News of companies that failed their say-on-pay vote is in the headlines almost daily this time of year. What don’t make the headlines are stories of the companies that barely passed (in the 50% to 70% range) or that passed but plummeted from their 2011 approval levels. Many in the former category last year failed this year. Many in the latter category this year may fail next year.While additional data will continue to trickle in over the summer, my firm has completed research on the first 54 failed say-on-pay votes in 2012, finding:
- Only four of the companies that failed this year’s SOP vote also failed last year. The other 50 companies that failed this year had an average approval rate of 78% last year with approval levels ranging from from 50% to 99%.
- 13 companies that passed the 2011 SOP vote with percent approvals in the 90’s – probably feeling like the issue was over – failed in 2012, averaging a 38% approval – no different from the average of other failing 2012 companies that had 2011 approval levels of 50% to 89%.
- Votes on replenishment of shares in equity incentive programs among the failing SOP firms ranged from 100% down to the one company that failed the additional shares request (37%) as well as SOP (33%).
- Increasingly, the Compensation Committee members are failing to attract a strong majority “for” vote – if SOP and equity votes don’t get their attention, a personalized message typically does. Many that were re-elected did so with an approval level in the 60s and 70s. We have seen how that can trend.
- In one company that has a triennial, rather than annual, SOP vote the shareholders who couldn’t vote against executive pay instead voted against all three Compensation Committee members, who failed to get majority support.
- The moral to the story: Don’t be complacent about an SOP success – even at 99% – in any given year. Several companies whose programs received ISS’s blessing last year saw that opinion reversed on the identical pay program this year, because ISS changed the rules which they may do again next year.
Do You See Your Company’s Equity Program Features on This List of 33?
There has emerged a consistent set of issues that have led Institutional Shareholder Services, Glass Lewis, and others to recommend an “against” vote and these are central to the steep decline in approval experienced by the companies failing. Most of these apply to executive awards, but some apply to broader programs. Here they are, in no particular order:
- Grants of stock options (not performance-based pay!)
- Grants of time-vested RSUs
- Large “retention” awards (2 or 3 times normal annual grant size)
- Time-vested stock options granted with a strike price at current fair market value
- Performance-vested awards without sufficient “rigor” of the goals
- Lack of disclosure needed to assess the rigor of goals
- Performance awards that payout at the maximum level several years in a row, indicating a potential lack of rigor
- Granted pay (per the Summary Compensation Table, the majority of which is equity) that is not aligned with total shareholder return in previous years…even though “realized pay” is aligned
- Performance measures for equity awards that are qualitative (e.g., synergy, leadership)
- Performance measures for equity awards that are quantitative but use nonfinancial measures (e.g., safety, quality) which are not externally auditable and verifiable
- Using the same performance metrics for both the annual and the long-term incentive plans
- Using non-GAAP performance measures (e.g., adjusted EBITDA) that are not clearly reconciled to GAAP numbers
- Overlapping goals in performance awards
- Unreasonably low performance thresholds and targets for performance awards that assure payout
- Payout opportunities for performance below the peer group median performance (e.g., performance at the 25th percentile that pays 50% of target)
- Use of subjectivity or discretion in determining award payouts, as an element of the plan design
- Modifying performance goals mid-cycle when the goals will certainly be missed
- After-the-fact discretionary override of missed goals to provide a performance award payout due to external circumstances
- Use of “either-or” performance measures that appear to ensure a payout
- Short-term (e.g., annual) performance periods within a multi-year plan
- Carryforward and/or carryback features in a performance plan
- Payment of dividends/dividend equivalents on unearned or unvested awards
- Inclusion of equity awards in pension or SERP calculations
- Tax gross-ups
- Lack of stock ownership guidelines or retention requirements on equity awards
- Large grants of RSUs in the same year that stock ownership guidelines are implemented, assuring that upon time-based vesting the aftertax shares will be sufficient to meet the guideline
- Lack of a clawback policy (even though the SEC hasn’t met their deadline for issuing clawback rules)
- Inadvertent timing of grants and the recognition of an accounting grant date, creating the appearance of a large “pay increase” year-over-year
- Single trigger, or modified single trigger, change in control provisions for equity grants
- No disclosure of holding periods for shares from exercised options and RSU/performance RSU awards
- Excessive “concentration” of equity grants in the year among the NEOs (NEO combined grant value as a percent of total grant value to all employees)
- Inadequate disclosure regarding the equity compensation program when requesting additional shares – which led to a judge prohibiting the vote at one company that reconvened the meeting later and received only 59% support
- And finally, ignoring last year’s criticisms of the equity compensation program because the SOP approval rate was satisfactorily high
Of course, some of your company’s equity program features are on this list. This is the problem. It is impossible to design an equity compensation program to meet all investors’ and proxy advisers’ policies and standards, include design features that make sense from strategic, financial, behavioral, and governance points of view and reflect sound business judgment by the Compensation Committee but nevertheless may be the trigger for a “no” recommendation on SOP, the equity plan, and/or the Committee members.
And the best plan design in the world may not be enough if your total shareholder return is negative or below that of your peers, and your investors are grumpy about that.
There are many other executive compensation issues that are not specific to equity compensation but are potential triggers of a negative recommendation from proxy advisers and institutional shareholders. This brief list above is limited to those that directly affect equity compensation practices.
I’ll be discussing these issues in depth in the next “Ask Fred” EASi webinar on 19-July:
Say-on-Pay 2012: The Effects on Equity Plan Design
With much of the 2012 shareholder meeting season having passed, we have the opportunity to review how the second year of say-on-pay in the US is influencing equity compensation program design. While often discussed as an executive compensation issue, one of the central themes in shareholder voting influences continues to be equity compensation. In fact, the approval rates for new equity plans and additions of shares to existing plans are declining compared with previous years. In some companies, voting outcomes are revealing more dissatisfaction with the equity plan than with executive pay. This session will review what companies experienced in 2011, how that changed in 2012, and what will continue to evolve as companies are already preparing for the 2013 season.
Register here for this session