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.
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Louis Thompson Jr. is
an internationally recognized expert on corporate governance and
disclosure, having served for more than two decades as president and
chief executive officer of the National Investor Relations Institute
until his retirement in 2007. An adviser to the Securities and
Exchange Commission and the New York Stock Exchange, Thompson is
currently serving a second term on the NYSE Individual Investor
Advisory Committee.
Prior to joining
NIRI, Thompson was assistant White House press secretary to
President Gerald Ford.
A veteran of the
U.S. Command in Vietnam and the Office of the Secretary of Defense,
Thompson has held executive communications positions for a number of
organizations, including the American Enterprise Institute for
Public Policy Research, and he served on the board of directors for
the National Council for Economic Education.
A former journalist
and news anchor, Thompson remains chairman of the advisory council
for the Greenlee School of Journalism and Communication at Iowa
State University, where he was the 2001 recipient of the James W.
Schwartz Award for Distinguished Service in Journalism and
Communication conferred by the Greenlee School.
Thompson is a former
member of the Harvard University New Foundations Working Group on
corporate governance.
Now a member of the
board of directors at Hanley & Associates, a consulting firm that
provides management access to institutions through non-deal
roadshows, Thompson can be reached at
lthompson@complianceweek.com.
More From Lou
Thompson
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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 20th 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.