Tips for coping with proxy advisers
In late October ISS announced its adoption of a ‘scorecard’ approach to evaluating equity plans in the US, among other benchmark policy changes for proxy voting in 2015. The change means recommendations will be based mostly on a mix of factors having to do with plan cost, plan features and grant practices. Under the new approach, cost will be weighted 45 percent, grant practices 35 percent and plan features 20 percent, with a dozen individual factors.
The voting recommendations of ISS and other proxy advisory firms have acquired added significance for US companies since 2011, with executive compensation plans subjected to greater scrutiny by institutional investors under the SEC’s say-on-pay rule. As Corporate Secretary reported in its research report on shareholder engagement in the Summer 2014 issue, 44 percent of companies surveyed said they had interacted with either ISS or Glass Lewis in the last year in order to request a correction of a data point, seek a change in a recommendation, or both.
Although most major institutional investors insist they have their own proxy voting policies on issues such as executive pay and only use proxy advisers’ recommendations as one of many considerations in their own voting decisions, a lot of criticism has been aimed at proxy advisers for the growing influence their policies and recommendations have on investors. Corporate Secretary spoke to Rhonda Brauer, senior managing director for corporate governance at Georgeson, about how companies can best cope with proxy advisers regarding their executive pay recommendations.
Peer group confusion
One factor that frustrates many companies in proxy advisers’ recommendations is their selection of peer groups as a basis for comparison. As more companies diversify their businesses to include new product lines or expand into new geographic markets, choosing the appropriate peers against which to measure a company’s financial performance and the way it ties that to financial incentives for executives has become less straightforward.
Some companies compete with private equity firms, privately held firms or international rivals, all of which may lack any comparable publicly available executive compensation data, says Brauer. In such cases, those companies would be well served to explain that to their proxy advisers and investors when identifying their peer groups.
‘You can use a chart to compare your company’s size with peers for which that compensation data is available,’ Brauer says. ‘But you’ll need to explain that you’re also competing with these other firms for talent and that your compensation committee factors those firms into its decision making when making awards.’
Providing such explanations does not ensure you will be able to change the proxy advisory firms’ view of who your peers should be for their analyses, however, and you may fail their say-on- pay tests (and get a negative recommendation) because the peer groups are just so different from the one you’re using.
‘If you sense this is going to happen, you may want to take your story to your investors and explain it directly to them – both in advance of your proxy statement filing and again in plain English, often with the use of helpful charts, in your proxy statement,’ Brauer suggests.
Off-season engagement with proxy advisory firms and a company’s investors can be a good idea for companies that expect to get a negative say-on-pay recommendation, simply because they have weathered financial turbulence better than their peers, preserving an upwardly sloping line in charts showing their total shareholder return or return on invested capital, Brauer says. In showing a year-over-year comparison, a designated peer that had a bad year followed by a stronger year can look like it performed very well in the one year being reported, due to its coming from such a low base. Conversely, the company that’s been a steady performer could be penalized as it has not had to bounce back from such a low base, she explains.
Depending on their particular situation, Brauer encourages her clients to have off-season discussions with proxy advisers and their investors to offer specific detail on the types of financial metrics they use to determine pay-for-performance alignment and to compare their designated peers with those selected by the proxy advisory firms.
In these discussions, companies can also explain any unique aspects of their businesses that may not be easily understood, and/or demonstrate what they are trying to achieve by – for example – issuing more equity awards than might be generally permitted under the proxy advisers’ models.
‘The feedback that such companies often get is, Wow, that’s really interesting. If we had understood that in your proxy statement, it would have really helped us in doing our analysis for our voting recommendations,’ Brauer says. ‘It might not change the proxy adviser’s initial quantitative analysis, but when it does its qualitative analysis, it may very seriously take that additional information into consideration.’
Brauer also suggests that her clients send a slide deck compliant with Regulation Fair Disclosure to the proxy adviser prior to a scheduled call or meeting, and offer to walk it through it. This can be done by a board member or the appropriate members of senior management who can best address the relevant issues, and sometimes a combination of both. Companies may then take the feedback they get from the meeting or call and, when appropriate, incorporate it into their proxy statements for the following year.
The right metrics
‘I like to see charts explaining the company’s peers, where the firm falls in terms of the relevant financial metrics it uses when selecting its peers,’ Brauer says. ‘Whether it’s market cap, revenues, total shareholder return or assets for financial institutions, consider setting forth the most relevant publicly available information for both you and the peers you’ve selected. Then companies should do the math for their readers and disclose the median metrics for their peer group and where they fall percentage-wise within that group.’
If proxy advisers and investors see a company is in the tenth percentile compared with its peers for each or most of those metrics, it may ‘raise concerns that you’re trying to compare yourselves with much larger companies in order to justify much larger pay’ for your company’s executives, Brauer warns. ‘There may be a perfectly valid reason. If there is, you’ve got to remember why your compensation committee did it and explain it in your proxy statement.’
For example, Brauer says, a non-tech company located in or near Silicon Valley that firmly believes it must compete for top talent in certain positions with local tech firms that earn much more revenue may want to explain why it went outside its own industry to recruit a particularly talented local tech executive.
Another way companies can respond to proxy advisers’ recommendations is to post comments on the designated portions of the advisers’ websites when they think a proxy adviser got something factually wrong in the data used in the firm’s recommendation, Brauer says. That will make it easier for the proxy advisers to gather such comments and share them with clients – the investment advisers who will be voting shares – so the latter (as a matter of their due diligence) can be made aware of any information that went into the recommendations that may not have been accurate or was at least questioned by the companies that were the subjects of the recommendation reports.