Preparing for the 2015 proxy season

As  2015 begins, it’s never too soon to 
prepare for proxy season. Last year, investors flexed their muscles as Apple was sued to distribute more of its cash reserves to investors, Coca-Cola was forced to restructure its compensation plan, and the entire board of Darden Restaurants was ousted in a proxy fight. To avoid such challenges, companies should bone up on some of the top issues on investors’ minds in preparation for their annual meetings.

Say on pay and compensation disclosure

Say-on-pay voting results should be a major concern during the 2015 proxy season, even as most 
companies receive extremely high levels of 
shareholder support for their executive compensation plans. While support for say-on-pay proposals has averaged 89 percent, history shows that many 
companies see substantial swings in their say-on-pay votes from one year to the next.

Among the 58 Russell 3000 companies that failed their say-on-pay vote in 2013, there was an average increase in support of more than 30 percent in 2014, says Rajeev Kumar, senior managing director of corporate governance for Georgeson. And the 60 companies whose proposals failed in 2014 witnessed an average decline in support of a similar magnitude from prior-year levels, he adds. Firms that failed to get the more than 90 percent level of support that most companies achieve need to be vigilant, says Kumar.

‘Most firms that fail their say-on-pay vote had some level of opposition in the previous year or years,’ he notes. ‘It’s better to address the issues of disgruntled shareholders early on.’

Kumar urges companies with low passing votes last year to talk with a wide range of investors in order to better understand the specifics, paying 
particular attention to how major shareholders weigh various issues. Companies that failed their votes a year ago or had support levels below 75 
percent should seek recommendations from a proxy adviser on how to increase investor support. After the compensation committee uses feedback from such engagement efforts to revise the compensation plan, Kumar suggests companies conduct a second round of shareholder outreach to ensure revisions have addressed concerns to investors’ satisfaction.

Companies should also be sure to provide 
clear disclosure in the compensation discussion and analysis (CD&A) of any investor outreach efforts and outline all steps taken to address say-on-pay issues leading up to the 2015 annual meeting.

Statistics from the most recent ProxyPulse released by Broadridge and PwC last fall indicate that, as part of their preparation for say-on-pay voting, companies are paying a great deal of attention to pay-for-performance alignment in their compensation plans. Eight out of 10 directors surveyed agree that say on pay caused their board to look at compensation disclosures in a different way. ‘Companies are paying attention to aligning compensation plans with shareholder interests,’ the report states.

Companies need to continue to figure out how 
to better align pay with performance in 2015. ‘Generally speaking, companies are paying significant attention to making sure their compensation plan incentives are aligned with shareholder value,’ says Chuck Callan, senior vice president of regulatory affairs at Broadridge. ‘I think there is greater 
overall alignment in the current plans.’

Proving that pay is aligned with performance will require companies to improve their compensation disclosure. This entails using the proxy statement, CD&A and company website to ‘tell the story’ about how the firm has addressed previous concerns regarding compensation – including the rationale around pay-for-performance alignment, how realizable pay is calculated and how decisions on equity-based grants are made. Even though not all of these 
disclosures are required, companies may want to consider whether and how each may help improve support levels for their say-on-pay proposals.

Proxy access

New York City comptroller Scott Stringer’s move to file proxy access shareholder proposals at 75 portfolio companies of the $160 billion New York City pension funds will undoubtedly have one of the biggest impacts on the 2015 proxy season. The proposals request 
that companies adopt a bylaw giving shareowners that hold at least 3 percent of a company for three or more years the right to list their director candidates, 
representing up to 25 percent of the board, on the firm’s proxy voting ballot. Companies that do not approve the measure will be subject to shareholder votes on adding such a bylaw in 2015.

In a November press release announcing what he calls ‘the Board Accountability Project’, Stringer says, ‘We are seeking to change the market by having more meaningful director elections through proxy access, which will make boards more responsive 
to shareowners. With this in place, we expect to see better long-term performance across our portfolio.’

The New York City pension funds have targeted companies ‘where we see risks associated with 
climate change, board diversity and excessive CEO pay,’ Stringer says. He is calling for a national 
movement to pressure companies into adopting proxy access proposals, and industry observers believe it would be wise for most companies to consider how they might react to a formal request for proxy access. If the comptroller’s efforts succeed, other prominent pension funds may initiate additional filings.

