Helping investors have their say

As both economic and political spotlights shine across the corporate landscape in this highly charged election year, the 2008 proxy season is likely to see a renewed, stronger focus on the compensation of top executives. And helping to crystallize the topic is the so-called ‘say on pay’ proposal, which has increasingly garnered shareholder support. Shareholder proposals on the topic received in excess of 40 percent support at some two dozen annual meetings during the 2007 proxy season. In a handful of cases, they broke through the 50 percent mark, resulting in public pressures for boards to respond.

Say on pay is the shorthand moniker for the effort to have companies accept a non-binding advisory vote on executive compensation at the annual meeting, something which has been strongly resisted by US public companies for many years. However, it has gained real traction in recent times. The House of Representatives voted more than two-to-one in 2007 to force such resolutions and a bill asking for the same thing was filed in the Senate, sponsored by no less a name than Illinois senator and Democratic presidential candidate Barack Obama.

‘It’s an election year and it is a hot button issue,’ notes Stanford University professor David Larcker, who is a director of both the Stanford Directors’ Forum executive program and its corporate governance research program. ‘There is a lot of populist rhetoric.’ But he adds that in his view, Washington prefers to see the market work this out.

Indeed, that seems likely to be the case. On the annual meeting front, resolutions seeking a shareholder vote on executive compensation were filed at more than 60 companies during 2007. While a number of these were later withdrawn, eight achieved greater than 50 percent support, effectively passing the enactment level. It is likely that more will be seen this year.
   
In the spotlight
Verizon Communications was one of the first big companies to take action in relation to say on pay. In November, following inquiries from activists and a very close vote passing the say on pay resolution at its May annual meeting, it announced that it will allow shareholders a non-binding vote starting with the 2009 proxy season. Others, including AFLAC, have said they, too, will put up the non-binding referenda. AFLAC, unlike Verizon which has received public criticism of its pay policies, says it found the concept of a say on pay resolution in keeping with its general approach to good governance. ‘We spoke with the group Boston Common, which brought up the idea, and found their concern was simply that we have [a shareholder review] process in place,’ says company spokesperson Laura Kane. ‘And our view was: Why shouldn’t they have a right?’

AFLAC originally planned to offer the resolution in the 2009 season, but moved it up after assessing shareholder attitudes on pay disclosure, which have taken on a more involved tenor since the SEC rule changes on compensation reporting, which became active for most companies during 2007.

It is all part of what activists see as a rising groundswell in the battle for greater shareholder say – a reality, they claim, whose time has come.

Indeed, shareholders are not alone. A number of large corporations are facing up to the matter, joining in dialogue with investors. This past summer 130 participants were at a roundtable put together in New York by a working group on advisory votes to tackle this subject. From the corporate side, representatives from Intel, Palmolive, Tyco, Bristol-Myers Squibb and Intel were among attendees, according to Timothy Smith, senior vice president of Walden Asset Management, an organizer of the working group.

‘The advisory group is trying to find ways this can be put into effect in the US market,’ Smith reports. ‘We have Stephen Davis at Yale’s Millstein Center [the Millstein Center for Corporate Governance and Performance] working on a very meaningful project on how we would expand communication between investors and companies. Our view is that the advisory vote has limited effect if it is not accompanied by a robust communications process.’

Davis has already authored a draft policy briefing on say on pay outlining how the matter has been dealt with in other countries. After gaining acceptance through the 1990s as the UK was engaged in a round of major public debates on changing corporate governance, the London Stock Exchange in 2002 made non-binding say on pay votes a requirement for listed companies. Other countries have similar policies. In the Netherlands and Norway, say on pay votes are actually binding in some circumstances; a binding vote will apply in France starting in 2009.

US corporate attitudes change
The involvement of shareholders in the development of key company policies is accepted to lesser or greater degrees in many places outside the US. In many European jurisdictions, for instance, it is not uncommon to see consultations taking place between companies and large institutional holders on a regular basis – the aim being to ensure a cooperative effort that will sidestep any public confrontations over issues that will require shareholder agreement.

