More Boards are Consulting Shareholders about Executive Compensation

More boards are reaching out to shareholders about executive compensation, according to a new report by PwC. Experts say shareholder engagement is increasingly important and that boards need to have a plan for approaching major shareholders and shareholder advocates.

The report found that 77% of directors said it is at least “somewhat appropriate” to engage with shareholders on the topic of executive compensation. That’s up from 65% in 2013 and 73% in 2014.

The Dodd-Frank Act, signed into law in the wake of the financial crisis in 2010, focused on financial system reform and included a number of corporate governance provisions. One of these was mandating shareholder advisory votes on pay practice. The “say on pay” part of the act also called for strengthening independent requirements for compensation committee members, tightening the rules regarding use of consultants by the compensation committee, and mandating disclosure of the ratio between CEO pay and median employee pay.

While the say on pay stipulation was intended to reduce income equality, the PwC report notes that, on average, shareholder support for ‘say on pay’ had been strong. Alex Edmans, professor of finance at London Business School, told the Harvard Business Review that legislative actions that attempt to reduce such pay ratios may even increase inequality. Edmans says a CEO might reduce his company’s pay ratio by firing low-paid workers, converting them to part-time status, or by increasing their cash salary but reducing their non-financial compensation. He says this could also lead boards to focus on the optics of pay and ignore more important things such as long-term performance.

“Leave the decisions to major shareholders, who have the expertise and incentives to get these decisions right. After all, high CEO pay comes straight out of shareholder returns, and if the contract causes the CEO to make bad decisions…shareholders suffer the consequences,” said Edmans.

“Leave the decisions to major shareholders, who have the expertise and incentives to get these decisions right.”

PwC says design practices in effective Compensation Discussion and Analysis (CD&A) include an executive summary highlighting the board’s philosophy on executive pay. They also include visual elements like tables, charts, and graphs, along with a disclosure of “what we do” and “what we don’t do” to address pay practices.

Direct communication between boards of directors and investors is a relatively new phenomenon, according toPwC. In most situations, the compensation committee chair is the point person to engage in conversations with investors. Directors should prepare to meet with investors by agreeing on an agenda, reviewing what information is to be discussed, defining directors’ roles in the engagement, and preparing directors to demonstrate knowledge, and promotion of the compensation package. Directors also need to also be careful not to communicate non-public information to those shareholders.

A 2015 article in The New York Times also noted that say on pay has had little impact on compensation. Since that article was published, CEO pay has risen 12% annually. The Times noted that few shareholders are expressing unhappiness with rising compensation levels.

According to Shareholder Forum, the median shareholder support for pay practices at the 500 largest companies was 95% of the shares votes. This could be attributed to the rising stock market as shareholder dissent typically occurs at companies that have awarded generous compensation while performance has lagged.

However, some sectors and companies have seen rising shareholder opposition to pay plans, especially when compensation is high relative to performance or shareholder value. In May, a record 33% of Goldman Sachs Group shareholders voted against a provision making Lloyd Blankfein the highest-paid CEO of a Wall Street Bank. There have also been similar rebukes of CEO compensation packages by shareholders at Citigroup, Caterpillar, BP and Oracle.

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