Shareholder Engagement On Executive Compensation A Primer On The Why, When, Who And How? by Frederic W. Cook & Co., Inc.

Abstract

As the 2015 proxy season enters the final stretch and shareholder votes are tabulated, calendar year public companies will be analyzing their Say-on-Pay outcome, lessons learned and next steps. While solid design and comprehensive proxy disclosure remain the most effective way to mitigate the need to defend a company’s compensation policies and practices, direct shareholder engagement can help to clarify key issues and establish credibility with investors. Five years ago, the idea of board members and senior executives actively engaging in direct discussion with shareholders about executive compensation was almost inconceivable. Today, it is a rapidly growing trend that we expect to accelerate as shareholder interest in executive compensation policy and alignment between pay and performance continues to grow. The purpose of this article is to provide an overview of the shareholder engagement process with respect to executive compensation and related governance issues.

Shareholder Engagement On Executive Compensation A Primer On The Why, When, Who And How? – Introduction

In general, interaction between shareholders and the directors and executives who lead companies happens formally once per year at the annual shareholders’ meeting, as well as through the proxy solicitation process leading up to the meeting. “Shareholder engagement” is an opportunity to take this structured, single-point, annual interaction and transform it into an ongoing, less formal, two-way conversation.

For the company, shareholder engagement is an opportunity to inform, listen and solicit feedback from shareholders outside the formal proxy solicitation process. For shareholders, it is an opportunity to learn more about the company and how it is governed, and to express views on important topics in an informal setting. Without such opportunity, unhappy shareholders will express discontent by (i) abstaining or voting against the company’s recommendations, (ii) selling their shares, or (iii) in the most extreme cases, launching a proxy contest or becoming an activist investor.

For public companies, shareholder engagement on corporate finance matters is long-standing and well established as evidenced by analyst earnings calls, investor days and corporate roadshows. However, shareholder engagement on executive compensation matters is a more recent phenomenon that began in the wake of “Say-on-Pay,” which took effect for all US public companies in 2011 (see Appendix A for a historical timeline of the regulatory drivers that have resulted in greater shareholder engagement). Despite the fact that the Say-on-Pay vote is non-binding, it has transformed the manner in which executive compensation is designed, administered and communicated. There are several reasons why:

  • The perception of a “pay-for-performance” disconnect invites investor activism and subjects the company to challenges regarding its organizational strategy and leadership
  • Investor discontent over CEO pay creates leadership credibility issues and can demoralize the workforce, leading to further performance challenges. This is especially true in companies that have experienced financial difficulties resulting in low or no compensation increases for employees, benefit plan reductions and/or workforce reorganizations
  • Failed or challenged Say-on-Pay vote outcomes attract unwanted media scrutiny to the company and call into question board governance and judgment
  • Finally, challenged Say-on-Pay is not a single-year issue. Rather, a challenge in one year leads to increased scrutiny in the subsequent year, and failure to adequately address investor concerns may eventually lead to “against” or “withhold” votes on compensation committee member re-elections

Shareholder Engagement: Form and Objectives

In the executive compensation arena, shareholder engagement typically occurs in the context of one or a combination of the following scenarios:

  • Part of a company’s regular shareholder outreach program

Regular shareholder engagement fosters a culture of transparency and openness, which helps establish credibility with investors. Companies that actively communicate with investors are more likely to establish goodwill and mitigate investor misunderstanding than those that reach out only in times of crisis.

  • To preemptively address a potential pay-for-performance disconnect or a compensation decision that could be viewed negatively by investors

The goal of engagement in this scenario is to mitigate potential adverse investor and/or proxy advisory firm reaction to a perceived poor compensation decision or pay-for-performance disconnect by explaining the rationale for the compensation decision to shareholders. When executed carefully, this engagement can preempt a negative Say-on-Pay vote outcome by explaining and rationalizing to investors why a decision or action that may be perceived as inconsistent with “best practice” was reasonable and appropriate in the context of the company’s unique circumstances.

Shareholder Engagement On Executive Compensation A Primer On The Why, When, Who And How?

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