Investors now see corporate governance as a hallmark of the board’s effectiveness and one of the best sources of insight into the way companies operate. In response to this trend, Farient Advisors LLC, in partnership with the Global Governance and Executive Compensation Group, produced the report 2017—Global Trends in Corporate Governance, an analysis of corporate governance practices in the areas of executive compensation, board structure and composition, and shareholder rights covering 17 countries across six continents.
NACD, Farient Advisors LLC, and Katten Muchin Rosenman LLP cohosted a meeting of the NACD Compensation Committee Chair Advisory Council on April 4, 2017, during which Fortune 500 compensation committee chairs discussed the report’s findings in the context of the current proxy season. The discussion was held using a modified version of the Chatham House Rule, under which participants’ quotes (italicized below) are not attributed to those individuals or their organizations, with the exception of cohosts. A list of attendees’ names are available here.
Global Governance Trends
2017—Global Trends in Corporate Governance finds that governance standards around the world have strengthened in response to financial crises and breakdowns in corporate ethics and compliance. Those crises and breakdowns have led to greater pressure from governments and investors, who are demanding economic stability and safe capital markets. In regard to executive compensation, the report notes a number of global governance trends:
Source: Farient Advisors, 2017—Global Trends in Corporate Governance, p. 18.
Most of the 17 countries surveyed (94%) require executive compensation disclosure, although the disclosures made and the quality of these disclosures varies from country to country. Surveyed countries that had the least developed disclosures are South Africa, China, Brazil, and Mexico.
Say-on-pay voting is mandatory in most developed countries, although there is variance on whether the votes are binding or not. For developed countries where the vote is voluntary (e.g., Canada, Belgium, Germany, and Ireland), it still remains a leading practice.
Common leading practices are to use competitive benchmarks, such as peer groups to establish rationales for pay, and to provide investors with information on components of pay packages and performance goals.
2017 Proxy Season Developments
Meeting participants shared a number of observations and practices from the current proxy season:
Continuous improvement on disclosures Council participants indicated they are sharing more information with shareholders, in a more consumable way. “We want to be in the front ranks as far as providing information to shareholders,” said one director. “Instead of asking ‘why should we share that?’ we’re starting to ask ‘why not?’” Another director added, “Over the last few years we’ve moved from a very dense legalistic document to something that’s much more readable. Our board set up a process to do a deep-dive review every two years; this fall is our next review. It’s a way to ensure our disclosures keep pace with current practices and also reflect where we are as a company and board.”
Council members also discussed the status of Dodd-Frank rulemaking, given the new presidential administration and SEC commission. S. Ward Atterbury, partner at Katten Muchin Rosenmann LLP, said, “While it’s unclear exactly what the SEC will do with Dodd-Frank requirements in the future, investors have spoken on some of the issues, especially on things like say on pay and pay for performance. There may be less formal regulation, but the expectations on companies and boards are still there [to provide pay-for-performance disclosure].”
Growing interest in board processes According to one director, “We’re hearing more interest about CEO succession as it relates to strategy. Investors are asking us to describe our process—they understand we can’t discuss specifics.”
Director Pay Dayna Harris, partner at Farient Advisors LLC, discussed the increased focus on director pay: “Given the recent law suits regarding excessive director compensation and an increase in director pay proposals in 2016, Institutional Shareholder Services (ISS) created a new framework for shareholder ratification of director pay programs and equity plans.” ISS’ framework evaluates director pay programs based on stock ownership guidelines and holding requirements, equity vesting, mix of cash and equity, meaningful limits on director pay, and quality of director pay disclosure. ISS’ updated factors for evaluating director equity plans include relative pay magnitude and meaningful pay limits.
Environmental, social, and governance (ESG) issues Meeting participants agreed that social issues, such as ESG and gender pay equity, are increasing in popularity among investors. In particular, nonbinding shareholder proposals on climate change received majority support this year at Exxon Mobil Corp., Occidental Petroleum Corp., and PPL Corp.
