Executive compensation decision-makers at publicly traded U.S. companies faced the 2011 say-on-pay vote mandated by the Dodd-Frank Act (see box below) with apprehension. For the first time ever, long-standing executive compensation practices and conventions would undergo intense investor scrutiny and be subject to their (nonbinding) approval.
What Dodd-Frank Says About Say-on-Pay
The Wall Street Reform and Consumer Protection Act (known as the "Dodd Frank" Act), signed into law in July 2010, requires publicly traded U.S. companies to provide their shareholders with a nonbinding vote to approve the compensation of senior executives. These say-on-pay votes give shareholders a voice in how the top five named executive officers are paid and are a way for a corporate board to determine whether investors view the company's compensation practices to be in the best interest of shareholders.
The law requires three separate nonbinding shareholder votes on executive compensation: approval of compensation of named executive officers; a vote on the frequency of future say-on-pay votes (every one, two or three years); and approval of any severance paid to named executive officers as part of a proposed merger, acquisition or similar transaction.
Although vote results are not binding on the company or its board of directors, ignoring a “no” vote on pay might result in negative news stories, lower ratings by independent shareholder advisory firms and challenges to independent directors in the next board election.
In 2011, in anticipation of the initial say-on-pay vote—most often held during the April through June "proxy season"—many companies revised what could be perceived as poor pay practices and learned how to communicate better about pay with their investors. These actions, buoyed by a relatively healthy stock market at the time of the 2011 vote, meant that most publicly traded companies (more than 90 percent of the Russell 3000 Index) received a “for” say-on-pay vote.
Because of this first-year success, compensation decision-makers might be lulled into complacency when looking ahead to the 2012 proxy season. Some might think, “We got over 90 percent approval on our say-on-pay vote last year, which was well above the minimum requirement of 50 percent. No need to worry about the 2012 vote.”
Regrettably, a struggling economy, a volatile stock market and evolving governance protocols suggest otherwise. Rather than fade into a routine procedure similar to the annual ratification of the independent accounting firm, the say-on-pay vote has emerged as a high-profile component of the executive compensation decision-making process, one that requires continued, disciplined oversight.
In anticipation of the 2012 say-on-pay vote, institutional investors and their advisors are refining their analytical approach, particularly around the alignment of pay with performance. Moreover, the Securities and Exchange Commission (SEC), as required by Dodd-Frank, will further influence say-on-pay outcomes when it issues its pay-for-performance and pay-parity disclosure requirements in 2012.
Call to Action
Compensation committees and corporate management need to up their game for the 2012 proxy season and its accompanying say-on-pay vote. The game plan requires stronger analytics, more transparent disclosure and evidenced alignment of pay with performance. To win the vote in 2012, compensation decision-makers must take steps to:
• Foster a noncomplacent, collaborative, fact-based executive compensation and governance decision-making, design, delivery and disclosure process.
• Assess the company’s alignment of pay with performance, taking into account findings from the 2011 say-on-pay vote, institutional advisory perspectives and an objective audit of the company’s compensation realities.
• Enhance plan designs to strengthen the alignment of pay with performance and address the needs of the business and its executives.
• Improve the execution of executive compensation decision-making at the leadership level.
To help companies assess the state of their executive compensation programs, Sibson Consulting has developed an assessment framework that consists of two checklists: the “Outside-In Audit” and the “Inside-Out Audit.” Executive compensation decision-makers can use the “Outside-In Audit” (see table 1 below) to identify the “outsider” context in which the company’s executive compensation decisions and corresponding disclosures are evaluated.
The “Inside-Out Audit” (see table 2 below) can be used to test the company’s pay plan designs, decision-making process and disclosure against outsiders’ standards and expectations.
By compiling and reviewing the data required to answer the questions in these tables, companies can identify the vulnerabilities in their executive compensation programs. These vulnerabilities should be addressed through redesign and disclosure in preparation for the 2012 say-on-pay vote.
Although the results of the first say-on-pay vote in 2011 were overwhelmingly positive, executive compensation decision-makers should not become complacent. The economic, financial, regulatory and legislative environments are uncertain and continue to change. A “for” vote in 2012 is far from a sure thing. Steps need to be taken to prepare the company for another “big win”: a second successful say-on-pay vote.
Myrna Hellerman is a senior vice president in the Chicago office of Sibson Consulting. She advises management and boards in the design and implementation of innovative, effective and sustainable people and reward strategies that lead to improved business results.
This article originally appeared in the December 2011 issue of Sibson Consulting's Perspectives, and is adapted and reposted with permission from Sibson Consulting, a division of Segal. © 2011 by The Segal Group Inc. All rights reserved.
Companies Work to Achieve Positive Say-on-Pay Votes, SHRM Online Compensation Discipline, August 2011
U.S. Companies Divided on Say-on-Pay Frequency, SHRM Online Compensation Discipline, January 2011
Designing Executive Compensation Plans, SHRM Tools and Templates, December 2011
Directors Looking Beyond Dodd-Frank Act to Fix CEO Pay, SHRM Online Compensation Discipline, November 2010
Reporting CEO-Employee Pay Ratios: Navigating the Minefield, SHRM Online Compensation Discipline, November 2010
U.S. Corporate Governance Policy 2012 Updates, Institutional Shareholders Services Inc., November 2011
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SHRM Metro Economic Outlook reports