While proxy season may not be in full swing quite yet, it is compensation season. Board room decisions over the approaching weeks of winter will translate into triumphs or headaches at spring annual meetings. If heeded, lessons from the 2012 proxy season can go a long way to making the upcoming season less bleak. Let’s start with some fundamentals and then build on those with some lessons from 2012.
Fundamentals
Know Your Reports: Carefully analyze the reports prepared by ISS, Glass Lewis and other proxy advisors on your company’s executive compensation and governance. Be sure you have a handle on their “concern” areas, whether you agree with them or not, and then file them away. We will need to revisit them later. Next, understand the quantitative analyses employed by the advisors (the first stage of their analyses) and whether those tests are changing for the upcoming season.
Assume You Will Fail: As you prepare for proxy season, assume that you will fail the quantitative analysis. Lest you think we are overly pessimistic, here are good reasons to take that advice:
- You have little control over much of what goes into the testing. You cannot control the macro-economy and you cannot influence the performance of your peers, so relative Total Shareholder Return (TSR) will always be something of a question mark.
- Even good news isn’t great news. High performance years set the bar higher and make off years more likely down the road in terms of three-year TSR.
This will force you to address the qualitative analysis. Almost half of the companies that failed the ISS quantitative test still received positive recommendations following the qualitative analysis. Institutional shareholders tend to vote “no” on only a subset of the companies that receive a negative recommendation from ISS. Focusing on the qualitative analysis means focusing on your disclosure.
Lessons from 2012
While lessons from 2012 involve specific hot button issues, one thread runs through them all: the power of good disclosure. Unless the compensation committee is willing to change a potential “red flag” practice in the compensation system, the company must explain their rationale with clear, concise and meaningful disclosure. A powerful “why” helps with the proxy advisors and often can sway the voters.
Total Shareholder Return: Proxy advisors need a single measure to compare apples to apples across thousands of different companies. Their choice of TSR for that purpose is unlikely to change anytime soon. If you believe that other measures are more important to your company’s compensation philosophy, disclose them in the CD&A and explain why. You should not ignore TSR or miss an opportunity to address a low relative TSR and mitigate its impact, but don’t be afraid to prominently present other relevant measures.
Realizable Pay: Many companies have been hurt by grant date fair values that overstate CEO pay and negatively impact the pay-for-performance analysis. If your company finds itself in that boat, consider presenting “realizable pay” as an alternative. There is no standard definition of realizable pay, so be sure to clearly explain how you calculate realizable pay to make your investors more comfortable with the alternative presentation.
Controversial Equity Awards: Proxy advisors do not consider stock options to be performance-based pay and also tag time-based equity awards with a red flag. If the compensation committee believes these awards are a valuable component of your company’s compensation system, you should explain the rationale persuasively in the CD&A. The proxy advisors and voters will not be swayed without a compelling story.
Peer Groups: Many companies objected to the differences between the peer groups that proxy advisors chose for the relative performance component of their pay-for-performance analyses and the peer groups that companies chose for their proxy statements. Changes are coming – Glass Lewis announced a revised methodology and ISS proposed changes as well. However, if your peer group in 2012 differed significantly from that of the proxy advisors and the differences negatively impacted their assessment of pay-for-performance, you should add disclosure that better explains why you chose the companies in your peer group. The added context can help sway voters.
Company-specific “Concern” Areas: The concern areas you noted from proxy advisor reports should be addressed in the 2013 proxy. Even if the compensation committee considers the criticized compensation component and decides to keep it, the disclosure of that component in the proxy should be augmented to explain their rationale and how the component compliments the company’s overall compensation philosophy.
Don’t Miss the Opportunity
Remember that the proxy advisors only evaluate public information. Engagement with the advisors aimed at influencing their analyses will have little impact unless the same arguments appear in your disclosure. In addition, supplemental proxy filings rarely result in a recommendation change. The 2013 proxy statement is the best place to make your case for your executive compensation program. Share the lessons from 2012 with your proxy team and incorporate them into your first draft. If you do not, you might end up being a lesson for 2013.
Additional Articles from the Fall 2012 Public Company Forum:
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