What’s Ahead for the 2010 Proxy Season
March 13 2010 by Russ Banham
Bill Hawkins is feeling pretty good about this year’s proxy season. As CEO and chairman of medical technology provider Medtronic, Inc., since August 2007, he’s experienced uneventful proxy statements the last two years and expects more of the same this year, despite the ongoing hue and cry over sky-high executive compensation. “If history is an indicator – and I don’t want to say this too loud and jinx myself – we’re having a pretty stable proxy season,” says Hawkins. “There are no shareholder proposals in the queue, and I don’t anticipate any. Of course, we’ve still got several months to go before our annual meeting in August.”
The qualifier makes complete sense, given the still-simmering public furor over executives raking in steep bonuses at financial firms blamed for the subprime mortgage fiasco and the recession and ongoing economic uncertainty it spawned. Many shareholders believe financial firms were footloose and fancy free, ignoring risk and thus creating a domino effect that continues to play out in lost jobs, tight credit and an economic recovery closer to an “L” shape than a “V.” Resentment over high salaries, bonuses and perquisites was so thick that some in the attack camps of academia, labor and shareholder groups were calling for the stringent TARP compensation rules to extend to all public companies. No more. What was a front burner issue has cooled off of late, thanks to more pressing concerns like unemployment. Even “Say on Pay,” the TARP provision requiring nonbinding shareholder votes on executive compensation that seemed a regulatory fait accompli just six months ago, has been shelved until next year.
So how is the 2010 proxy season shaping up? Well, change is in the air, with several new Securities and Exchange Commission rules to contend with. The SEC is requiring greater disclosure of executive compensation policies as they relate to corporate risk, and has approved a proposed rule by the New York Stock Exchange eliminating stockbroker discretionary voting in uncontested director elections, a response to sharp criticism by institutional shareholders and shareholder activist groups. The SEC also has crafted a new method for reporting the value of stock options and awards. Previously, companies were required to disclose in the Summary Compensation Table and Director Compensation Table of proxies all outstanding equity awards, based on the dollar value recognized during the year for financial statement reporting purposes. Companies must now disclose the value of only those stock options and stock awards granted during the year, based on the aggregate grant date fair value of the awards.
- Other likely stressors can be distilled into a single word – “disclosure.” They include:
- Greater disclosure of severance pay in corporate change-of-control situations, including tax gross-ups;
- Greater disclosure and transparency regarding the peer companies used to set compensation levels;
- Enhanced disclosure of CEO succession management plans and board director biographies;
- Disclosure of fees paid to compensation consultants for services beyond just compensation advice;
- Disclosure of the rationale for a single individual performing the roles of chairman and CEO.
Added up, the 2010 proxy season won’t be a picnic in the park, but it is not the Armageddon many feared. “Compared to the outrage of eight months ago, executive compensation just doesn’t rank as high in importance from a proxy standpoint right now,” says Aaron Boyd, director of research at executive compensation firm Equilar. “As the economy rebounds, people are less concerned about how much executives are paid. The scrutiny hasn’t ended; it just won’t be as severe.”
As the economy rebounds, people are less concerned about how much executives are paid. The scrutiny hasn’t ended; it just won’t be as severe.
Indeed, when CEOs like Lloyd Blankfein from high-flying Goldman Sachs take a haircut in their bonuses – in Blankfein’s case from a $68.5 million payout in 2007 to a comparatively paltry $9 million bonus for 2009 – one can argue that Wall Street is making amends to Main Street. Not that shareholder activists like The Corporate Library see it that way. “The reaction of many firms to the TARP regulations, and the public and media calls for some degree of moderation, has been [to ignore them],” chides Paul Hodgson, senior research associate at the independent compensation research firm. “It’s as if nothing happened, given the bonuses we’re seeing at firms like Wells Fargo, Fifth Third Bancorp and PNC Financial Services, which are through the roof. I’m a bit disheartened.”
