Six Shortcuts to Guide Your "Say-on-Pay" Vote
January 2011
As proxies start to trickle in from companies in which I own shares, my perspective shifts from that of a disinterested advisor on executive-pay practices to one of a thrifty owner reviewing the pay and performance of my senior staff. This year, thanks to the say-on-pay provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), I can now do more than merely sound off on those pay practices. I can vote on them.
Among the provisions of the Dodd-Frank Act is its Section 951 requirement (adding Section 14A to the Securities Exchange Act of 1934) for a non-binding shareholders’ vote to approve the compensation of a company’s named executive officers—as described in the company’s Compensation Discussion and Analysis (CD&A) and related compensation tables—at least every three years. In addition, Dodd-Frank calls for a separate, non-binding shareholder vote, the results of which would influence how frequently in the future a company holds a say-on-pay vote: annually, or every two or three years.
Given my profession, it may surprise some to learn that in preparation for casting my proxy votes I have no intention of poring over the details of each company’s CD&A and pay tables. First of all, as an outside shareholder, I give the board and management the benefit of the doubt when it comes to pay. Their understanding of what the business needs and how their industry operates far exceeds any armchair analysis I might perform during the standard course of my occasionally checking out the stock price or skimming an annual report.
So what information do I consider for guidance in casting my proxy say-on-pay vote? To get a sense of each executive-pay program’s fundamental design and how well it’s being managed, I will look for any of six company practices, described below, that I consider red flags. If I find three or more, I will vote no. Otherwise I will probably support the proposed compensation plan.
Companies might find this six-point checklist helpful as they develop shareholder communications around executive compensation, and I offer it also as a time- and money-saving alternative to individuals and institutions who want to vote responsibly on pay without having to analyze CD&A details or purchase expensive ISS advisory reports.
Red-flag Pay-related Practices
1. Convoluted Writing. If a company cannot provide a clear written explanation of its pay practices, levels of compensation, bonuses, pay raises and long-term grants, those practices probably (or at best) make no sense. I am not suggesting that complex plans are bad plans. A company’s business goals and human-resource requirements might appropriately lead to a plan with a number of layers, triggers, offsets, etc. But whether complex or simple, all aspects of a company’s compensation plan should be based on logic that can be readily explained and implemented. Be wary of any proxy that provides nothing more than vague, "pay-for-performance" boilerplate terminology or, alternatively, one with complicated jargon and charts instead of straightforward explanations.
2. Perquisites and Special Benefits. Perquisites, even personal use of an airplane, represent relatively small dollars when compared to cash and equity compensation. And since the attraction they hold for some executives is disproportionate to their cost, special benefits can even have a “bigger-bang-for-your-buck” justification. Nonetheless, in my mind perquisites are like the canary in the coal mine. Given the strong trend away from perquisites in executive pay practices, the presence of a particularly broad or rich perquisite package suggests to me a management team that might not have its priorities in order or is tone deaf to changes in external tunes. I suspect the leadership qualities of an executive who insists upon using the company jet for personal travel rather than buying a first-class ticket—or, for that matter, paying for a home security system or an enhanced medical plan—with his own sizable paycheck.
3. No Off-target Years. Patterns of awarding bonuses for performance that is infrequently or never below "target" and/or customary approvals by the board of discretionary gross-ups are warnings of poor pay practices such as setting goals too conservatively and weak board oversight.
4. The “Better-than-Average” Strategy. Bonuses and equity programs targeted at the competitive median or 50th percentile already have the flexibility to pay larger than median payouts as long as performance and/or results are also above the median. But pay programs targeted above the 50th percentile, usually justified as “needed to attract the best” or "we are better than the median", effectively confer above-average pay for average or less-than-average performance. That’s not a policy to support.
5. Evergreen Employment Agreements. Although employment agreements are often required to hire new senior executives, guaranteeing employment to a long-term executive has little or no business rationale. On the contrary, the endorsement of any such agreement can indicate a board that is either inattentive or unwilling to stand up to management—a bad sign no matter which is the case.
6. Frequent Base-pay Increases. Once a senior executive's base pay has reached a competitive level, the only circumstances under which I might expect to see significant increases would be the infrequent—and clearly explained—occurrences of a change in the competitive structure of the industry, an expansion of the scope of his/her job, or demonstration of a manifest leap in the skills that individual brings to the company. Rather than base-pay increases, raises at the senior level should be awarded primarily in the form of bonuses and/or equity.
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The question begged by the say-on-pay vote—and one that vote cannot fully address—is how competent the board and management are to fulfill their responsibilities with respect to an issue as important as compensation. If my proxy analysis were to uncover pay practices that I believed warranted a negative vote, I would probably choose also to vote against incumbent board members. Or, better yet, sell my shares and reinvest in a better-run company.
