The fourth season of mandatory say on pay in the United States is under way and the first wave of annual meetings suggests that the vast majority of companies continue to receive good marks from shareholders regarding their pay programs. Based on the first 131 Russell 3000 companies to hold their 2014 meetings, average support for say-on-pay resolutions is 94% so far this year, up from 90% in 2013. While 2% of companies failed their say-on-pay votes last year, only one Russell 3000 company has failed this year as of March 10 (one other reported 2014 failure was a smaller company outside the Russell 3000).
While we anticipate that pay-for-performance alignment will remain the primary issue shareholders evaluate when casting say-on-pay votes in 2014, shareholder engagement and company responsiveness to shareholder concerns appear to be increasingly important, based on our ongoing analysis of say-on-pay voting patterns. Our experience suggests that companies can and should do a better job of communicating with shareholders about their pay programs. But effective engagement takes many forms and is driven by each company’s unique circumstances (and shareholder base).
The recent Towers Watson/Alliance Advisors survey of institutional investors and corporate directors identified a sharp disconnect in how these key stakeholders view the impact of shareholder engagement on executive compensation program effectiveness (see “Survey Finds Corporate Directors, Institutional Investors Remain Divided Over Current State of Executive Pay,” Executive Pay Matters, January 16, 2014). The survey found that 69% of investors felt that executive compensation programs would be more effective with more frequent shareholder engagement, while just 13% of directors shared this view. This gap may offer clues as to why responsiveness to shareholder concerns was increasingly cited as a concern by Institutional Shareholder Services (ISS) last year in the proxy advisor’s say-on-pay recommendations. Based on our review of ISS commentary in recent proxy seasons, compensation committee responsiveness was cited as a high concern at about 19% of companies receiving ISS “against” recommendations for say-on-pay votes in 2013, up from 10% of the cases in 2012.
So, what’s triggering the growing concern about responsiveness? According to our review, nearly half (44%) of the cases in which responsiveness was rated a high concern by ISS involved situations in which the committee was deemed to have not gone far enough in making changes to the pay program (Figure 1). While it’s understandable that shareholders and compensation committees might not see eye to eye when it comes to changing a pay program, some of the other reasons cited for a high level of concern speaks directly to the current state of the dialogue between companies and shareholders. Our review found that too little disclosure regarding shareholder engagement was cited by ISS in 20% of the subset of high-concern cases, while a lack of engagement was cited in a third of these cases.
Figure 1. Issues driving ISS "high concern" ratings for compensation committee responsiveness in 2013*
The proxy advisor’s growing focus on shareholder engagement isn’t surprising, based on what we see in our consulting. Closer scrutiny by proxy advisors and shareholders signals that expectations are higher — and not just with regard to shareholder engagement but also with regard to the disclosure of these activities. Based on our analysis of the 2013 proxy season, a passing reference to engagement in the compensation discussion and analysis (CD&A) section of the proxy statement may not be enough. The disclosure of how the company engaged with shareholders is becoming more detailed, including information on the estimated percentage of the shareholder base the company reached out to, topics where feedback was consistent and any company actions taken in response to investor feedback. Including this level of detail in the CD&A helps ensure that companies get credit for their engagement efforts and demonstrates responsiveness to shareholder concerns in cases where feedback resulted in changes to pay programs or was given serious consideration by the compensation committee.
More transparent disclosure of these activities also reflects the changes we’re seeing in the quality of engagement taking place. During the first few years of say-on-pay voting, much of the engagement activity was driven by unanticipated scrutiny or negative vote outcomes that put companies on the defensive with shareholders at times. More recently, there’s been a shift in tone and many companies are taking the initiative to reach out to shareholders sooner and more frequently, effectively building an ongoing process around regular discussions. Figure 2 illustrates the range of approaches to shareholder engagement.
Figure 2. Stages of shareholder engagement
RANGE OF DISCLOSURE OPTIONS
How companies approach and share information with investors has continued to evolve in the say-on-pay era, especially among companies that have experienced challenging say-on-pay votes. One-on-one dialogue with key shareholders is important and often the most effective, but time and cost constraints make it difficult. As a result, companies often revert to mass communication channels, such as corporate websites or public filings, to communicate messages regarding their pay programs. The most frequent avenues for disclosing shareholder engagement efforts include:
- The proxy statement: Specifically, the CD&A is the usual place companies explain their executive pay programs and philosophy and report any pay program changes. While Dodd-Frank ushered in the mandatory say-on-pay era, it also required companies to disclose how their pay programs changed or were influenced by the say-on-pay vote. While many program changes result from discussions with investors, shareholder engagement efforts are rarely mentioned voluntarily in the CD&A. While our experience suggests that most companies frequently engage in discussions with investors about their pay programs, our review of 2013 proxy statements found that just 24% of Fortune 500 companies included specific details about their shareholder engagement activities in their CD&A.
- Supplemental proxy filings: In 2012, companies made frequent use of supplemental proxy filings to highlight pay program changes made in advance of the annual meeting and to voice disagreement with negative proxy advisor and investor statements about the company pay program. In general, experience has shown that investors are not likely to change their vote on say on pay as a result of such filings unless there is a fundamental change to the pay program that was not previously disclosed in the proxy statement. Not surprisingly, the use of supplemental filings dropped by 44% from 2012 to 2013.
- Current events (8-K) filings: If a key pay program change has been made since the proxy was filed, the filing of both an 8-K and a supplemental filing often yields better results in terms of winning shareholder support for a say-on-pay proposal. The supplemental filings can explain why the changes were made and give the company another avenue for telling its pay story, while the accompanying 8-K can spell out the exact changes made. Presentations and transcripts of communications with selected shareholders are often posted within these filings for other shareholders to see, even if they were not primary participants. In preparation for the 2014 proxy season, a small number of companies have filed an 8-K solely to meet Regulation FD requirements. Regulation FD requires disclosure to all shareholders if material nonpublic information was made available to selected shareholders. In some cases, it appears that those filings were made to facilitate shareholder discussions ahead of a proxy filing.
There are clearly many considerations for companies when reaching out to shareholders. Ideally, companies should have ongoing discussions with shareholders, but the proxy season is an especially good time to evaluate the information needs of your company’s shareholders and see if additional steps need to be taken or if your CD&A disclosure can be enhanced. As with many aspects of say on pay, there is no single right answer, although all signs point to the strategic benefits to be gained from effective ongoing engagement with shareholders.
Our 2014 Proxy Webcast on April 16 will provide an up-to-date look at say-on-pay voting outcomes and shareholder engagement strategies in the current proxy season, along with insights into the latest trends in executive compensation. To register for the webcast, click here.
Robert Newbury is a director in Towers Watson’s Arlington, Virginia office who leads the firm’s Executive Compensation Resources unit, and Jessica Yu is a consultant in that unit. Jim Kroll is a director in the firm’s New York office who leads Towers Watson’s executive compensation governance advisory practice. Email firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com.