Seven minutes. That’s about how long the average proxy voter can devote to the average corporate proxy statement. This is bad news for the corporate legal and communications folks who offer 40-plus pages of tiny type to explain their compensation practices.
Bad news, too, for corporate managements and boards of directors for whom say-on-pay is a referendum on top managers’ pay packages and, at least by implication, those managers’ stewardship of the corporation they lead.
A few savvy companies have adopted a two-part approach to making their strongest possible case in the very narrow window available to them.
First, they offer a very brief intro to the Compensation Discussion & Analysis (CD&A) section of the proxy – one that presents essential topics with almost comic-book simplicity and vividness.
Second, they scour the pages to find, remove or repair any of the red-flag items that signal to a proxy voter that a company may be trying to paper over flaws in its compensation process.
Here are some brief thoughts on what builds and kills the credibility of a CD&A treatment of say-on-pay.
A word on context
Say-on-pay is now a centerpiece of investor activism. At its most obvious level, it is about how good a job management is doing. At a deeper level, it is a measure of how boards and managements choose to deal with a participatory investor population.
This last year, 27 companies flat out failed their say-on-pay vote, getting less than 50 percent of the vote. It’s an advisory vote, but 49 percent, or 32 percent (the worst we found) is a pretty strong statement of disapproval. Some advisory organizations put forth 70 percent as the minimum threshold of acceptability.
More than 100 other companies got their majority vote, but fell short of the 70% threshold. At these levels, boards have to take notice. And each year, the scrutiny is more severe.
The core document of say-on-pay is the CD&A (Compensation Discussion & Analysis) of the proxy statement. Here is where, usually at great length, boards explain what they paid their CEO and other Named Executive Officers (NEOs), and how they decided what to pay.
We, at the Abernathy MacGregor Group, read the CD&As of most companies under 70 percent and talked to a bunch of actual proxy voters. We found the dangerous symptoms include the ‘one life-or-death test’, and a handful of ‘credibility killers’. The credibility builders are fewer and simpler: using them tells voters you do want to communicate to them.
Dangerous symptoms
The ‘one life-or-death test’ is all about total shareholder return (TSR), generally defined as increase/decrease in share price plus dividend payments, as a percentage of beginning share price. It’s fine to use a different metric of shareholder value creation, as long as you explain why it is more appropriate.
The test comes is two parts. One, is there a strong and clearly stated connection between TSR and CEO compensation? Yes, NEOs matter too, but this is really all about the boss. If the answer is no, a fair number of proxy voters will stop reading and cast a ‘no’ vote.
Some companies never mention TSR or anything like it. Others mention it as a concept, but never state what its value was last year or at any other time. Both are bad ideas.
If the connection is stated, then comes part two. Is there a disparity between TSR and CEO compensation? Compare TSR and CEO total compensation for the last three years. If they don’t mesh, a ‘no’ vote could be looming.
The credibility killers come in many forms. There are many ways to present CD&A information. But when something appears duplicitous or deceptive, votes can be lost. Some common topics that cause concern:
1. Exceeding your own upper limits. If you set a $1 mn cap on restricted shares for the CEO, don’t award $2 mn. No explanation will be believed.
2. Using numbers from nowhere. CD&As use numbers to quantify performance. Sometimes these numbers don’t match up with the numbers in the company’s financial statements. That’s a big problem.
3. Packing the peer group. CD&As compare performance and compensation with other companies similar in scale and business dynamics. Some peer groups are padded with companies that aren’t natural peers – but which pay better and/or perform worse. Voters notice.
4. Maxing out the soft stuff. Some compensation is determined by financial metrics, some by verbal characterization. Some executives who score badly on the numbers get maximum ratings on team building, succession planning and such like.
5. Achieving undefined targets. Comp-driven performance metrics commonly have a threshold (pays 0 percent), a cap (pays 100 percent) and a target (somewhere in-between). Sometimes, executives are said to have achieved their targets – but the targets, thresholds and caps are not stated.
6. Low-balling real compensation. Way at the back, in small type, is the summary compensation table. That’s what the CEO and NEOs actually have to pay tax on. The numbers shown up front in the colorful charts are often lower, sometimes so low there’s explaining to do.
Credibility builders
Very large investment managers vote so many shareholder meetings per year that their proxy voters give only minutes to a typical proxy statement. If you want to get through to the proxy voter, you’ll need to be user-friendly.
So compress the important things you want proxy voters to consider into three pages, no more, right at the start of the CD&A. Proxy voters love this format. If you have a good case, this is your best chance to make the sale.
We have seen this done – and helped clients to do this – in a number of ways. The successful approaches explain very clearly and simply the criteria applied to corporate and individual performance – and how those criteria were translated into dollars and cents and shares of stock.
First, what did you tell your management to do? This is the board talking here.
Second, how did you measure how well they did what you told them to do? This is about metrics and stated accomplishments. Third, how did you translate those performance metrics into compensation decisions? This is only partly about metrics: comp committees do, and should, make judgments.
Successful approaches actively direct the limited attention of proxy voters, using attention-grabbing and attention-holding presentation techniques. That means large type. That means color. That means clear and simple graphics and tables. But mostly it means reducing the case-for-comp into a form that can be understood in just a few minutes.
Everything that didn’t get included in this opener, and any amplification that’s needed for what was included, goes in the following pages. Here, the proxy voter plea is universal: ‘We cannot read it all. Show us what’s new. Show us what’s important. Use type and color and graphics and whatever else you need. Or else we won’t notice.’
If you’ve navigated the hazards, credibility builders will get you a more attentive and favorably inclined audience – which is something to prize.
James MacGregor is vice chairman of the Abernathy MacGregor Group.
