Say on Pay Update: Finishing Strong with Your Stockholders

By Amy Muecke

The Wall Street Journal article describing recent say-on-pay related developments at General Electric touches on several developing trends surrounding say-on-pay proposals this year:

1. Pay-for-Performance is a Hot Button: Pay-for-performance issues are driving many of the negative ISS vote recommendations. ISS looks at only one measure of performance – total stockholder return (TSR). If a company's TSRs are in the bottom half of its GICS industry group for the applicable one- and three-year periods, ISS then looks at only one measure of pay – the CEO's total direct compensation and whether it increased year over year. If so, ISS then further scrutinizes the source, amount and reasons cited for the pay increase to determine whether the "pay-for-performance disconnect" warrants a negative vote recommendation. Because of this discretionary element, it is especially important to bolster the pay-for-performance discussion in the CD&A, particularly with an explanation of the company-specific performance criteria that are used and why such criteria are the appropriate measures of company performance. Good disclosure may sway the ISS analyst/recommendation, or at a minimum help set the stage for later explaining to stockholders why a negative ISS vote recommendation should be ignored.

A pay-for-performance disconnect was the reason cited by ISS for the negative recommendation on GE's say-on-pay proposal and ISS specifically noted that GE did "not adequately explain to shareholders the decision to move away from performance-based equity awards for the CEO to solely stock option grants for FY2010". Note that, even though stock options provide compensation to the employee only if the stock price increases, ISS does not consider time-vested stock options to be performance-based compensation.

2. Companies Are Publicly and Aggressively Fighting Back: Additional proxy materials are being filed to urge stockholders to disregard negative ISS or Glass Lewis vote recommendations and instead support their say-on-pay proposals. Shortly after the negative ISS vote recommendation was issued, GE filed additional proxy materials seeking to convince stockholders that the ISS analysis was flawed and that its say-on-pay proposal should be supported.

Other companies that have filed similar additional proxy materials (several of which address pay-for-performance issues) include: Walt Disney, Northern Trust Corporation, Textron Inc., Tyco International Ltd, Unisys Corp, Hewlett Packard, Allegheny Technologies, Headwaters Incorporated and Jacobs Engineering Group.

3. Say-on-Pay Is Prompting Change: About a week and half after GE filed additional proxy materials arguing that stockholders should ignore the ISS recommendation and support its say-on-pay proposal, it filed additional proxy materials explaining that following constructive conversations with its stockholders, it decided to modify the stock options granted to its CEO to include performance conditions and resume the practice of only granting performance-based equity awards to its CEO going forward.

In addition to making changes to executive compensation practices to avoid or reverse negative vote recommendations/votes, companies will need to consider whether the results of this year's vote warrant changes to executive compensation practices in light of the requirement to disclose in next year's CD&A whether the results of this year's say-on-pay vote were considered in determining compensation policies and decisions and if so, how that consideration affected the company's executive compensation decisions and policies.

4. ISS Vote Recommendations Can Be Changed: As a reminder, ISS will change a vote recommendation if something in its report is incorrect or if additional materials are publicly filed to satisfactorily address the issues that triggered a negative vote recommendation. Shortly after GE filed its additional proxy materials adding performance criteria to the CEO's options and committing to granting future performance-based equity awards, ISS issued an alert changing its vote recommendation explaining that "in light of this new information indicating the company's long-term commitment to pay-for-performance, ISS believes that support for the Advisory Vote on Executive Compensation is now warranted." Note that GE's annual meeting is scheduled for April 27 – it will be interesting to see the results of this vote when disclosed late next week or early the following week.

A couple other points/trends:

• Know Your Stockholders: The impact of a negative vote recommendation from ISS depends on your stockholder base. Based on the results available in an ISS database, of 195 say-on-pay proposals that have passed, ISS recommended voting against 20 of them. It is important to know your stockholders, know what influences your stockholders' votes (ISS, Glass Lewis or internal guidelines) and have the appropriate stockholder outreach strategy in place.
• Most Successful Proposals Are Receiving a High Level of Support: Of the same 195 proposals that have passed and based only on votes cast for/against (i.e., not counting abstentions or broker non-votes), ~78% of them have received at least 90% support, ~13% have received between 80% and 89% support, ~4.5% have received between 70% and 79% support, ~3.5% have received between 60% and 69% support and ~1% have received between 50% and 59% support. Additional stockholder outreach effort to obtain the highest possible level of support for your say-on-pay proposal may avoid the need for the additional stockholder outreach after your annual meeting that may otherwise be necessary or advisable if your proposal passes by a slimmer margin.

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