He is not the only one dismayed. Consultants say the 2010 proxy season will be tempestuous, even if the seas are calmer than many predicted last year. “The economy was teetering on the brink and still has not recovered, which is swinging the pendulum toward greater transparency and shareholder rights,” says Paul Winum, senior partner and global practices leader at RHR International. “There remain a lot of angry citizens writing their Congressional leaders and demanding more of a say, and a new administration trying to respond to the cacophony of voices. The 2010 proxy season is occurring at the crescendo of these forces. Shareholders will be banging their collective fists about compensation and its relationship to corporate performance and risk.”
Proxy Governance, a provider of proxy voting and corporate governance services, has a slightly different perspective. “I think ‘uncertainty’ will be the tenor of the season,” says Allie Monaco, the firm’s vice president of research and managing director of policy. “There are a number of rule changes related to disclosure and broker discretionary voting that create uncertainty from both the issuer standpoint and the shareholder standpoint. There also remains a lot of concern about ‘pay for performance,’ especially large bonuses and severance payouts that don’t seem justified in cases of relatively poor or indifferent company performance. That said, I do think companies are paying a lot more attention.”
One of the surprises of the 2010 proxy season is that “Say on Pay” proposals are not proxy bound, as anticipated. This hasn’t stopped a parade of large companies like Pfizer and Microsoft from voluntarily implementing the advisory votes by shareholders on their executives’ compensation. Companies like Medtronic, on the other hand, see no reason to jump the gun. “Our board has discussed it and there is some belief this will be legislated or regulated, but for now we have no immediate plans to get in front of it,” Hawkins explains. “Executive compensation here is established by our independent compensation committee, and I stress the word ‘independent.’”
Winum, however, believes it is in boards’ best interests to be proactive rather than reactive on the matter. “Smart companies, boards and shareholders reading the tea leaves need to get ahead of the bow wave,” he advises. “There is definitely a movement afoot, and to maintain the confidence of shareholders it is prudent to be proactive about how you plan to manage compensation and risk.”
Prudence in many cases is being dictated rather than advised. The new SEC rules requiring additional disclosures on compensation practices related to risk are a case in point. The onus on companies is substantial. “There is supposed to be a big, long description of how the compensation structure and policies may create incentives that increase risk,” explains Deborah Nielsen, director of compensation at Salary.com. “The goal is to shed light on policies that might create an incentive for employees to take risks beyond what is considered prudent.”
If the CEO isn’t serving as the chair – no problem, but if he or she serves in both positions the board has to disclose chapter and verse why they picked that structure.
The new rule extends beyond the compensation provided senior executives to all employees. In part, it is a reaction to the subprime mortgage debacle, when traders at firms like American International Group were compensated based on the volume of deals structured and sold, despite the potential risk they created. Compensation consultants don’t expect much reporting this year relating to the new rule. “You only have to report it if the pay is likely to cause risk-taking behavior,” says Robin Ferracone, executive chair at Farient Advisors, and author of the book Fair Pay, Fair Play. “Boards and compensation committees will be addressing the issue, but are likely to be conservative.”
Boyd from Equilar agrees. “No one wants to overexpose themselves,” he says. “People are being cautious, waiting for the SEC to provide more guidance on what needs to be disclosed, given this is all new.”
Hodgson shares the view: “Companies will say they looked at it and there is no problem, or they won’t say anything at all.”
More taxing from a reporting standpoint is the new SEC rule requiring disclosure of stock and equity awards granted during the year. Consultants and proxy firms like the change, expecting it to breed easier comparisons of actual pay for performance one year to the next. “It’s a big change and a positive one,” says Nielsen.
“It will provide a much better indication of what a CEO actually received for that year’s performance,” agrees Peter Chingos, senior founding partner at Compensation Advisory Partners.
Overall, “Pay for Performance” is beginning to prove itself, as boards become more rigorous about the relationship. “We’re seeing companies taking an aggressive stance on equity and long-term compensation practices, reducing them by 10 percent to 30 percent, in some cases,” Chingos says. “There has also been a tightening of the belt on salary progression. Nevertheless, since 2009 was a good year for many companies, we expect that compensation should reflect performance.”
