Rob Swystun, Pristine Advisers
Sometimes those say-on-pay votes just don’t go the way the board of directors want. Shareholders just aren’t convinced at times that company executives need a raise.
Data from executive compensation consulting firm Semler Brossy shows that 46 companies in the Russell 3000 Index that earned over 70% ‘yes’ votes in their 2012 say-on-pay votes failed their 2013 say-on-pay votes, earning under 50% support.
But how can compensation committees make sure they stay above that 70% threshold? The simple answer is outreach. As an example, in 2012, Pitney Bowes received 35% ‘yes’ votes, but in 2013, after outreach and program changes, it earned 94%.
Among the pay-practice changes the company made:
- Increased weighting of financial performance in the annual incentive plan;
- removal of duplicative metrics in the annual and long-term incentive plans;
- reinstatement of a cumulative three-year total-shareholder-return adjustment for cash incentive units;
- stronger disclosure of performance goals;
- adjustment of the peer comparator group; and
- elimination of excise-tax gross-ups upon a change in control.
Okay, maybe that’s not all that simple. The slightly more complex answer to how to make sure your say-on-pay votes pass is brought to you by Semler Brossy managing directors Seymour Burchman and Blair Jones for the National Association of Corporate Directors.
Step 1: Understand the Reasons for Failure
After proxy season, review correspondence from investors on pay practices, plus reports by proxy advisors ISS and Glass, Lewis & Co. There very well could have been warning signs in this correspondence and these reports.
Common shareholder concerns about pay proposals include:
- limited or no shareholder outreach over pay,
- limited disclosure of pay practices,
- a lack of performance-linked long-term compensation,
- outsized awards to new or terminated CEOs,
- “problematic” pay provision such as tax gross-ups, and
- a poor link between the previous year’s rewards and performance.
After this review, it’s time to hit the road for a “listening tour” with shareholders. What sounds like some kind of hippy nature walk is actually a series of meetings with your top institutional investors, those being the ones that collectively hold over 50% of your stock. Meet with the governance expert, if the shareholder has one. Find out what they like and what they loathe about your compensation program. Ask them what they would like to see change. Find out how they are evaluating different aspects of the compensation programs.
Although it’s generally recommended that compensation committees go to these investor meetings together, or at least have more than one person from the committee attend, Burchman and Jones recommend the compensation committee chair to go alone. Their reasoning is that a committee chair going alone signifies that the board, not management, controls pay. Even if the chair doesn’t go alone, Burchman and Jones recommend that he or she be the one to lead the conversation. This will project more credibility and elicit more candor.
During the meeting:
- Kick off these meetings with an explanation of the most important elements of your pay program, those elements’ history, and how they serve the company’s strategy.
- Then, dedicate the meeting mainly to asking questions:
- Are we hearing shareholders correctly?
- Have we heard everything that concerns you?
- Which items are most controversial?
Explain your plan but talk about those hot button issues that the investors have.
Topics to include:
- most critical metrics,
- performance-based pay,
- peer group selection,
- gross-ups and other pay elements,
- fixed pay elements and guarantees,
- disclosure transparency.
Step 2: Decide Whether Changes Are Warranted
Compile and condense the results of your listening tour and by November or December, discuss the feedback you received. Make some tentative decisions about what things to change and how, keeping in mind that you’ll need to balance the direction from shareholders with what’s best for the business strategy.
Step 3: Consult with Proxy Advisors
Schedule visits with proxy advisors and share feedback from investors. Ask more questions:
- What are your concerns?
- What about our disclosures in the Compensation Discussion & Analysis (CD&A) section of the proxy could be better?
Discuss changes on the table and your reasons for not changing important provisions. The compensation committee chair should also lead these conversations.
Step 4: Decide Which Changes to Make
Consider the objections of shareholders and proxy advisors and determine if they are the result of one-time economic or business challenges that won’t recur or if they are the result of continuing challenges that will likely happen again. Determine what the consequences of making changes will be. For each proposed change, ask yourselves if it will help the company, hurt the company or be neutral. Determine where you will hold your ground and be prepared to justify it. Some proposed changes may just be the result of current governance trends. Heed these. Failing to do so may result in your company lagging behind competitors and current best practices.
After this internal discussion comes the painful part; making changes, or at least getting down to it. Although the right changes for your company should be ones that align with your business priorities, some common changes include:
- changing pay benchmarks,
- stopping gross-ups,
- adopting an anti-hedging policy,
- shifting to performance-based long-term incentives,
- improving disclosure,
- adding a total-shareholder-return incentive,
- adopting a clawback policy,
- adopting share-ownership guidelines, and
- eliminating single-trigger provisions.
Step 5: Re-Engage with Important Players
In January and February get back to the important shareholders and proxy advisors and share the results from your previous tour. Explain the changes you plan to make and fine tune them. Discuss disclosure, let your shareholders and proxy advisors know what you’ve learned, raise potentially controversial issues, and explain how you’ll handle them. When you’re done all that, finalize your changes.
Step 6: Prepare Your Disclosure
Incorporate your changes and rationale into the CD&A of the proxy, being sure to communicate changes clearly. Explain why you didn’t make changes that shareholders suggested if necessary. This disclosure will position you well for future engagement with important players after proxy filing. It’s a good way to prepare for meeting again after the proxy season.
Although this should go without saying, managing a pay program that can be voted on by shareholders is going to require dialogue with those shareholders. It’s all about striking a balance between company performance and shareholder gains.