But resistance to the idea in the US has traditionally run deep – part of an overall culture in which boards have acted independently and in some cases in close harmony with management to draw up and implement policy without the involvement of shareholders. The idea that shareholders are stakeholders, or even owners who should decide company action, is hotly debated here.

That said, Smith adds that a real engagement is starting to take place among all significant players in the US market. The Business Roundtable and compensation consultants Frederic W Cook & Co are a part of the working group, which Smith says has a good feel to it. Following the summer meeting, he says, ‘a number of people said they felt the process had a lot of integrity. The working group continues to operate, with not only the Davis communications paper in development but TIAA-CREF and others working on language that a company might use if it wishes to implement an advisory vote.’

Accessing the latest thinking on all this is not without its difficulties since the working group has not yet established a website to summarize its work. Nor is it issuing any sort of regular publications highlighting its recommendations. But the door to learning is open, in a somewhat unusual way.

‘We’re glad to share with corporate secretaries who are concerned,’ says Smith, who has had scores of letters and other contacts from companies and directors. ‘We have also developed a little dialogue team, with groups like TIAA-CREF, the State of Connecticut and others. They are more than willing to spend an hour or two on the phone with a company, talk with the chairman of the compensation or governance committees, and discuss firsthand why they [the working group] think this reform is useful. Directors don’t have to believe everything they hear, but at least they hear it first hand from the State of Connecticut and CalPERS and so on.’

The working group has assisted the Millstein Center in its original policy draft and in doing so developed a list of frequently asked questions (FAQ) that further developed the subject. The paper and FAQ are available through the center’s website.

Meanwhile, Davis’ new communications suggestions will be published in February, Smith says, providing corporate secretaries and others with ideas on how to proceed. It is among a group of topics that are being elucidated by the working group, whose members comprise a real cross-section of the investment world. In addition to corporates, TIAA-CREF and CalPERS, the working group also features labor groups such as the American Federation of State, County and Municipal Employees (AFSCME) and concerned individual citizens.

Dealing with proxy advisors
Although the non-binding resolutions do not require specific action to be taken by the compensation committees of companies that have been targeted, they do shine a spotlight on executive compensation packages and allow shareholders the ability to pass judgment on the appropriateness of the overall pay structures. Experts say this leaves a board with a conundrum should a majority of shareholders vote against a salary package. Ignoring a suggestion for change will likely mean redoubled efforts in following years and organizations such as Institutional Shareholder Services (ISS) may be expected to ratchet up the pressure by using its power to recommend that large holders withhold votes on other matters – such as the re-election of board members.

Smith cautions that the ISS role is one that bears examination and his working group will explore it in detail. Among corporate secretaries, he says, ‘there is great consternation about ISS and Glass Lewis, and other proxy advisors and, in fact, the working group is going to deal with it in more detail because there is a lot of myth about it, we think.’

For example, he continues, ISS is said to control 25 percent of the vote. ‘They don’t actually control that percentage of the vote; they offer recommendations and in some cases cast votes at the direction of some clients. The final decision still ultimately lies with the investor,’ Smith asserts. ‘Most large investors are not just blindly doing what ISS says and neither
is our firm, Walden Asset Management, which has about $4 billion under management.’

For its part, ISS has stated that for the 2008 proxy season, it will examine each company on a case-by-case basis, for now at least forestalling concerns that it might attempt to create an across-the-board requirement regarding implementation of a say on pay standard. It explained its US approach in part by saying: ‘Shareholder proposals calling for US companies to seek advisory votes on pay have received strong support, pointing towards the probability of more companies adopting the practice.’ The group’s policy for the new season is based on several factors, and observes the following dictum: ‘The criteria for US say on pay vote evaluations fall within the scope of the proposed global principles and emphasize investors’ demand for executive compensation programs that have a strong link to performance and minimize non-performance or potential pay for failure components.’

It is an issue that will not disappear. And one that law firm Latham & Watkins prudently summed up in a late fall letter to clients: ‘Many companies will be lucky and not receive a say on pay proposal in 2008. Many of the others who are not so lucky will find a way to postpone implementation of say on pay for a year or perhaps two. But given the strong national trend in favor of corporate governance activism and the obvious popular appeal of say on pay, momentum is building toward a pervasive say on pay regime for US public companies.’