IR magazine reports from a proxy season that has seen issuers stand firm against negative recommendations from ISS and Glass Lewis
As the first proper say-on-pay proxy season draws to a close, the vote is in on one thing: proxies will never be the same. High-profile disputes between issuers and influential vote advisers ISS and Glass Lewis have broken out at a handful of companies including Disney, General Electric, Textron, Northern Trust and Tyco International.
While the specifics in each case differ, Disney for one addressed ISS’ concerns about excise tax gross-ups in its golden parachute plan, ultimately gaining a positive ISS recommendation and shareholder vote.
In other cases, issuers reached out to shareholders in the initial or supplemental proxy filings to directly make their case, confronting ISS or Glass Lewis critiques head-on, suggesting some companies no longer feel they need to tread lightly.
General Electric’s proxy takes the leading advisory firm on by name, with an aggressive tone, stating that ‘ISS’ analysis fails to consider actions that aligned pay with performance during the recession’ and ‘ISS’ valuation of Immelt’s option grant significantly overstates his total compensation’.
Textron filed a supplemental proxy in the form of a letter from its vice president of IR, Doug Wilburne, who told shareholders: ‘You should dismiss the Glass Lewis recommendation, as its model does not appropriately reflect the substantial accomplishments being made by Textron and its new management team, and its analysis contains several quantitative flaws.’
The supplemental filings then provide detailed, point-by-point refutations of the questioned analyses. At the same time, issuers across the board have enhanced their compensation discussion and analysis (CD&A) to be more informative, including executive summaries, more numerous and more sophisticated charts and graphs, and brief recaps of financial results. The changes have not gone unnoticed.
‘Companies have begun to realize that readers of the proxy are not the same as readers of the 10K,’ observes Donna Anderson, vice president and corporate governance analyst at T Rowe Price Associates. ‘In the past, companies dived into compensation with little context. Now they’re starting out with a brief recap of the year, then saying: And here are the decisions we made about compensation.’
T Rowe Price votes about 4,000 US proxies a year, Anderson says, so adding say-on-pay and voting frequency questions added 8,000 additional votes it had to handle. She notes a definite improvement in the quality of CD&As with greater use of financial reviews and executive summaries, as well as more charts and tables, helping investors quickly grasp performance and compensation comparisons, although she has not seen the longed-for slimmed-down narrative.
Customizing policy
T Rowe Price has traditionally taken an independent view on proxy questions, Anderson says, and sets its own proxy vote guidelines, even though the firm is a client of both ISS and Glass Lewis. That independent approach is no surprise to Patrick McGurn, executive director at ISS, who describes greater customization of voting policies as ‘the growth part of our industry’, particularly regarding management compensation and board elections.
McGurn points out that public pension funds, socially responsible investing funds, and Taft-Hartley funds (union pensions) can each have specific and varying guidelines that differ from ISS’ benchmark guidelines. Though not typical, as a result ISS will sometimes mark a particular issuer’s proxy ballot differently from other clients’, he acknowledges.
McGurn disputes critics’ characterization of ISS as imposing an inflexible, ‘cookie cutter approach’, saying that the bulk of proxies voted by ISS over the past five years have had some customized client-directed guidelines. He points to Tyco and Disney as examples of companies that engaged positively with the issues.
Through its supplemental filing, Disney ‘raised its concerns about our concerns. After dialogue with its shareholders, it made changes to its program and we changed our recommendation,’ McGurn notes. ‘I have no problem with those sorts of supplemental disclosures; I assume issuers are engaging with investors. That was our hope: add light, take away heat.’
What’s more, he sees a continued important role for ISS, even in a world of more customized proxy guidelines. ISS’ benchmark policy will still be necessary to ‘whittle down the number of proxies to a manageable level’ for further analysis, he says, which will ultimately increase the accuracy and efficiency of the proxy voting process.
Some ISS and Glass Lewis critics are less sanguine about the firms’ future. In a recent Harvard Law School Forum paper titled ‘Proxy advisory business: apotheosis or apogee?’ attorneys Charles Nathan and James Barrall, specialists in governance practice at Latham & Watkins, argue that the current success of the proxy advisory business may also ‘hold the seeds of its demise’.
They say proxy advisers are overwhelmed by the sheer volume of say-on-pay proxy questions, which forces them into a mechanistic ‘check the box’ approach that prevents deeper analysis, despite what they may say. As their institutional investor clients drive for lower costs and greater efficiency in voting the proxy, that pressure is only made worse.
‘Too many votes on too many issues expose the current model for what it is: a low-cost, largely mechanistic answer to a perceived governmentally mandated requirement that institutional investors vote all portfolio shares on all matters,’ the attorneys write.
Barrall predicts more firms will challenge ISS’ negative recommendations this proxy season than ever before. He points to ‘flaws in ISS’ methods for determining performance and valuing pay’, especially noting gaps in the value of compensation ‘actually delivered’ instead of Black-Scholes valuations used by ISS based on the date of an option grant.
He urges clients to ‘proactively use their CD&As to anticipate negative ISS recommendations’ and challenge their analysis. While he doesn’t think that will make ISS change its recommendations, ‘it will be persuasive to thoughtful shareholders and could be critical to some votes.’
Robin Ferracone, founder and executive chair of compensation consultant Farient Advisors, warns issuers to take note of their say-on-pay vote tallies, despite the vote’s non-binding nature.
If an issuer scores an 80 percent or better ‘yes’ vote, it can ‘feel pretty good about that,’ she says, while a score below 50 percent clearly indicates shareholder dissatisfaction. Ferracone warns issuers scoring between 50 percent and 80 percent not to feel certain they have a majority vote, but to recognize that they ‘need to improve their outreach program to investors.’
Such enhanced disclosure, she maintains, is necessary to counter ISS, which still wields tremendous power. ‘Certain investors will vote with ISS, without considering anything else, because it’s easy to defend their vote,’ she explains. ‘ISS’ pay for performance approach is flawed: performance is up, pay is up; performance is down, pay is down. It says nothing about whether the pay was high or low in the first place, or why performance went down. It lacks context.’
Joining the discussion
Gary Tygesson, partner specializing in governance practice at Minneapolis-based Dorsey & Whitney, says his firm has been busy this season rewriting client CD&As. In addition to executive summaries, more charts and tables and eliminating boilerplate language, Tygesson says clients are ‘changing the tone’ of the CD&A.
It is more a ‘statement in support of the compensation plan than a description of it.’ He adds that some clients are affirmatively pointing out the lack of negatives, telling investors the company does not have excessive perks, excise tax gross-ups, single-trigger change-in-control provisions or other ‘problematic pay practices’.
Tygesson also sees ISS’ influence increasing, not waning. ‘It is getting more aggressive in listing so-called problematic pay practices,’ he says. ‘Before, it just lobbed a statement out there: Gee, I don’t like this particular bad pay practice. There wasn’t really a forum where these issues would get discussed.’
Now if a significant number of compensation plans get voted down or a few get voted down for a specific reason, ‘all companies will start paying attention,’ he says. ‘The end game here is to drive firms to talk more with their shareholders’ about compensation issues. When companies do so on a regular basis – get feedback and find out what investors’ hot buttons are – investors will ultimately get involved in the process.’
But ISS will still hold sway over other items, such as stock plans. ‘It has a really tight grasp. Unless somebody finds a way to push back or it becomes subject to regulation, ISS’ influence will continue to grow,’ Tygesson says. ‘I don’t think it has hit its apex yet.’
