In the current environment of “Say on Pay,” heightened shareholder activism, along with intensifying interest in environmental, social and governance (ESG) and sustainability, companies are exploring ways to improve shareholder communications through their proxy statements. In this article, DFIN proxy expert Ron Schneider dives deeper on proxy themes, such as board diversity and executive compensation, which are major topics of investor interest.
For most investors, the proxy statement is the primary voice of the board. Investors elect board members to oversee their portfolio companies, yet most investors never meet these directors in person. The responsibilities of a board member typically include appointing the CEO, developing their pay program and evaluating the CEO’s performance. Some executive pay programs are primarily formulaic (i.e., their incentive pay is based on the achievement of specific pre-set metrics) and some feature degrees of discretion that the board or compensation committee can exercise.
Under both circumstances, pay ultimately is established and then publicized in the next proxy. At that point, proxy advisors and investors evaluate the pay-for-performance (PFP) alignment to see if they feel the pay package was justified. There isn’t one definition of PFP alignment, as companies, proxy advisors and investors evaluate this in a variety of ways. What is emerging as a critical factor for companies is to discuss the pay program in terms of its alignment with the underlying business strategy.
Larger investors may have contact with board members through engagement calls, and investors of all sizes can participate in the annual meeting of shareholders. However, for most investors, the proxy statement is the primary touchpoint for board engagement. Over the past decade, the quality and depth of board-related disclosures have improved significantly at many companies.
Driving this enhanced messaging is not solely investor interest, but also board and management concerns about high levels of activism, which could surface at any company. Perceived PFP disconnect can receive negative attention via poor say-on-pay vote results, media articles, and activist challenges. Also, in cases of crisis, the question quickly becomes, “where was the board?”
Companies are proactively telling their best board and executive compensation stories, rather than reacting after a crisis or in the face of activism.
If your proxy could talk, what story would it tell about your board?
As companies formulate their answers, they should consider how clearly and effectively the following board-related topics are answered and conveyed.
- Board independence and diversity
- Is diversity, which can consist of any combination of gender, geographic, ethnic/racial, age, tenure, as well as experience and qualifications, reflected clearly?
- Is the mix of skills and qualifications right for the company’s current and foreseeable future strategies? And if certain skill sets are missing, are there efforts underway to fill these gaps before they become apparent to the outside world?
- Enterprise Risk Management
- Is the board effectively overseeing a broad range of enterprise risks, including any potential risks associated with their compensation programs?
- Risk management increasingly includes board-level oversight of ESG-related risks and opportunities.
- Management Evaluation and Succession
- How robust are your board evaluation and director recruitment processes and are you effectively telling this story?
- Are you doing the same with the board’s role in CEO succession planning?
- Engagement
- If directors are involved in investor engagement to identify investor concerns, are you informing other investors that don’t participate in this engagement of these activities?
- Are we humanizing our directors through techniques, such as board-level engagement, substantive board-level cover letters, photos in the proxy, links to director videos in interactive online proxies and more?
What story is your proxy telling about your executive compensation program?
While the quantum of CEO pay and its increase over time attracts attention, most investors are more concerned about the alignment of pay with performance. Yet PFP alignment can be measured in many ways. Definitions of pay include reported pay (i.e., summary compensation table) and alternative pay (i.e., realized or realizable pay). Performance can be measured by absolute total shareholder return or achievement of financial or strategic priorities, or measured relative to index stock performance or peer company CEO pay.
However, the company doesn’t own this story outright. Proxy advisors do publicize their version of PFP alignment and investors can calculate their own. As we said before, companies have a range of strategies to tell this important story.
For years investors, have requested a clear articulation of how the pay program is aligned with the business strategy of the company. If that strategy is evolving, is the pay program evolving as well? In other words, what performance are you paying for and why are the metrics you employ the best measures of such performance?
If PFP and pay and strategy alignment can’t be explained clearly and credibly, perhaps the pay program should be fundamentally re-examined.
If you have certain compensation practices that are non-standard or the pay program seems to be overly complex, it is probably worth the extra effort to explain clearly why you use these practices and why you feel they are appropriate. This type of clear, company-specific discussion can often help you avoid unnecessary negative say-on-pay voting.
Speaking of vote results, if pay or director votes are lower than normal (with 80% increasingly being the adopted, satisfactory level), are you subsequently demonstrating responsiveness to the vote? A board’s response can include post-meeting engagement with investors on
compensation and governance issues, obtaining investor feedback, making appropriate
changes in response, and publicizing these activities in the next proxy.
If your CEO/median employee pay ratio is significantly above the median for your industry group or business model, this can attract unwanted attention from employees, the media and others. Boards should be prepared to explain how these results make sense in the context of your business model and labor requirements.
What about ESG?
ESG issues are increasingly impacting boards and even executive compensation. How industries and companies impact-- or are impacted by -- climate change and potential technology, competitive and regulatory responses clearly differ and investors appreciate that. Investors want to know that their portfolio companies, management teams and boards have a handle on a company's specific ESG risks and opportunities. It’s also comforting for investors to know there are plans in place to mitigate the risks and pursue opportunities that are actively overseen at the board level. The board should be ready to report back with decision-useful information on their activities and progress on these initiatives.
A related issue is Human Capital Management (HCM) and how companies are managing these valuable assets. Some companies appoint committees that are responsible for overseeing these ESG/HCM efforts. Other companies are adding individuals with expertise on these issues to the board and c-suite, including chief sustainability officers. Increasingly we are seeing board skills matrices highlighting those specific directors and their competencies. Also, depending upon the industry, the performance of ESG or HCM-related objectives may be added to traditional performance metrics in incentive compensation plans.
Given the intense scrutiny of board diversity and competencies, executive pay and PFP alignment against a backdrop of investor activism, telling your best board, compensation and sustainability stories are a must-have and no longer nice to have.
Fortunately, we can help. If you are thinking about how you can craft a compelling statement, get in touch with a DFIN proxy expert today. We can start the conversation and help you mold a unique proxy story that makes a compelling statement.
When you work with DFIN on your proxy, you:
- Ensure it speaks to your objectives
- Harness the power of design to focus the attention on your corporate strengths
- Build a strategic document with clear messaging that’s easy to digest