Taking Advice: The Say-On-Pay Debate

It’s not the way most corporate boards like to start the year: at the January annual meeting, directors of Jacobs Engineering put their executive compensation plan to investors for an advisory say-on-pay vote and watched it go down in flames. More than half (53.7 per cent) of the shareholders gave the plan a thumbs-down, winning the California-based company the double ‘honour’ of being the first to have its compensation proposal defeated in 2011, and the first ‘no’ vote since the SEC adopted new rules requiring such advisory votes, as mandated under the Dodd-Frank Act. 

In that role it may serve as a cautionary tale, as the bulk of companies prepare to offer their compensation plans up for investor review in the months ahead. ‘I don’t know if it’s a harbinger of things to come,’ says Patrick McGurn, special counsel at RiskMetrics Group’s ISS governance services unit. ‘But I think it is a wake-up call. Companies need to do a better job of communicating, because there is a possibility their plans are going to fail.

‘Investors also rejected Jacobs’ proposal to hold triennial advisory votes on compensation – the most infrequent option allowed under the new SEC regulations. Instead, 67 per cent of shareholders voted for an annual review, while just 28.7 per cent supported the triennial option. John Prosser, CFO of Jacobs, would say only that the board is taking the vote under advice, when contacted by IR magazine.

Most large investors won’t publicly comment on their reasons for rejecting the Jacobs plan. But several industry observers attribute the no-vote in part to an analysis performed by ISS, which notes that Jacobs’ CEO compensation rose 33.7 per cent over the past year, even as the company’s shareholder returns lagged below the median returns of peers. 

Patrick Quick, a partner at Foley & Lardner, who has assisted with several proxy statements already this season, says a negative ISS recommendation like the one Jacobs received doesn’t necessarily doom a say-on-pay proposal. ‘But if you can’t win over ISS, you have to work to override it by knowing your shareholders and talking to them in advance and making them comfortable,’ he adds. ‘You need to anticipate what potentially negative recommendations you might get and try to work to counter that pretty quickly after you mail your proxy statement. You have to be very active.’

The 1 percenters 

Though this is the first year the majority of US companies face mandatory say-on-pay votes, the Jacobs’ poll was actually the fourth time a company compensation plan had been rejected. The fifth came soon after, when Beazer Homes USA had its pay proposals voted down the following week

Troubled Asset Relief Program recipients were required to hold say-on-pay votes in the wake of the financial crisis, and a number of other companies decided to offer non-binding votes off their own bat prior to the expected SEC regulations; last year, Occidental Petroleum, Motorola and Key Bancorp all received ‘no’ votes. McGurn notes that such results are unusual, accounting for about 1 per cent of the say-on-pay votes put to shareholders. About 300 companies held the votes last year. ‘Most companies passed with flying colours with an average support level of 90 per cent,’ McGurn adds. ISS has evaluated about 125 proxy statements to date, and has recommended ‘no’ votes on 13 so far.

Tim Smith, senior vice president at Walden Asset Management, an investment firm based in Boston with $1.8 bn in assets, says corporate secretaries and IR officials can counter negative shareholder sentiment with effective communication. ‘They should reach out to shareholders for feedback on pay,’ he suggests. ‘It can be as simple as setting up an email box for the chair of the compensation committee so that the company can hear feedback from shareholders. Most companies have spent more time making sure their proxy statement is thoroughly detailed, and many are striving to make it plain English. A convoluted proxy statement will frustrate investors.’

Frank Steeves, general counsel and corporate secretary at Emerson Electric, which held its annual meeting in January, said he made sure his proxy statement spelled out the firm’s positions in clear language. And though the company compensation plan was not controversial, when Emerson decided not to adopt the exact format for sustainability reports pushed by Walden and its allies, Steeves wrote a personal letter to investors explaining the company’s reasons and followed it up with phone calls. 

But communication can only go so far. Last year, Occidental Petroleum, for instance, held several conference calls with investors, and was widely praised for its communication. Yet its compensation plan was still defeated – in large part because Occidental Petroleum consistently awards its CEO one of the highest salaries in the US. 

Steeves cautions against ‘over-analysing’ the reasons for the ‘no’ vote at Jacobs or other companies. ‘Even though communication is critically important, the investor is looking for financial performance,’ he says. ‘I would venture to guess that both now and in the future the thumbs-up and thumbs-down votes will result from an investor’s perception of that performance.’ 

Three versus one 

Even companies that won strong support for their pay proposals are getting push back in another area mandated under the new SEC proposals: the frequency of say-on-pay advisory votes. Several big institutional investors and mutual funds, including State Street, Vanguard, Putnam and Fidelity have indicated they intend to oppose the triennial vote option, and are pushing instead for annual reviews. And investment advisory groups like ISS have also recommended a one-year review. 

Meanwhile, some of the more activist investors, including large pension funds like CalPERS and the New York City Employment Retirement System, have launched a campaign to press for annual votes. On January 31, some 39 institutional investors, representing more than $830 bn in assets, issued a press release calling for annual say-on-pay votes.

‘These are early days, so I don’t want to predict anything or say this is a definitive trend,’ says Smith, who is helping lead the campaign for annual advisory votes. ‘But the early indicators are that a broad cross section of investors are voting for annual say on pay as a standard, rather than picking and choosing.’

Indeed, some of the companies that saw their triennial proposals voted down won very large investor support for the rest of their resolutions. Steeves says 97 per cent of Emerson’s investors supported directors up for reapproval, 93 per cent voted in favour of the stock option plan, and executive compensation won almost 92 per cent of the vote. Yet the firm still saw its proposal for a triennial say-on-pay review soundly defeated. 

‘These are all pretty strong indicators of satisfaction with company performance,’ Steeves says. The company had recommended a three-year review because that is how often pay options for executive and performance shares are reviewed. But the ‘no’ vote did not surprise the board, which had already spoken with large investors beforehand: many had said they planned to followed advisory firm recommendations to support a one-year review. In a board meeting before the vote, therefore, the directors decided it would immediately announce a decision to adopt the one-year advisory votes, once the shareholders rejected the triennial review, Steeves says.

A version of this article appears in the March issue of Corporate Secretary, IR magazine‘s sister publication.

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