Q&A with Susan Choe, Senior Director, and Bill Ultan, Managing Director, of Morrow Sodali’s Corporate Governance Consulting Group
1) Since 2011 and the introduction of Say on Pay, how have compensation trends evolved?
SC: Early on there was a perception (and, in some cases, a reality) that the compensation committee and the board were merely rubberstamping the executive pay program and it was much more a “check the box” approach. The focus was more on pay practices, such as excise tax gross-ups or single / modified single trigger vesting upon a change of control. Shareholders opposed these types of provisions, and companies have largely eliminated these so-called “shareholder unfriendly practices.” Today compensation trends are reflected in three key questions:
- Is there a true pay-for-performance culture or is it merely a mantra?
- How does a company’s executive compensation program support its short, medium and long-term strategies? And
- How effectively is the company’s pay program pivoting along with changes in strategy?
BU: There also was an incredible amount of angst because of the lack of familiarity with how investors and proxy advisory firms would assess this issue. We are in a far more stable place now; however, there are a number of variables that continue to shift. My concern is that in an effort to secure shareholder approval, executive compensation plans are becoming too homogenous. Compensation committees still must ensure that they are structuring pay programs in a way they think is most effective, even if not checking every box with proxy advisory firms or institutions. They also must clearly explain the efficacy of the programs and articulate their decision-making.
2) What trends do you see around compensation from both a strategic and disclosure perspective?
SC: Shareholder engagement and proxy statements have become the strategic tools through which companies are telling their stories. On the engagement side, in situations where a company has had a low Say on Pay vote, an increasing number of compensation committee chairs are engaging and effectively articulating their compensation decisions as well as their approaches to rewarding the executives responsible for driving the success of the business. Many companies have implemented a year-round shareholder outreach program through which governance and investor relations teams, in conjunction with legal, human resources, and sustainability colleagues and others, are collaborating to communicate a much more substantive story to their shareholders.
Disclosure practices have improved dramatically since the early days of Say on Pay. We are seeing companies recognize that the proxy statement is the single most important investor communications tool. They are utilizing it to communicate important events and decisions that transpired over the course of the year. In particular, the proxy statement can explain how the compensation program supports long-term strategy. Companies are also utilizing charts, graphs and tables to add a visual component to their presentations so that the story melds together well.
BU: I agree. It is all about communication. The importance of the Say on Pay proposal goes beyond just the compensation paid to executives; this is a proposal that directly reflects on the board and provides the outside world with insight into the board’s connection to the strategy and ability to oversee the execution of that strategy. Say on Pay disclosure and communication have tentacles that touch on other important aspects of corporate leadership.
3) On a more granular level, can you speak to some of the mistakes companies make with regard to their approach to compensation?
SC: Often times the mishandling of Say on Pay stems from an inability of the compensation committee to effectively communicate, leading to disclosure that comes across as if there is some hesitancy or discomfort with the program. It is important that the committee take ownership of the narrative and own it. Investors want to understand the thinking behind how pay was structured for the most recent fiscal year and how it aligns with long-term goals that best serve the investor base.
BU: Another common mistake is that compensation committees make decisions before thinking through their ramifications. This is particularly true of smaller and mid-size companies that do not regularly interact with shareholders on governance issues and do not face regular challenges on proxy matters. Decisions are made in a bubble. When directors discover that those decisions raise concerns with key shareholders, it is too late to reverse them. Because Say on Pay is a vote on decisions the compensation committee made a year or longer ago, it is critical to think through those decisions and how they will be perceived by investors.
4) Regarding the role of directors, what are shareholder expectations on the board with respect to engagement on compensation matters and how has this evolved?
SC: Being able to communicate the right message to top shareholders has become increasingly important for directors. What we have seen in the last few years, especially by large index funds, is a greater demand for the compensation committee chair, perhaps along with a lead director, to participate in discussions. Investors expect that compensation committee chairs fully understand and can articulate the thought process behind the pay program and incentive structure to compensate the executives who are driving and executing strategy.
BU: This is an issue of preparedness. For every public company a director, whether it is an independent chair, lead director, or chair of the compensation committee, should be ready and up to the task to speak to shareholders when necessary. We are aware of too many situations where, unfortunately, companies did not feel comfortable putting a director in front of shareholders. This is no longer an acceptable circumstance for any public company and suggests that greater challenges may lie ahead.