Compensation issues are again dominating annual meeting season. Have shareholders begun to assert their rights more aggressively, or have companies learned nothing from years of dialogue?
An explosive start to this year’s proxy season has many observers calling 2016 the second Shareholder Spring. Significant opposition to compensation at companies such as BP, Citigroup, Anglo American and Smith & Nephew has caused embarrassment and surprise, while more investors seem willing not only to oppose management in key votes, but to engage in very public debates on the subject.
In this special edition of Proxy Monthly, we ask what has made 2016 such a challenging year, and whether issuers across the S&P 500 and FTSE100 yet to face shareholder votes are right to feel increasingly nervous.
Support for Say on Pay Votes
Coming after the relative stability of 2015, the level of opposition at some companies this year has come as a shock. Between 2014 and 2015, the average level of support for advisory (i.e. non-binding) Say on Pay Votes remained virtually the same at S&P500 and FTSE100 companies (92.4% in 2014 and 92.3% in 2015 for the S&P 500, and 93% in both years for the FTSE 100). James Kroll, a Director at Willis Towers Watson in the US, says a 2-3% failure rate for Say on Pay “is low and average shareholder support regularly exceeds 90%.” That is reasonable, he argues—and “probably higher than most companies expected initially.”
Yet given the column-inches devoted to the subject and the often personal attacks on individual board members, one may be forgiven for expecting the average support levels to be much worse. Yet, while US issuers have enjoyed a relatively constant level of support so far in 2016, their London-listed counterparts are facing a chill wind. Compared to 2015 levels of support, the average for the FTSE100 has dropped nearly nine percentage-points to 84.3%.
That should cause concern at all companies. Several investors appear to be radically reappraising their approach, leading to more aggressive stances. Yet the trend is not universal. Many investors prone to voting against management have become more, not less supportive, at the same time as large asset managers have moved the other way. Michelle Tan, a Principal at Hugessen Consulting advises issuers to “Know your shareholders. While it may seem like shareholders vote in lock-step with each other, the rationale for their votes are varied and can even conflict.”
Moreover, certain issues have dominated the rationales for discontent, suggesting a path forward is available for those with a keen sense of danger. As Tony Wu, a Principal at Korn Ferry puts it, “A negative Say on Pay vote outcome can be avoided if issuers are willing to put in the time to prepare and understand the lay of the land when it comes to their proxy adviser and shareholder landscapes well in advance of their annual shareholder meeting.”
That task won’t always be easy. According to Alex Little, a Senior Consultant at Willis Towers Watson UK, “Investors’ expectations of the levels of explanation and detail required from companies to justify their executive pay arrangements certainly have increased over the past few years.”
Are shareholders really becoming more aggressive?
First, observe the trend among shareholders. Although many investors continue to be generally supportive in the majority of Say on Pay votes, others are taking a far more aggressive stance. Table 1 details the voting in Advisory Say on Pay votes at UK and US companies by the top 20 Investors since 2013.
While BlackRock, State Street, Fidelity Management & Research, Northern Trust and Wellington continue to support the vast majority of votes, Fidelity Worldwide, BNY and JP Morgan are all becoming more aggressive. Indeed, Fidelity Worldwide’s emerging opposition is worthy of note. Supporting 88% of UK votes in 2013/14, 65% in 2014/15 and a lowly 43% for the tail-end of 2015, this pattern is replicated in the US to a lesser extent. [NB Fidelity Management & Research and Fidelity Worldwide are completely separate businesses].
There are also a clear regional differences. While in aggregate the top ten investors are marginally more aggressive in the UK than in the US, Goldman Sachs and Fidelity Worldwide have very different approaches, revealing a 15 percentage-point gap between support for US and UK companies. BNY Mellon, on the other hand, is more than 20 percentage-points more aggressive in the US, a rare feat.
With this in mind, issuers would be well-advised to consider why investors are behaving the way they are, and whether “red-line” policies are starting to eat into support for increasingly complex pay packages.
The key aggressors
While there is clear variance amongst the top investors regarding voting for Say on Pay, it is worth highlighting the attitudes of the most aggressive investors. Table 2 details a selection of the most significant investors who oppose say on pay votes in the UK and US (plenty of more aggressive investors have been left out due to their small size, but are available online at Proxy Insight).
Dutch Pension Fund PGGM tops the list in both countries, supporting only half of Say on Pay votes in the UK last year, and less than a quarter in the US. Marcel Jeucken, Managing Director for Responsible Investment at PGGM Investment, has previously told Proxy Insight that “Voting against proposals is not something PGGM takes lightly” but adds “we believe it can (and will) improve remuneration practices over time.” Their more recent opposition suggests the pace is slower than it would wish.
PGGM is unrepresentative of the broader trend, however. Instead, the average support from shareholders has actually increased over the last three years from 69% to 73%. Unlike PGGM, some investors are clearly seeing enough improvement to justify less aggressive voting.
Spotlight on Aviva
To demonstrate some of the reasons for votes against remuneration in the UK and US we have analysed the rationale provided by Aviva for their votes against in 2015 at Advisory Remuneration Votes in the UK (sample size: 123) and US (161).
Several themes suggest themselves. UK companies are more likely to face opposition for the sheer amount of compensation allocated, as well as their disclosure. In the US, the performance-link and inappropriate contracts are more likely to be the explanation for Aviva voting down a compensation policy.
