What do you say about Say on Pay?

Say on Pay is not a new concept to executive compensation but since it’s now law (Dodd-Frank Act), a quick look at history might be useful.

  • Shareholder votes on executive compensation practices initially surfaced in the UK as early as 1999.
  • The first negative vote on executive compensation occurred in 2003, when GlaxoSmithKline shareholders voted against the report of compensation paid to executives.
  • In 2007, in the U.S. there were about 50 companies that had shareholder resolutions calling for an advisory vote on executive compensation.
  • In the 2007 – 2009 proxy seasons combined, there have been about 200 companies with shareholders voting on compensation practices.
  • In 2009, under the American Recovery and Reinvestment Act, all companies receiving funds from the US Treasury (TARP) were required to include a non-binding advisory vote on compensation to the highest paid group of executives.  This resulted in approximately 400 companies required to hold such vote, mostly banks.

On July 21, 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”), was signed into law by President Obama and includes a provision requiring public companies to allow shareholders a non-binding advisory vote on executive compensation.

Specifically, the Act requires:

  • A vote at least once every three years, beginning with the first shareholder meeting that occurs after January 21, 2011.  Therefore, say-on-pay will be required for many public companies this upcoming proxy season.
  • Also at this first annual meeting, the shareholders must decide on whether the vote should be held every one, two or three years (thereafter a vote on frequency must be held by a separate resolution no less often than every six years).

What are Shareholders actually voting on?

With the non-binding advisory vote, what are shareholders actually going to be voting on?  Are they voting on the amount of compensation paid? Are they voting on the compensation philosophy of the company?  Are they voting on the types and delivery of compensation?  Ultimately, you would think the vote would be on all of the above but the compensation philosophy seems to be the most important issue.  Poor compensation philosophy can lead to many other problems, specifically overpayment for poor performance.

Issues to Consider

As with many of the provisions in the Act, there will unintended consequences of the new legislation.  Here are a few issues to consider when asking shareholders to vote on executive compensation:

  • Companies will need to revise proxy statements to include the mechanics of voting on compensation.  Will the Board make a recommendation on the vote?
  • Institutional shareholder advisory services will have a greater influence on compensation practices as a result of the vote and therefore companies will more likely want to comply with mandates from such advisory firms (i.e. employment agreements, change in control provisions, severance arrangements).
  • Ongoing educational efforts of a company’s compensation plans and philosophy will be necessary to inform shareholders required to vote, especially since retail shareholders/brokers will need instructions from beneficial owners in order to vote the shares in favor of compensation plans (no instructions = a no vote).
  • While the vote is “non-binding”, Directors will be forced to react to such votes or risk a “withhold” vote on their re-election as board members.  In the 2010 proxy season, there were three companies that received a no vote (KeyCorp, Occidental Petroleum and Motorola)…so it can happen.
  • A more subtle influence of the Say on Pay shareholder vote of confidence will be the risk of focusing senior management on shorter term performance results so that a company’s annual performance will justify higher compensation when a longer-term, strategic investment focus would result in greater shareholder value in the long run.

With the many issues to consider and the potential of getting a negative vote from shareholders on compensation practices, companies would be wise to get an early start on reviewing current practices and seek advice on their proxy draft now.

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