The rule requiring disclosure of fees in excess of $120,000 that are paid to compensation consultants for services unrelated to compensation gets wide plaudits, since it should cut down on conflict of interest risks. It also should spur competition among consultancies – the new rule has effectively given life to specialty firms like Chingos’s Compensation Advisory Partners that do only compensation consulting. (Chingos formerly was the head of the compensation practice at broad shouldered consultancy Mercer.)
The elimination of broker discretionary voting in director elections poses more turbulence. “It may have a swing-vote impact, pushing someone from the positive to the negative column,” says Pat McGurn, special counsel to the ISS governance services unit of Risk Metrics Group. “‘No’ votes against director elections have generally been rising over the last couple years, and I would expect the broker voting change to hike the number up a notch.”
Boards also will be expected to show more backbone when it comes to disclosing executive severance packages and practices, and the peer companies used to compare and set executive pay. “Severance is a front and- center topic,” says Chingos. “In a change-of-control situation, Congress has adopted and the IRS has ruled that a CEO can get 2.99 times his or her average compensation. In non change-of-control situations we’re seeing those numbers come down to closer to two times salary and bonus.”
Under particular attack in change of-control situations are tax gross ups – cash compensation provided to cover personal taxes on various corporate perquisites like travel. “We’re clearly seeing a retreat by many boards and compensation committees from inking gross-ups,” says McGurn.
In concurrence is Peter Oppermann, a Mercer partner, who predicts that the term “gross-up” will soon disappear from proxy statements in reference to new or renewed executive contracts. “We’ll still see severances two to three times salary and bonus, but without the gross-ups,” he says. “Perquisites other than company funds to offset housing relocation also are quickly fading.”
Not that many CEOs should miss the perks. Says Chingos, “CEOs making $5 million a year can afford their own health club fees.”
Peer to Peer
Greater transparency of the peer companies used to benchmark compensation also shouldn’t be a stretch for companies to undertake. “You simply make a list of appropriate choices, name the companies, their revenues and market cap, and discern the median compensation,” Oppermann says. “Now just lay it out in the proxy – it’s pretty straightforward.”
John Donleavy, president and CEO of Vermont Electric Power (VELCO), demurs. “It’s easier said than done,” Donleavy explains. “We’re a unique company, in that we handle only transmission [for 20 Vermont utilities]. Finding a peer group that fits our revenues and other benchmarks is a challenge.” VELCO’s board previously relied on a large compensation consultancy to do the peer-to-peer comparisons, but found the results unacceptable. This year, the board has retained a firm specializing in peer panels to undertake the task. “We’re hoping for comparisons that are truly relevant,” Donleavy says.
Disclosing CEO succession plans and director biographies also aren’t perceived as overly difficult tasks. When it comes to why the CEO is also the chairman, the devil is in the details. “If the CEO isn’t serving as the chair – no problem, but if he or she serves in both positions the board has to disclose chapter and verse why they picked that structure,”McGurn says. He notes that there has been a substantial increase in shareholder petitions on the topic last year, with many companies splitting the duties and switching to independent chairs.
According to The Corporate Library, approximately 37 percent of companies in the Standard & Poor’s 500-stock index had separate chairmen and CEOs last year, up from 22 percent in 2002. Among them are Boeing, Dell, the Walt Disney Company, MCI, Oracle and Tenet Healthcare. “We’re definitely seeing a steady erosion of support for combining the positions,” McGurn adds.
Going against the grain is General Motors Co., with Chairman Ed Whitacre recently announcing that he has become the embattled automaker’s CEO. Which just goes to show you that one company’s best practice is another company’s idea of a dumb move. Or, as we’ve seen time and again as proxy seasons come and go, the pendulum is always swinging.
Russ Banham is a veteran journalist and author. His The Fight for Fairfax.