There is no evidence yet that the non-binding “say on pay” shareholder votes on executive compensation plans have had a material impact on the actual amount of compensation paid to executives.
However, just the possibility that a corporation could get a no vote or even a vote that shows a lower-than-average level of support for its executive compensation has dramatically changed how boards of directors approach the entire compensation issue — much of it for the better, experts say.
“All things considered, it was an ordinary or average year for executive compensation,” said Andrew Goldstein, a practice leader for executive compensation in the Chicago office of New York-based Towers Watson. “But the bigger story is year two of say-on-pay and what we saw at a result of that.
“Two years ago everyone was still wondering if say-on-pay would make a difference in how companies manage and design their executive compensation pay plans,” said Goldstein. “Well, the answer is that it is making a difference and it has made a difference.”
Joe Mallin, a managing director at New York-based Pearl Meyer and Partners LLC, agreed. “It is having a very large impact, even though not that many companies failed the vote,” said Mallin, who is head of the firm's Atlanta office.
“A lot of companies are paying attention and trying to tell the pay story better. They are explaining the changes they made to the plan and why they made them, and putting a greater emphasis on analysis.”
Whether say-on-pay is having an impact on the “actual numbers” is another matter, according to Aaron Boyd, the research director at executive compensation research firm Equilar Inc. of Redwood Shores, Calif. “It's too soon to say,” he said. But, one thing is clear: “Say-on-pay has firmly rooted itself in the executive compensation landscape.”
Companies are definitely “working harder to make sure that compensation is tied to performance, and making sure that story is communicated to shareholders,” Boyd said. That goes for all companies — not just those that have failed a say-on-pay vote or received low stockholder support for their compensation plans, said Boyd.
As a result, firms are disclosing more information in the required compensation discussion and analysis (CDA) sections of their proxies, Boyd said. “Companies are putting simpler, clearer explanations about pay practices in the CDA and saying this is why we've done this, this and this,” he said.
They also are making supplemental filings to address shareholder concerns after the proxies come out, he noted.
“There has been a definite increase in the number of companies who are putting performance results in the CDA,” said Christine Oberholzer Skizas, a Chicago-based partner in New York-based executive compensation consulting firm Pay Governance LLC.
“They are saying, here is how pay is structured and here is how we performed,” she said. “We are also seeing more supplemental charts and exhibits, multiyear looks at the relationships between performance goals and the results achieved, and information on what is the realizable pay for executives” — that is, what is the real value held by executives from recent equity grants, not the grant-date value of those holdings.
“All the information was always there, but now they are putting together a clearer, more rational story for investors,” Skizas said. “It has become a story, not just the facts. Companies are providing more thoughtful explanations about their decision-making.”
And, said Mercer Inc.'s Mick Thompson, companies are putting the “key points” upfront, “at the beginning of their executive summaries.”
“They are putting in more charts and graphs to illustrate information and to make it easier to understand,” added Thompson, a Chicago-based principal in Mercer's human capital consulting business.
But they aren't counting on printed material alone to do the job of communicating information. Companies now are routinely arranging meetings and conference calls with major stock- holders and representatives of the two major proxy advisory firms, Institutional Shareholder Services Inc. and Glass, Lewis & Co. LLC.
“There is enhanced shareholder outreach to understand their concerns,” Skizas said. “We are seeing much strong and more open dialogue with institutional investors.”
The net effect, according to Thompson, is that firms “come away with an increased knowledge about what investors value and what they don't.”
Pearl Meyer's Mallin calls it “managing the process — not just designing the executive pay plan.”
But all the scrutiny is bringing about changes in pay plans, particularly incentive plans, as firms look to prevent a low or no vote on say-on-pay or make sure such a vote doesn't happen a second time, Mallin said.
“They are now trying to merge together the interests of various groups of stakeholders, shareholders and the business,” he said. “If shareholders think CEO pay was too high, companies tend to reduce pay or reduce long-term incentive grants because they are the biggest driver and largest component of CEO pay.”
That's also spurring a shift from absolute to relative performance-based measures, with relative total shareholder return (TSR) becoming the most popular vehicle for that.
“One of the things that companies are doing that shareholders like is finding ways to incorporate relative performance into incentives,” said Goldstein of Towers Watson. “Investors are leery of rewarding executives for absolute increases in earnings, stock price and sales because a company could do all that and still be underperforming its peers and falling behind,” he said. “Shareholders and investors are really looking for companies that outperform the competition.”
Relative TSR is a measure that gives them insight into that.
Though say-on-pay is prompting many good things, the fear of failure has prompted firms to take fewer risks with compensation plans, said Goldstein, who's not sure that is good in the long term.
“No one wants to be below average, no wants to be above average, and everyone is just trying to understand what they need to do in design to pass the say-on-pay test,” he said. “So the effect is that it is forcing everyone to the middle, to the same flavor, to the same design.”
Mallin agreed. “You are seeing more compensation policies trending toward the median.”
And when that occurs, he said, “you eliminate the ability or willingness to create a competitive advantage for your company through your compensation plan.”
“That is one of the unintended consequences of say-on-pay and I wonder if that is really healthy over the long term,” he said.