Public companies have been required to address the requirements of Say-on-Pay (SOP) since 2011, which allows shareholders to cast a nonbinding vote on the executive pay program. In other words, a score on how shareholders view how much you compensate your CEO compared to their return. Yes, the vote is nonbinding, but it is highly visible, and an unfavorable vote without action by the company, can impact your company’s image and future vote outcomes for Board members.
What have we learned from 2017?
- High level of favorable vote result. Every year, the vast majority of companies - over 80% - gain an SOP approval of over 90% of the votes cast. For 2017 proxies the median “FOR” vote submitted was about 95% and the 25th percentile was about 93%. To fall below 90% is now considered an indicator of a possible issue, and below 80% a signal that shareholders have genuine concerns about your CEO’s compensation.
- Company size impacts the SOP vote result. Favorable vote outcomes decline as the size of the company decreases: For example, 90% of S&P 500 companies gained a 90% or better favorable vote whereas only 78% of Russell 3000 companies had votes at over 90%. This difference can occur for several reasons: smaller companies rely more on stock options, which results in very high proxy-reported grant date values; they have more volatile share price and financial results from year-to-year; a few key shareholders can meaningfully sway the SOP vote; and finally, they have less staff resources for tasks related proxy disclosure and shareholder communications.
- Proxy advisory firms have a big impact on the SOP vote result. In 2017, Institutional Shareholder Services (ISS) recommended that shareholders vote ‘Against’ Say on Pay for 12% of companies. SOP results were 26% lower at companies with an ISS ‘Against’ recommendation. This vote impact has been consistent from year-to-year.
- SOP has impacted CEO pay plans. Proxy advisory firms have focused primarily on relative share return (RTSR) to evaluate CEO pay-for-performance and do not view time-vested stock options as performance-based. As a result, companies have implemented performance share plans, using RTSR as the vesting metric. These plans have become the most common plan design, with over 50% of public companies implementing them.
Given the above, what should you be doing?
- If your vote was below 80% favorable, you should understand why this is happening and do something about it. At this level, your outcome ranks in the lowest decile across all companies. It may be your pay plan. If so, there are creative solutions that can deliver very competitive pay to your CEO and garner stronger support. On the other hand, your CEO pay may be appropriate and perhaps your key shareholders do not fully understand the plan or the rationale behind it. Conduct an independent review of your CEO pay plan design, the clarity of your proxy CD&A and your shareholder outreach efforts.
- Don’t let the size of your company work against you. You may have the right plan in place and may be receiving an unfavorable assessment due to how the value of stock-based compensation is reported in the proxy. With stock options and performance shares, actual value to be realized may be very low. You may need to retain resources skilled in plan analysis and design, proxy CD&A drafting, and shareholder communications, with the ability to work across several functions – HR, finance, and investor relations.
- Use proxy firm SOP policies as a guide, not something to debate. Other than correcting a technical error -which do happen and can impact a vote recommendation - neither ISS nor Glass Lewis (who both have a lot of credibility with institutional investors) will revise their report. The transparency of their methods provide you with a benefit – you can “pre-test” how your CEO pay-for-performance will be evaluated and then take possible actions: 1) refine the CD&A and communicate with key shareholders explaining how the current compensation plan and pay-for-performance relationship is actually better than as described, or 2) agree there may be an issue and proactively revise the plan and communicate the changes via the upcoming proxy CD&A. Taking either or both courses of action, will likely result in a more favorable SOP vote.
- The compensation plan for the CEO needs to be aligned with your competitive realities and your company’s long-term business strategy. Do not conform to what every other company is doing. Expanded disclosure requirements and proxy firm policies have forced conformity. It is easier to go with the flow. However, this can reap a bad outcome: those highly prevalent performance share plans (based on RTSR) have been found in study after study to be the least effective plans in terms of pay vs. financial and shareholder return. Have a plan in place that reflects your company’s business strategy, and the role your executives play in creating value and driving financial success.
Finally, remember readers of proxies and followers of public discourse include your employees and the CEO pay ratio disclosure is likely to be required for 2018 proxies. Think about your SOP outcome as part of your brand image. Develop a plan to improve your SOP outcome along with retaining and motivating your CEO and key executives.
FGMK specializes in executive pay solutions.
Don Nemerov is Managing Director of Compensation Advisory Services at FGMK. Don is an independent compensation consultant with nearly 30 years serving public companies in executive pay matters – plan design, pay benchmarking, proxy firm evaluation procedures - helping companies and Boards to benchmark and design executive pay plans and gain favorable vote outcomes for equity incentive plans and Say-on-Pay.
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