Tom Germinario, senior vice president at DF King, expects the proposals will receive ‘a significant amount of traction in voting results. Companies need to be prepared with good analysis and a 
well-planned engagement strategy to put forth their response to the proposal.’

Separation of the CEO and chairman roles

Another central issue this proxy season will be 
proposals for an independent board chair. ‘Separation of the CEO and chairman is typically a high-profile proposal, as was the case with JPMorgan a few years ago,’ says Germinario. ‘The proposal has now been submitted to Bank of America, another prominent target in the financial sector.’

Separation of the CEO and chairman roles was the predominant issue in shareholder proposals in 2014, as institutional investors continue to debate the merits of having the two roles combined. 
The Conference Board cites 72 proposals on CEO/chairman separation submitted at Russell 3000 
companies by June 30, 2014, 62 of which (86 
percent) went to a vote. Support for these proposals was lacking, however, averaging 31 percent of votes cast – far below the majority threshold needed 
for them to pass. In fact, only four shareholder 
proposals on this matter received majority support.

This may reflect ‘recognition that [several firms] have made persuasive arguments for keeping the CEO at the helm of their boards while increasing the roles and responsibilities of their lead independent director,’ the Conference Board said when announcing its ‘Proxy voting analytics’ report in November.

Although these proposals were not very successful last year, Germinario says calls for independent chair proposals will continue this year, ‘particularly with new proxy adviser policies that make the 
recommendation less predictable on this proposal.’

Shareholder rights

Expect to see greater emphasis on other shareholder rights in 2015 as well. In its ‘Critical issues for board focus in 2015’ report, the National Association of Corporate Directors (NACD) warns that investors will hold directors accountable for matters such as the right to call special meetings, majority voting and declassified boards. Many investors view these measures as ’governance basics’ that should be 
generally accepted practices, says NACD.

Additionally, the NACD report illustrates 
investors’ particularly strong opposition to companies changing bylaws without shareholder consent. The report states: ‘While recognizing that directors should be able to adopt amendments to improve [board] 
efficiency and effectiveness and understanding 
that boards sometimes need to take actions quickly, investors emphasized that unilateral actions to change bylaws and/or their application in ways they believe adversely affect shareholder rights can be cause for significant concern.’ The report goes on to quote one investor as saying, ‘We encourage directors to have some discussion – why a particular action is being taken, the potential impact on shareholders, whether investors should be allowed to weigh in – and provide a rationale where appropriate. Otherwise the board appears blind to investor views.’

Germinario expects investors and proxy advisers to pay close attention to unilateral bylaw amendments. ‘Some amendments made without shareholder approval may lead to increased ‘against’ or ‘withhold’ votes on directors and committees,’ he says.

Board composition

For a number of reasons, board composition has been a major issue of concern for shareholders over the last few years. Expect shareholder proposals related to this issue to increase in 2015.

Kumar notes that shareholder proposals on board diversity have increased as the movement to add women to boards has gained support. Board expertise also continues to concern some investors, as several proposals asking that boards add 
members with environmental experience surfaced last year. Even ISS has slowly begun to incorporate considerations around board composition into 
its policies, as evidenced by the update of its 
independent chair policy, which now looks more closely at tenure of board members. Long-tenured directors and a long-tenured CEO would incline ISS toward a negative recommendation for a company’s proposal to re-elect a board of directors, says Kumar.

‘Companies should be looking to see how ethnic and gender diversity can become a part of their board,’ Kumar adds. ‘They should also be assessing whether they have any long-serving directors, whether they are refreshing their boards sufficiently, and if they have the right skill sets on the board.’

Shareholder activism

The rising tide of shareholder activism aimed at firms of all sizes continues in proxy contest activity. The new activism is not focused on takeover activity, however; increasingly, it is an attempt to secure influence on company decision making.

Kumar suggests companies check to see how they rate on corporate governance issues and try to address areas where they may be viewed negatively. ‘Proxy solicitors can be helpful in determining 
shareholder makeup and coming up with probable vote outcomes,’ he says. They can also forecast different scenarios showing various levels of shareholder 
support for a range of governance issues.

Correction: An earlier version of this story misstated the group of companies that failed their say-on-pay votes in either 2013 or 2014 among which there was either a significant average increase the following year or decline from the prior year, respectively, in support for their say-on-pay proposals.