Say-on-Pay Looms; Cos Should Seek Shareholder Input

By Louis M. Thompson, Jr., Compliance Week Columnist — December 16, 2008

ost of Corporate America already knows that investors clamoring for more say over executive pay will be one of the big battles in the coming proxy season. Wise corporations should instead be bracing for exactly what investors will say when they have the chance. 

Expect a lot of four-letter words.

This should catch nobody in the boardroom by surprise. Many argue that boards of directors are in the best position to determine whether compensation for key executives is appropriate … but that argument holds little water given that many boards have failed to fulfill their duties to tie compensation to performance. And when shareholders look at their stock portfolios or their retirement funds over the past year, they can’t fathom why executives of companies where stock prices have plummeted still receive bonuses or walk away from failed companies with millions through change-of-control agreements.

Take the Wells Fargo acquisition of Wachovia as an example. Should the deal close, the top 10 Wachovia executives could receive a combined $98 million through change-of-control provisions in their employment agreements. This comes on the heels of a third-quarter 2008 loss of almost $24 billion—one of the largest losses ever posted by a U.S. company. (A company spokesperson does say that not all 10 executives would accept those payments, since several plan to take positions at Wells Fargo once the sale is approved.)

This sort of situation is why shareholder say-on-pay votes are so politically popular. Important members of Congress plan to introduce legislation to mandate shareholders an advisory vote on executive compensation, and President-elect Barack Obama filed such a bill himself last year. Rest assured, say-on-pay’s time has come.

That momentum for say-on-pay suggests that boards must take a closer look at future employment agreements and consider including claw-back provisions for executives whose failed companies are rescued through mergers or acquisitions. But clearly, board responsibility goes far beyond that; it goes to the core of creating compensation goals that are tied to performance—and an executive’s performance is not always measured by boosting the stock price. A CEO who takes over a troubled company and has performance goals tied to a turnaround should be compensated accordingly.

Another reason investors are so irate over executive pay: Companies were given an opportunity in 2006 to make compensation more transparent and easier to comprehend when the Securities and Exchange Commission amended its rules on executive compensation disclosure. Over the last two years, however, too often boards appear reluctant to state executive performance goals in ways that help shareholders determine whether these executives really earned their keep.

Why the artful dodge, despite the new disclosure rules? A loophole allows boards to avoid stating performance goals clearly if that would compromise their position against competitors—and boards have glommed onto that clause rather than present their CEOs’ performance targets. This makes no sense to me; can’t boards understand that better disclosure and transparency are essential to building trust between them and their shareholders? Besides, plenty of competitive information is already out there for those who want to look for it.

All this leads to an avalanche of resentment from Main Street investors. According to the Economic Policy Institute, for most of the 20^th century, CEOs earned about 20 times as much as their average employee. In this decade that ratio has escalated to an average of 400 to 1. Yet, with many of our overseas trading partners, we find that most CEOs earn only 20 times that of their average worker.

What the 2009 Proxy Season Holds

Corporate America saw about 90 say-on-pay proposals placed on proxy statements last year. Expect shareholder activists to keep riding that anti-executive wave this year, with even more proposals that would give shareholders a non-binding advisory vote on executive compensation. Some activists, however, are going beyond mere say-on-pay votes. Richard Felauto, director of pension investment at the American Federation of State, County and Municipal Employees and an outspoken leader of activism today, has said at least some groups will be searching for new compensation models that reward CEO performance more accurately.

The International Brotherhood of Teamsters and the Laborers’ International Union of North America are filing proposals at companies participating in the Treasury Department’s Troubled Asset Relief Program, calling for directors to adopt reforms that would limit annual incentive compensation, require a majority of long-term compensation to be awarded in the form of performance-vested equity instruments, require senior executives to hold at least 75 percent of stock provided through equity awards for the duration of their employment, and limit senior executive severance payments to amounts no greater than the executive’s annual salary.

The United Brotherhood of Carpenters, a leader over the past two years in issuing pay-for-performance proposals, is planning to target 25 financial services firms in the upcoming proxy season on issues such as freezing new stock option awards that are not indexed to peer-group performance and limiting severance pay to twice the senior executive’s annual salary.

TIAA-CREF says it will increase its efforts to get companies to adopt a say-on-pay concept voluntarily as well as other compensation changes.

U.S. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, says he wants to re-introduce say-on-pay legislation that he first proposed in 2007 that could also include a provision giving shareholders proxy access to nominate independent directors. That may yet happen, but activists say they aren’t waiting for the legislation to arrive. Instead, they are moving ahead aggressively with proxy proposals to achieve their executive compensation agenda.

How to Respond

From a corporate perspective, taking a wait-and-see attitude is not a good option, nor is holding out hope that Congressional allies of Corporate America will defeat say-on-pay legislation. Instead, companies should reach out to their shareholders—particularly the activist investors—and demonstrate they are willing to adopt changes that would make executive compensation more equitable.

Schering Plough provides a good example. The pharmaceutical company announced on Oct. 24, 2008, that it would conduct a shareholder survey on director and executive pay. The survey will be mailed to their shareholders in the 2009 proxy materials and the results will be discussed in the Compensation Discussion and Analysis section of the 2010 proxy. The company says the results will be used to guide the board as it develops future compensation plans. Rich Koppes, former CalPERS general counsel and currently of counsel to the Jones Day law firm, will oversee the survey tabulation process and report the results to the board of directors, according to the Schering Plough release.

Timothy Smith, senior vice president of Walden Asset Management, says Schering Plough stopped short of instituting an official shareholder advisory vote on executive compensation. But he still hails what the company is doing as “another act of corporate governance leadership by the company.”

Voluntary examples like this would demonstrate to individual and institutional shareholders that companies are serious about changing their compensation programs to reflect executive and corporate performance more accurately. Moreover, investor relations officers should reach out to individual investors through the company’s Website and through meetings with their institutional portfolio managers to explain how the company is addressing executive compensation concerns. On a parallel track, the corporate secretary and legal counsel should meet with those who vote the proxies in the institutional firms and explain the same.

Of utmost importance is the authenticity of company representations to the investment community. In the executive compensation arena, that starts with the board’s commitment to providing credible performance goals for the key executives and transparency of those goals. In the end, it’s all about building trust between companies and their shareholders. That trust is in short supply right now, so you’d better get started.

 

---