Say on pay (SOP) has become an established practice in Canada, with many companies voluntarily allowing shareholders to vote on their executive compensation packages.
Over the past few years, 80 per cent of TSX 60 companies have adopted this policy and 120 held the vote in 2013, with support averaging about 90 per cent, according to Mercer.
But are they really a reflection of C-suite compensation or are they more about corporate performance? And what kind of impact are these non-binding votes having on executive compensation?
The factors that lead to a negative vote tend to tie, in some respects, more to the shareholders’ perception of company performance as opposed to the relation of the comp to company performance, says John Tuzyk, a partner at Blakes in Toronto.
“So compensation, which is perfectly fine if things are going relatively smoothly, (is) not fine when commodity prices drop.”
In Canada, there’s no question say on pay votes improved between 2012 and 2013 when TSX performance also improved, says Michael Thompson, a partner in Mercer’s talent practice in Toronto.
“The number of companies that have say on pay votes is increasing and companies who have say on pay votes don’t want a failed vote, so if it’s voluntary and you’re going to bring it to market, presumably you’re going to bring something pretty positive to market — so it may be kind of a self-fulfilling outcome.”
In looking at the United States, the higher the level of total shareholder return in the company, the higher the say on pay vote.
“There’s no question it is a report card on both the design of the compensation programs and shareholders’ satisfaction with performance,” he says.
“If you have say on pay vote in a year when you have bad financial results, your chances of being successful are probably slim unless you have a pay design that really demonstrates a material impact on the executive, to the negative.”
The first year Cameco ever held a say on pay vote, it had overwhelming support of more than 90 per cent, says Paul Gryglewicz, managing partner at Global Governance Advisors in Toronto. The following year, there was the Fukushima earthquake and while the compensation elements didn’t change, the vote changed.
“There’s definitely a direct link between company performance and shareholder voting behaviour,” he says. “The end result is either the corporation that gets a ‘no’ vote, they either, at a minimum, they pick up the phone and they talk to those institutional shareholders more than they have, and that is a desired outcome of both parties.”
Compensation design, levels
Considering the scrutiny, companies are being more transparent and deliberate in executive compensation design. But could they be too restricted by the votes?
Companies are trying to decipher the voting intention of the proxy advisory firms’ recommendations and, therefore, intending to adopt cookie-cutter compensation plans to earn a positive vote from groups such as Institutional Shareholder Services (ISS), says Tuzyk.
“Tailoring plans to a company’s circumstances runs the risk of a negative ISS recommendation, which can lead to a significant although not majority withheld vote,” he says. “To some degree, (companies are) reaching out to shareholders but I’d say the more predominant influence is what the proxy advisory firms recommend… to those shareholders.”
When companies change compensation programs specifically to meet say on pay tests, that’s a bit problematic as they need to design programs that make sense for them, says Thompson. For example, ISIS may look to the U.S. for comparator groups because there are too few in Canada.
“By definition, it means you’re always behind the eight ball… even though you’ve followed good governance process, even though you’ve been rigorous and balanced in the way you’ve identified your compactor group — it may not meet the test that ISS is following to assess you.”
And while say on pay may not be meant to dictate pay levels, that still can happen, says Gryglewicz. In looking at the methodologies and math behind the recommendations of advisory groups, evaluations of peers can be problematic.
“They are influencing how much you do end up paying because they don’t want you to pay too many percentage points outside of what they would classify as your peer group, whether it’s your peer group or not,” he says. “They look at it under one lens and they say, ‘If you’re paying too high, then we’re going to mark you negative in that category.’ So they are, in a way, trying to control pay levels.”
But say on pay votes don’t seem to be having much of an effect on executive pay levels, says Tuzyk.
“They’ve got to be really, really, really out of market and then, even then, tied to bad corporate performance. But for 95 per cent of companies, I don’t think it’s having any effect on levels.”
Pay levels have actually risen because of the exposure with say on pay, says Thompson. A “perfect market of information” has been created, making it difficult for a board to negotiate with a CEO who knows about the compensation of others in the industry.
“If we really wanted to be more tough-minded and to create a sort of an outcome that resulted in decline of executive compensation…. you’d change disclosure because the absolute disclosure of individual compensation elements has had no other effect other than to increase compensation.”
Overall, say on pay is a very interesting approach to governance, he says. While shareholders have always had the ability to vote out directors or sell their shares if they don’t like a company’s program, process or performance, now they have this additional process around compensation, says Thompson.
“You kind of wonder where it fits relative to other things that they might also have a point of view about — they’re not asking for a say on business strategy vote or financing strategy vote, they’re asking for a say on compensation and I think that’s a reflection of how significant the public optics are of inappropriate compensation. And, for most companies, that’s just not the case. For the vast majority of companies, boards have good governance around these processes, the design of programs is completely transparent.”
Impact on directors
The votes are having a significant effect on boards, according to Thompson.
“The say on pay vote is highly public — a failed say on pay vote is rare so the exposure’s significant but, more than anything else, they just see it as an expected part of a good governance process,” he says.
“Corporate directors now are thinking about the proxy circular not just as a compliance document but as a communications document and so they’re investing in drafting these documents in a way which makes the messages very clear and specifically addresses issues and concerns that shareholders may have about compensation programs so that the plans are as transparent as they can be and as understood as they possibly can be.”
Say on pay is also having a significant effect on directors with the introduction of individual director voting.
“The director who assumes the role of chair of the compensation committee tends to get the lowest support of shareholders as a
director, so it’s a bit of a cursed role right now… it really shouldn’t be, it just needs a good strong person with the right knowledge to oversee the committee — it’s a necessary evil,” says Gryglewicz.
As a result, companies will probably be adjusting pay levels for chairs of compensation committees to reflect their growing responsibility.
“There’s a pattern emerging for those directors that happen to sit on a committee that must be staffed properly with the right levels of skill, and that skill is going to be HR, legal, finance, industry, in that compensation committee... given this extra layer of individual voting risk,” he says.
With majority voting policies, it’s more dangerous to be a director on a compensation committee than an audit committee, according to Tuzyk.
“That’s going to start to effect, and has begun to effect, how compensation committee members do their executive compensation process and make their executive compensation decision because they don’t want to get a large withheld vote, frankly.”
But independent directors on compensation committees are far better-educated and more capable in dealing with executive compensation these days, says Thompson.
“There’s been a steep learning curve and they’re all well-qualified to deal with issues now.”
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