Editor: What trends is NACD seeing in executive compensation this proxy season?
Bew: The say-on-pay vote results to date have been positive. Around 73 percent of Russell 3000 companies received greater than a 90 percent approval rating so far, which is slightly higher than what we saw for the full 2013 proxy season. The 2013 results were in turn just a couple of percentage points better than 2012.
From our membership, we’re hearing that compensation committees are continuing to look for ways to enhance their communications with investors. In the CD&A, they’re using executive summaries and graphs and tables to make information more understandable. Many companies are also including in the CD&A a summary of the shareholder feedback that they received in the prior year and how they acted on it. One compensation committee member I spoke with recently reported that over the last few years the company has been holding shareholder forums just prior to the annual meeting that specifically focus on issues related to compensation.
So, putting those two trends together, what we’re taking away is that the efforts by many companies and boards to enhance their communications with shareholders are reflected in positive say-on-pay vote trends.
Editor: What information should a company provide when executive compensation is being considered by the board or a committee of the board?
Bew: Compensation committee chairs are looking for ways to keep their colleagues on the full board educated and informed on an ongoing basis, given the complexity of pay plans and the fact that the full board is not as deeply involved in those issues on a regular basis as the comp committee is. Over the last few years, executive pay plans have been getting much more technical. There are multiple varieties of short-, medium- and long-term pay vehicles. Each of those is tied to different metrics and targets, and everything is playing out over multiple pay periods. And of course, executive pay is very much in the spotlight, especially around proxy season time.
NACD believes that every director, not just the members of the compensation committee, needs to be able to understand the company’s pay program and explain why it supports the creation of long-term value for investors. Some committees do an annual deep dive with the full board during which they take a lot of time to go through the details of the company’s pay philosophy and plan design. They then follow that up with a score-card-type update on executive pay and performance at each board meeting, so that everyone on the board is aware over the year how the executives are performing against their targets. Some committees schedule their meetings at a time when all independent directors can attend, which is another way to help the rest of the board stay informed.
Editor: Why should a company develop effective shareholder outreach when it is at odds with a recommendation of the ISS proxy advisory service?
Bew: Effective shareholder outreach should be a goal for companies regardless of what proxy advisors are saying. ISS and Glass Lewis don’t vote proxies, investors do. NACD believes that outreach is most effective when it is proactive and really part of an overall program of communication with investors. All companies need to know who their shareholders are and should have an ongoing dialogue with those shareholders as a matter of course; it’s just good governance practice.
In addition, investors are increasingly expecting that type of ongoing engagement, including from members of the board where that’s appropriate. CEO compensation would definitely fall in that category. If a company or a board waits until a problem arises to start building those relationships, it’s going to be much more difficult.
NACD did a series of forums recently with major institutional investors collectively representing over thirteen trillion dollars in assets under management. They told us that they see an important distinction between solicitation and ongoing engagement.
In their view, solicitation meetings are the events that are happening during proxy season when the company is looking for support on a vote or to explain the company’s rationale behind a decision that might be at odds with the recommendations of a proxy advisory firm.
Those meetings are definitely necessary, but they’re not sufficient for relationship building. Investors tell us that it’s important that companies are engaged with them outside of the proxy season. This engagement can be in the form of in-person meetings, and other channels can be used as well, such as online information, required disclosures, road shows, investor days, and so on.
Editor: How do companies link business strategy to executive talent management and pay-for-performance alignment?
Bew: Talent management, performance metrics and pay-for-performance outcomes are integral parts of a board’s responsibility. Because strategy is the starting point, the details will look different company by company – there is no one-size-fits-all answer.
What we’ve heard from investors in NACD’s recent conversations with them is that they’re looking for the context behind the board’s decisions in all of these areas. For example, with pay-for-performance, investors are looking to understand how the board and the compensation committee connected the dots among strategy, the pay philosophy, the pay-plan design, the selection of peer groups and the decisions that the board and compensation committee made. They’d like to understand that all those components are connected and linked.
Editor: After four years of annual say-on-pay votes, what would you say the impact has been of the say-on-pay provision of Dodd-Frank?