Refining approaches to outreach and engagement with investors Meeting participants discussed leading practices for engaging shareholders. Some directors indicated that investors have turned down their offers to speak on a regular basis because of time constraints. One delegate emphasized that just making the offer to meet with shareholders is appreciated, even if that offer is turned down. One director said, “We invited one of our major long-term shareholders to speak at one of our off-site [meetings] as part of a board-education session. It was a different type of engagement and very valuable.”
This spring, as usual, most pay-related resolutions in proxy statements will be from corporations seeking shareholder approval of pay packages for named executives. But not all the pay votes will implement this now-familiar “say on pay,” where shareholders look back at the past year’s compensation plan to give thumbs up or down. More shareholders will be proposing their own pay concepts for a vote this season—and many of these proposals will reflect shareholder’s growing interest in social issues.
Who Needs Dodd-Frank?
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Directors in 2017 may see a new kind of resolution meant to re-assert any Dodd-Frank pay rules that get stalled or repealed this year. As reported in detail in the January/February 2017 issue of NACD Directorship magazine, President Trump may use executive orders to delay or undo Dodd-Frank, and Congress may revive a number of bills to repeal Dodd-Frank, including the parts of the law focused on executive pay. As expected, the president on February 3 issued an executive order outlining core principles that should guide the rollback of Dodd-Frank era regulations. As a result of this potential pullback on pay rule-making, companies may see shareholder resolutions mandating what those rules would have imposed, e.g., mandates for stricter executive pay clawbacks or for pay-versus-performance and pay-ratio disclosures.
Not surprisingly, directors and shareholders have been talking face-to-face about pay in preparation for this season. The 2016–2017 NACD Public Company Governance Survey reveals some interesting trends. In 2016, 48 percent of respondents indicated that a representative of their board had held a meeting with institutional investors over the past 12 months, compared to 41 percent in 2015. The most common discussion topics at those meetings were executive pay and CEO performance metrics and goals. Another common topic was “specific shareholder proposals,” which no doubt included the range of causes noted in our recent post predicting a rise in socially-minded proxy resolutions.
For many companies, measurement of performance includes social goals. In 2016, 80 percent of respondents to the NACD survey indicated that they consider non-financial metrics when evaluating executive performance to determine executive compensation. The metrics they use include, in descending order from 37 percent to 8 percent, the following:
Maintaining good standing with regulators;
Sustainability-related measures, and;
Many of these performance metrics could be considered “social” aspects of pay.
Executive Pay Proposals at Apple, Walgreens Boots Alliance
The 2017 proxy at Walgreens Boots Alliance (WBA) reveals that Clean Yield Asset Management proposed that WBA issue a report linking sustainability metrics to executive pay. The proposal asks the board compensation committee to prepare a report “assessing the feasibility of integrating sustainability metrics into the performance measures of senior executives,” and defines sustainability as “how environmental and social considerations, and related financial impacts, are integrated into corporate strategy over the long term.” The company recommends a vote against this proposal, highlighting its achievements in the field of sustainability, and concluding that preparing this report would not be a productive use of company resources.
On another note, Apple’s 2017 proxy statement contains two shareholder resolutions on pay—one focusing on increasing the requirements for stock ownership, and one that takes a more social turn. In proposal 8, shareholder activist Jing Zhao brings into the current season an economic concern voiced by a significant number of shareholders across several companies in 2016, when the 250 largest companies saw 38 shareholder-sponsored proposals on pay. While the subjects of these proposals varied, most of the 2016 proposals alluded, in one way or the other, to compensation practice reform.
Zhao’s current resolution proposes the following: “Resolved: Shareholders recommend that Apple Inc. engage multiple outside independent experts or resources from the general public to reform its executive compensation principles and practices.”
In summary, Zhao’s proposal takes aim at the identical nature of the senior executive pay below the CEO, and questions the need of a compensation consultant given such conformity. But the supporting details reveal that the proposal is not really about how many advisors Apple engages. Rather, it is about income inequality. Zhao’s commentary goes on to address the larger picture of societal well-being. He quotes Thomas Piketty, arguing that income inequality “has contributed to the nation’s financial instability,” and tracing this inequality to “the emergence of extremely high remunerations at the summit of the wage hierarchy.” (Capital in the Twenty-First Century, Harvard University Press, 2014, pp. 297-298, reviewed here in NACD Directorship).