Those concerns can be applied to other investors too. Willis Towers Watson UK’s Alex Little says companies in the process of changing their pay awards are most at risk and should engage early. “Non-disclosure of bonus targets continues to be a red line with investors,” he says. “If you disclosed little or nothing last year, you should consider what can reasonably be disclosed retrospectively this year or commit to future disclosure – or be prepared to fight your corner.”
Most investors aren’t as aggressive as Aviva and it remains very rare for a company to actually fail its advisory vote. Indeed, a majority of the top ten largest investors supported compensation proposals at least 90% of the time, and only a few companies in the FTSE 100 and S&P 500 failed theirs last year: Bed Bath & Beyond, Intertek Group, Oracle and Vertex Pharmaceuticals. Taking a look at a couple of these in closer detail may explain why they failed.
Intertek was the only FTSE 100 company to lose a Say on Pay vote last year. Intertek only just failed with 52% votes against and 48% for. The voting of the ten largest investors reflects how close this was—of the nine that voted, four were against and five were for. Unsurprisingly, the likes of Fidelity Worldwide and Goldman Sachs opposed the proposal while the generally less aggressive Vanguard supported it.
A number of investors provided a rationale for rejecting the proposal. Calvert Investment Management was among many shareholders citing a guaranteed bonus of £560,000 and signing-on bonus of £5 million for new CEO André Lacroix.
Bed Bath & Beyond received the highest level of opposition to its Say on Pay of S&P 500 companies, with 65% votes against. Based on the length of Calvert’s rationale alone, there were plenty of issues at this company. These included: “The magnitude of CEO pay exceeds the 75th percentile of the company’s peer group. The CEO’s total pay exceeds 4 times the average NEO pay” and “The
CEO received a very large base salary because the company does not utilize an annual cash bonus program this sets a cash compensation floor that is not subject to performance conditions”. Also “the redesigned equity program maintains a relatively short-term focus and the ROIC goal provides for target vesting for below-average relative performance.”
An issue touched on earlier in this piece is highlighted by both these examples; investors dislike compensation that isn’t properly tied to performance. For Intertek a guaranteed cash bonus and for Bed Bath & Beyond a modest ROIC goal set the hurdles too low. The quantum of CEO pay at Bed Bath & Beyond was clearly also a problem, failing both internal and external comparisons. Calvert also mentions the issue of overly short-term focus in compensation. “Companies anticipating close scrutiny that do not proactively discuss and disclose the relationship between pay and performance to their shareholders may find that this creates a void,” says Kroll. “This will be particularly important in years in which a company’s total shareholder return (TSR) is lagging.”
The push in recent years for companies to extend LTIP performance measures beyond the minimum of three years highlights frustration over this, and many other issues are coming to the fore. As Little points out, “So far this reporting season, we’ve seen low votes or negative voting recommendations from ISS/IVIS where there has been an unexplained or unjustified reduction in LTIP targets, a perceived misalignment of performance and pay outcomes, or where companies have given insufficient retrospective bonus target disclosure.”
What the experts think
As well as looking at what investor’s rationale says about compensation we’ve asked some industry experts why they think investors have started to vote more aggressively and ways that companies might avoid the embarrassment of a receiving a negative vote on pay.
Say on Pay Voting continues to be a hot topic with more investors willing to vote against. Why is this the case– are investors getting stricter or are issuers failing in their disclosure or simply paying their boards too much?
Willis Towers Watson UK
Alex Little, Senior Consultant
Negative voting seems to continue to centre on pay and performance and, in particular, ensuring performance targets are sufficiently stretching and pay outs are warranted.
Willis Towers Watson US
James Kroll, Director
For those companies experiencing challenging say-on-pay votes, we have observed that the largest institutional investors have refined their voting procedures to take a closer look at pay and, specifically, the alignment of pay and performance.
Simply put, while many investors have a robust process for determining how they will vote on say-on-pay resolutions, companies should not be complacent and must ensure that they provide adequate information to shareholders to inform their say-on-pay vote decisions.
Michelle Tan, Principal
As the world becomes more connected and transparent, investors are better informed than ever before and are more comfortable opposing say on pay votes where they have concerns, there is also a growing willingness to import and export what investors see as better practices from one market to another.
What should issuers do to avoid the embarrassment of a negative vote on pay?
Korn Ferry – HayGroup
Tony Wu, Principal and Reward Services Leader
A pay program that is optimally aligned to business performance is important, but you can’t ignore the shareholder landscape in a post Say-on-Pay era. Continuous shareholder outreach and appropriate responsiveness to shareholder feedback as well as testing of the pay program against proxy voting guidelines will all be important considerations to successfully avoid a negative shareholder voting outcome. Equally important may also be detailed explanations within the CD&A rationalizing the “why” on any potentially controversial pay practices.
Willis Towers Watson UK
Alex Little, Senior Consultant
Given economic realities, companies may be justified in reducing targets. Where this is the case, we recommend devoting more time and effort this year to ensuring a strong explanation based on forecast performance.
Incremental improvements look as if they will continue to win you brownie points. If making changes to arrangements, we recommend engaging early with key shareholders to understand their concerns and incorporate their feedback.
Willis Towers Watson US
James Kroll, Director
Two actions can help companies. First, communicate with shareholders well in advance of the proxy season about important pay actions and design elements to open a line of communication. Second, ensure the feedback received and key points discussed are easily found in the company’s Compensation Discussion and Analysis (CD&A).
Michelle Tan, Principal
Engaging directly with shareholders to understand their concerns and educate them on the company’s pay philosophy and program is the single most effective proactive action a company can undertake.