Bew: First, CD&A statements have been getting more and more comprehensive as communication tools because they have taken on a greater significance with the annual say-on-pay vote. We’re seeing more and more compensation committees going beyond the standard required information. The annual say-on-pay vote process has prompted companies to try to tell their story as comprehensively as they can.
Another impact of say-on-pay is that it’s driven a higher quality of dialogue between companies and shareholders than in previous years. The interesting thing is that this dialogue is happening not just on pay-related topics but on a whole host of other governance issues – like CEO succession or board policies and practices.
So it seems as though say-on-pay has opened the door for both more and better engagement between companies and investors, which NACD sees as a very positive outcome.
Editor: Are you surprised that more compensation committees are not including alternative pay definitions, such as “realized or realizable pay,” in their CD&A statements?
Bew: Realized and realizable pay descriptions are definitely an emerging trend, again as a result of increased interest in the link between pay and performance, especially CEO pay and company performance. The challenge with this is that there are no set definitions. The Dodd-Frank legislation required that the SEC write a rule on pay-for-performance disclosures, but the legislation didn’t define either “performance” or “pay.”
As a result, it’s not too surprising that many companies and boards are saying, “Let’s wait until the SEC gets further along with its rule making.” This is one of the Dodd-Frank provisions where the rule is pending but has not yet been proposed.
At NACD, we support the principle of supplemental definitions because we think that boards and companies should be encouraged to provide as much transparency as possible to investors, particularly on a critical issue like how pay ties with performance. In order to make it easier for investors to compare this information across companies, we’re hoping that disclosures will eventually evolve to a place where companies can adopt some sort of a standard baseline definition of pay and performance, provided companies are free to go beyond the baseline and include additional information if they choose to do so. NACD developed a proposal for realized and realizable pay definitions, which was partly informed by multi-stakeholder conversations with Fortune 500 compensation committee chairs and large institutional investors. We published the definitions in late 2013 as a resource for companies and boards who are considering including this information in their CD&A, and we shared the definitions with the SEC as well.
Editor: What expectations do boards and compensation committees have of both corporate and outside counsel with respect to compensation disclosures?
Bew: These days, shareholder engagement is a team sport. It involves the CEO, investor relations, outside counsel, corporate counsel, corporate secretary and the board (typically the lead director or non-executive chairman and key committee chairs). All of these individuals and groups need to understand who the company’s key shareholders are and what their priorities are, how the company is communicating with them, who is doing the communication, and what channels are being used.
Compensation committees want the CD&A to be reader-friendly and transparent, but they are also very mindful of liability concerns. In recent proxy seasons, there have been a number of lawsuits alleging inadequate proxy disclosures specifically related to CD&As – and counsel can be of help in avoiding pitfalls that might result in litigation. At a recent meeting with Fortune 500 compensation committee chairs, what we heard was that even if your say-on-pay vote results have been excellent and you have strong relationships with your investors, it doesn’t hurt to do a review to see what kinds of enhancements you might be able to make instead of simply using last year’s CD&A as a template. That too is where counsel can be very critical to the process. NACD recently did a short piece on considerations for CD&A design, format and content based on conversations we have had with institutional investors, which is available on our website and might be useful to legal teams and others as a resource if companies are thinking about doing this type of review.
Editor: Regarding pay-plan design, what current practices are you seeing across the NACD membership?
Bew: As we discussed earlier, there is no one-size-fits-all compensation design since companies are going to start with their strategy and work from there. That said, we are seeing a couple of trends across the NACD membership. One is that compensation committees are placing greater emphasis on using a mix of financial and non-financial performance metrics. The non-financial metrics vary by company, but include things like customer satisfaction, employee engagement, and health and safety measures. A second emerging trend is that some compensation committees are looking at how long-term incentives, particularly performance-based equity incentives, can be used to reward high-potential future leaders in a differentiated way. It goes back to the question of the link between strategy, talent management and pay for performance. Boards are looking for ways to strengthen their company’s internal leadership pipeline and retain the next generation of leaders.