The response from Apple management addresses the proposal itself rather than the surrounding complaint. Apple’s executive officers “are expected to operate as a high-performing team; and we believe that generally awarding the same base salary, annual cash incentive, and long-term equity awards to each of our executive officers, other than the CEO, successfully supports this goal.”
The Sleeper Issue: Director Pay
The sleeper issue this year may be director pay. The 2015-2016 Director Compensation Report, authored by Pearl Meyer and published by NACD, showed only a modest rise in director pay, and predicted the same for 2017. Nonetheless, director pay is becoming a hot issue for shareholders.
Consider the new guidelines from the leading proxy advisory firm, Institutional Shareholder Services (ISS), which serves some 60 percent of the proxy advisory market. Proxy voting guidelines of ISS and Glass, Lewis & Co. contain updates to discourage perceived director overboarding—and compensation does not follow far behind. It is notable that ISS amended its proxy voting guidelines, effective February 1, 2017, to include director pay. The ISS voting changes also include changes to ISS policies on equity-based pay and other incentives, as well as amendments to cash and equity plans, such as mandatory shareholder approval for tax deductibility. But the most unexpected development was ISS’ support for “shareholder ratification of director pay programs and equity plans for non-employee directors.”
ISS says that if the equity plan is on the ballot under which non-employee director grants are made, ISS policy would assess the following qualitative factors:
The relative magnitude of director compensation as compared to similar companies;
The presence of problematic pay practices relating to director compensation;
Director stock ownership guidelines and holding requirements;
Equity award vesting schedule;
The mix of cash and equity-based compensation;
Meaningful limits on director compensation;
The availability of retirement benefits or perquisites, and;
The quality of disclosure surrounding director compensation.
These values are not new. NACD went on record supporting such concepts in our Report of the NACD Blue Ribbon Commission on Director Compensation, issued in 1995. Every year since then we have issued an annual survey on director compensation with Pearl Meyer (cited above), reinforcing these key points.
In explaining the rationale for its policy update, ISS notes that there have been several recent lawsuits regarding excessive non-employee director (NED) compensation. For a summary of these lawsuits, see the Pearl Meyer/NACD director compensation report cited above.
ISS notes activity behind the scenes re director pay. According to the proxy vote advisor, “some companies have put forth advisory proposals seeking shareholder ratification of their NED pay programs,” and further, “ISS evaluated several director pay proposals during the 2016 proxy season, and we expect to see more submitted to a shareholder vote.”
Say on Pay for Directors?
Given the new interest in director pay, might it become subject to “say on pay” in the U.S.? Such a mandate has already begun overseas. Since 2013, Switzerland has had an “Ordinance against Excessive Compensation with Respect to Listed Companies.” The law mandates annual shareholder votes on the total pay awarded in any form by the company to its directors and, in a separate vote, to its senior executives. The pay period can be retrospective (last year) or prospective (next year). So far, after an initial wildensprung of rebellion against some boards, approval ratings have been very high. The 2017 proxy season may continue this trend—or contain surprises. Given volatility in the global economy, and in shareholder sentiment, it is wise to avoid complacency.
With an expected regulatory downshift under the incoming Trump Administration, standard-setting for business conduct may move from the government to the corporate sector, with shareholders and socially conscious directors driving the trend in myriad areas, from industry-specific concerns such as animal welfare to broader issues such as climate change. To be sure, we will continue to see proxy resolutions in the dozen general categories that have become hallmarks for activists, but the rise in attention to social issues by activists seems inevitable (See Figure 1).
Corporate leaders and major shareholders alike are recognizing the role that social issues can play in corporate value. In 2016, corporate leaders and prominent investors issued “Commonsense Principles of Corporate Governance,” a collaborative document containing a key message: “Our future depends on…companies being managed effectively for long-term prosperity, which is why the governance of American companies is so important to every American.” Among their recommendations was the suggestion that boards pay attention to “material corporate responsibility matters” and “shareholder proposals and key shareholder concerns.”
