was paid last year.

In the letter to Abercrombie dated October 6, 2011 CalSTRS congratulates the retailer for its positive relative performance over the last year, while questioning Jeffries' pay.

"The excessive companesation is especially concerning given the Company's underperformance over three years and only marginal outperformance over 5 years," the letter reads. "The lack of clarity into how your company links pay to performance is exaggerated by the overwhelming use of discretion afforded your (compensation) committee."

A spokeman for Abercrombie & Fitch told CNBC the retailer has not received the letter, but when it does it will likely continue to do what it has been doing in the past and actively engage shareholders on important topics.

Sheehan said CalSTRS decided to send the letters after a "say on pay" vote became mandatory for public companies under Dodd-Frank. Through July of this year shareholders at only 37 of the 2,340 companies adding the proposal to their proxies, rejected the companies plans.

At 168 of the Russell 3000 companies at least 30 percent of the shareholders voted to reject the pay plans, a high percentage given on average less than 9 percent of the shareholders voted to approve the plans of the Russell 3000 members.

"We felt in fairness to the companies, they need to know if they got a "no" vote and why," Sheehan said, adding the companies are appreciative when they hear about CalSTRS concerns, given especially if a high number of shareholders voted against their pay plan last year.

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