Most publicly traded companies hold their annual general meeting in the spring. Prior to this meeting, the company will file a proxy statement that includes the proposals that shareholders will be asked to vote on, how the board believes shareholders should vote on each proposal, detailed information supporting the recommendation, and other information required by the Securities and Exchange Commission. Most of these proposals are governance-related, such as director selection, but many companies are required to hold “salary” votes on executive compensation programs. Say-on-pay became mandatory in 2010 and has since received significant attention from investors, the media, and corporate boards.
“It is important to understand and try to address low voting results.”
One positive development regarding the U.S. executive compensation model is that the majority of companies have overwhelming support for pay, with an average of 90% of stocks voting “yes.” Of course, every year there is a portion of companies that receive suboptimal support levels (typically defined as 80% or less) for a variety of reasons, including but not limited to overcompensation, disconnection between pay and performance, and poor program governance features. For people receiving suboptimal support, the next logical question is often, “What should we do about it?” We provide a Q&A-based guide below with the aim of providing advice and action to these companies.
Should we do something about the low support for paid speaking rights?
Technically, this is a non-binding advisory vote, so companies are not obligated to do anything with the vote. However, the answer to this question is certainly yes. It is important to understand and try to address low voting results. Say-on-pay is often referred to as a blunt instrument because it is a simple “yes” or “no” vote. The company likely won't know exactly why shareholders voted against its executive compensation plan. They will only find out that the level of support was below par. Therefore, it is a best practice to conduct outreach to better understand the concerns that shareholders may have regarding programs and compensation-related decisions and to fulfill the board's unique responsibilities to shareholders. Failure to do so may have a knock-on effect on relationships with shareholders in other areas. A lack of responsiveness could also leave companies in a cycle of low support in future pay votes, potentially leading to recommendations for negative votes against compensation committee members.
What should we do about this?
I advise companies to break down their activities into four main steps. First, companies need to assemble internal work teams suitable for this process. The core team typically consists of a combination of internal investor relations, legal, and human resources personnel. The team is also likely to bring in outside resources such as proxy attorneys and the board's independent compensation advisor. The CEO and other board members may also be asked to review materials and participate in meetings as needed.
Second, the core team must develop an approach and strategy for identifying which shareholders to research in the outreach, how to reach them, and what to cover with those who have agreed to participate in the discussion. Third, create materials to distribute to shareholders who have agreed to engage in a say-on-pay dialogue. These documents generally summarize important points about the company's compensation programs and decisions and reflect what is disclosed in proxy materials. Fourth, the core team should summarize the results of the outreach and engagement discussions and report them to the compensation committee.
What should we expect from these meetings?
The atmosphere and content of the meeting will vary depending on the company's relationship with each shareholder and the current circumstances surrounding that relationship. Discussions are often led by the governance team of a large institutional investor, but may include portfolio managers, investment team members, and others as appropriate. Since these meetings are intended for dialogue between the company and its shareholders regarding its current executive compensation program, it is wise to plan for approximately equal amounts of speaking and listening time. It is important to share important points with shareholders.
- How does your compensation program connect to your business strategy?
- What is the process for determining programs and making decisions?
- Why the executive compensation system works well
- Highlight the main benefits of the program from a shareholder and governance perspective.
It is also important to review the proxy advisory report in advance to understand its criticisms and specific areas where each shareholder may have questions. If you are willing to listen to shareholder feedback, we recommend that you do not make any changes at this stage of the investigation. Rather, document their concerns and ideas in detail and bring them to the committee for internal discussion. Shareholders may also wish to discuss areas other than executive compensation, such as the structure of the company's board of directors and other corporate governance topics. It's also important to address these items on the call, assuming the appropriate company representatives are on the call and available to answer questions, but make sure the topic of executive compensation is well covered.
What are some common problems and pitfalls to avoid?
A few things come to mind. One of the first things to avoid is delegating the actual engagement discussions to more junior team members. The expectation from shareholders is that senior management, and often board members such as the compensation committee chair, board chairman, and lead director, represent the company. It is also important not to disclose important non-public information in handouts or during meetings. Also, as mentioned before, agreeing to recommended changes during a call is problematic.
One of the most common problems that companies encounter is that shareholder feedback can be disparate or contradictory. For example, one shareholder may propose increasing the relative weighting of TSR in a long-term incentive program, while another shareholder may propose lowering the weighting to focus on internal financial results. This can make it difficult to respond to their suggestions. In these cases, the best advice is to make decisions on a more holistic basis, based on what is best for the company, taking into account business and leadership strategy and the environment, and be prepared to address why certain specific actions were considered but not adopted.
Our investor base is highly fragmented. What is the best strategy if shareholder outreach cannot be implemented effectively?
Even if a company has a diverse shareholder base, it's important to pursue outreach efforts. Outreach may only occur to a select few groups, as retail investors typically do not participate in outreach activities. For example, instead of developing a strategy to reach out to the top 20 largest shareholders, a company might decide to reach out to shareholders who own more than 2% of the company's stock. In this example, this list includes five shareholders, and it is possible that only two of the five will agree to meet. Although the engagement side of the process will be less fruitful, the board and company can rest assured that they have done their best to understand shareholder concerns. In this case, companies may place more weight on comments from proxy advisory firms. As the name suggests, companies act as agents for how investors evaluate their programs.
What happens after the engagement process?
The engagement process typically culminates in a summary for the remuneration committee and/or board of the process undertaken, key themes (and detailed comments) from the shareholders involved, and some perspective on feedback from the company's perspective. The committee should then have a robust discussion on the feedback, including any alternatives it should consider in response. You must decide whether to respond to specific feedback and, if so, how to change your program to accommodate that feedback. My advice is always to look at it through the lens of what is the best outcome for shareholders, given what the committee/board knows about the business strategy, management team and the impact of a particular change.
This process and key results should be documented in the company's next proxy statement. This explanation is typically found in Compensation Discussion and Analysis (CD&A), but may exist in other areas if CD&A is not required or if the change is more pervasive than a compensation change. Clear disclosure of the process, including details such as the number of shareholders contacted, what percentage of the company's outstanding shares they represent, the number of shareholders who have agreed to engage, and who from the company participated in the engagement process are all important disclosure points. In addition, companies should clearly articulate the key themes heard as part of the engagement process and link those themes to company responses and changes as appropriate.