As revealed in the NACD Resource Center on Board-Shareholder Engagement, proxy resolutions can play a role in raising board awareness of key issues. Although shareholder resolutions rarely win by a majority, and even then are only “precatory” (non-mandatory), they do raise boards’ awareness of issues and can spark change over time. Many of today’s governance practices began as failing proxy resolutions but ended up as majority practices, with or without proxy votes.
Take for example proxy bylaw amendments, which have only been fair game for proxy votes since spring 2012 (thanks to a new rule that removed director nominations from the list of topics disallowed for shareholder resolutions). That season saw only three proxy access resolutions at the largest 250 companies, and only one got a majority vote. Fast forward to spring 2016 when 28 companies had such votes, and nearly half succeeded in getting a majority vote. By December 2016, proxy access had been adopted by a majority of Fortune 500 companies, as Sidley Austin reports. Those early proxy access resolutions lost their early battles, but in the end, they won the larger war. The same could happen over time to social resolutions over the next four years.
Directors Want More Dialogue on Social Issues
Interestingly, directors seem to be intuiting that they will need to step up on social issues this year.The 2016-2017 NACD Public Company Governance Survey, which features responses from 631 directors surveyed in 2016, reveals a significant finding in this regard. When asked to judge the ideal amount of time to be spent on various boardroom topics, directors ranked five topics as highest in terms of needing more discussion time:
director succession; and
corporate social responsibility.
One in three respondents said they would like more time devoted to discussing the “social responsibility” topic. For all issues other than these five, fewer than a third of respondents said that the topics merited more board attention. While this is a relatively new question, NACD has asked similar questions in the past, and this is the first time our respondents have ever ranked social issues so highly as a “need to know” topic.
A Gravitational Pull to Social Issues With a Strategic Slant
So what lies ahead for the next proxy season in the social domain? Aristotle is attributed with coining the phrase “nature abhors a vacuum,” a theorem in physics aptly applied to the likely vacuum in new corporate rule-making in 2017. USA-first trade rules aside, we believe that shareholder activists may try to fill the break in Dodd-Frank rule making with their own social agendas.
As we go to press, attorney Scott Pruitt is slated to head his institutional nemesis, the Environmental Protection Agency, while Governor Rick Perry, former leader of oil-rich Texas, is in line to direct the Department of Energy. Neither man is likely to crack down on carbon-based fuels, so if shareholders want carbon reduction, they will need to redouble their own efforts—and indeed that seems to be the plan.
According to the environmental group Ceres, quoted in an overview by Alliance Advisors, LLC, U.S. public companies will face some 200 resolutions on climate change in 2017, up from a total 174 such resolutions during 2016. This prediction may be conservative. According to Proxy Monitor, in 2016 the 250 largest companies alone saw 58 environmental proposals—meaning that nearly one out of every four large companies faced one.
In other developments, As You Sow, a community of socially engaged investors, has already announced 46 of its own proxy resolutions, including three on executive pay. All the rest are on social issues, including climate change (11), coal (10), consumer packaging (5), and smaller numbers of resolutions in a variety of other social issues, including antibiotics and factory farms, genetically modified organisms, greenhouse gas, hydraulic fracturing, methane, nanomaterials, and pharmaceutical waste. The gist of many of these resolutions is to ask for more disclosure, including more information on the impact of current trends on the company’s strategy and reputation. For example, the “climate change” resolution in the Exxon Mobile proxy statement asks Exxon to issue a report “summarizing strategic options or scenarios for aligning its business operations with a low carbon economy.”
Similarly, the Interfaith Center on Corporate Responsibility has already announced the filing of five shareholder resolutions for the 2017 proxy of its longtime target Tyson Foods on a variety of issues, including one on the strategic implications of plant-based eating. Sponsored by Green Century Capital Management, the resolution seeks to learn what steps the company will take to address “risks to the business” from the “increased prevalence of plant-based eating.”
In the same vein, at Post Holdings, which holds its shareholder meeting January 28, a shareholder resolution from Calvert Investment Management asks for disclosure of “major potential risks and impacts, including those regarding brand reputation, customer relations, infrastructure and equipment, animal well-being, and regulatory compliance.” Note that animal welfare is only one factor here; Calvert is making a business case for the social change.