For public companies in the United States, the 2011 proxy season is over and the 2012 proxy season is getting into full swing.
The 2011 proxy season included the inaugural say-on-pay (SOP) for most companies. While most companies in 2011 received overwhelming shareholder support for their executive compensation programs, others will need to modify their programs if they wish to improve their voting results in 2012 and avoid negative recommendations from proxy advisers, such as Institutional Shareholder Services (ISS) and Glass, Lewis & Co. (Glass Lewis). This is especially important considering that a number of companies that failed to receive majority shareholder support for their executive compensation programs in 2011 have become the target of shareholder derivative lawsuits and this trend is expected to continue in 2012 and future years.
For the 2012 proxy season, executive compensation will once again be the primary focus in the corporate governance arena. Proxy advisers, including ISS, have redesigned their models for 2012 to take into account whether companies sufficiently responded to shareholder concerns in 2011. This adds a new twist in predicting potential negative recommendations from proxy advisers, even for companies that passed their 2011 SOP votes by a comfortable margin. But as the 2012 proxy season gears up, it is useful to review 2011’s inaugural SOP votes.
Recap of the 2011 Inaugural Say on Pay Proxy Season
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank) was enacted on July 21, 2010. It requires, among other things, that US public companies solicit advisory (non-binding) votes from their shareholders to approve the compensation paid to named executive officers in the prior fiscal year (the SOP vote), to determine how often the SOP vote should be held (the frequency vote), and to approve so-called “golden parachute payments” triggered by an acquisition, merger or other similar corporate transaction (the golden parachute vote). The following summarizes how companies prevailed in the 2011 proxy season:
Say on Pay
- Over 70 percent of Russell 3000 companies received over 90 percent shareholder approval
- Over 90 percent of Russell 3000 companies received over 70 percent shareholder approval
- 37 Russell 3000 companies failed to receive at least 50 percent shareholder approval
- 30 companies received 50-60 percent support
- Of Russell 3000 companies, approximately 81 percent of shareholder votes favored annual SOP frequency and 19 percent favored triennial SOP frequency
- Of Russell 3000 companies, approximately 52 percent of companies recommended annual SOP frequency and 42 percent recommended triennial SOP frequency
- Substantial majority of companies are expected to have annual votes
- Most companies adopted the shareholder preference that received a plurality of votes
Golden Parachute Vote
- The golden parachute vote is permitted, but not required, in annual proxy statements; most companies are electing to delay the golden parachute vote until the merger proxy
- Of the at least 46 companies that have filed proxy statements proposing approval of “golden parachute payments,” it appears that most have seen their golden parachute payments approved by a substantial margin
Influence of Proxy Adviser Recommendations
Proxy adviser recommendations have become increasingly important as institutional shareholders typically do not have the time or resources to analyze thousands of proxy statements in a short period of time each year. In 2011, the most significant proxy advisor was ISS and the other proxy advisor of note was Glass-Lewis. In 2011, institutional shareholders frequently relied on the recommendations from proxy advisers (particularly ISS) in casting their SOP vote. This effectively allowed ISS to significantly influence the SOP voting process. As a result, many companies took affirmative action in anticipation of the SOP vote, such as contacting shareholders directly, communicating with proxy advisers, hiring a proxy solicitor and even making changes to their existing compensation programs.
Proxy advisers, such as ISS and Glass-Lewis, were aggressive in making negative recommendations with respect to SOP votes based upon their review of company proxy statements with negative recommendations ranging from 13 percent to 17 percent of the total proxies reviewed in 2011. The influence of proxy advisers is evident as companies with negative recommendations from ISS received approximately 27 percent less support, on average, than those with favorable recommendations.
Negative recommendations from proxy advisers often occur when companies have adopted certain pay policies and practices that proxy advisers have deemed to be “problematic” or “egregious.” Of these poor pay practices and policies, the most significant is a finding by the proxy adviser that a pay-for-performance “disconnect” exists with respect to the company’s financial performance and its pay to executive officers. This remains a hot issue that many companies are planning to address in further detail in the 2012 proxy season. In addition, the US Securities and Exchange Commission is expected to issue proposed rules on pay-for-performance in 2012. Other poor pay practices include excise tax gross-up payments on golden parachute payments, single-trigger change-in-control payments, broad change-in-control definitions, excessive severance pay and excessive relocation payments. In response to these concerns, many companies have already eliminated excise tax gross-up payments altogether, moved from single-trigger to double-trigger change-in-control payments, raised the threshold percentage in the change-in-control definitions, and reduced the amount of severance and relocation payments. Although each company subject to the SOP vote requirements needs to design its executive compensation programs in a way that it believes is appropriate to encourage the success of the company, it has become critical that companies understand the impact that ISS and other proxy advisors have on the SOP voting process.
In deciding how to respond to a negative recommendation, companies have traditionally discussed the points of contention directly with proxy advisers in an attempt to persuade them to issue a correction. However, there was a dramatic shift in the approach of dealing with negative recommendations. In 2011, more than 100 companies filed public responses to proxy adviser negative recommendations with a majority of the controversy relating to companies disputing the findings by the proxy adviser that a pay-for-performance disconnect existed. Other companies changed their existing compensation agreements or made prospective commitments to modify their compensation policies to induce the proxy advisers to reverse their negative recommendations.
Shareholder Derivative Lawsuits Following SOP Vote
At least 10 companies have been subject to shareholder derivative lawsuits that were filed against the company’s board of directors and executive officers, and in some cases, the independent compensation consulting firms that advised them, following 2011 SOP votes. In almost all of these lawsuits, the companies failed to receive at least 50 percent shareholder approval of their SOP vote. Of the 10 shareholder derivative lawsuits filed in 2011, one has been dismissed, one has survived a motion to dismiss, two have settled and the remaining six are pending.
The plaintiffs in these shareholder derivative lawsuits face significant obstacles both substantively and procedurally. The lawsuits are similar in that the plaintiffs generally allege that; (i) the company’s board of directors breached its fiduciary duty of loyalty when it approved salary increases and bonuses for the company’s top executives during a year in which the company’s performance declined, and (ii) the failed SOP vote is evidence that the compensation paid to the top executives was not in the best interests of the company’s shareholders. Before proceeding with the merits of a shareholder derivative lawsuit, a shareholder-plaintiff is generally required to either make a pre-suit demand on the company’s board of directors asking the board to pursue the alleged claims or plead with particularity that such pre-suit demand should be excused because it would be futile. If the board fails to enforce or pursue the alleged claim, then the shareholder has a derivative right to pursue it.
In assessing the merits of the alleged claim, the plaintiff must overcome the application of the “business judgment rule” which is a presumption that directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. This is a difficult presumption to overcome as courts have commonly found that compensation decisions regarding executive compensation made by independent directors fall within the protections afforded by the business judgment rule. As a result, many of these claims are dismissed at the early stages of litigation which reduces the time and expense associated with a long trial. Alternatively, many companies enter into settlement agreements with the shareholders early on to avoid expensive court cases.
Thus far, only one lawsuit has survived a motion to dismiss. Many companies are troubled by this case because the court’s decision appears to be inconsistent with the common application of the business judgment rule. However, in another lawsuit, the court granted the company’s motion to dismiss on multiple grounds and concluded that the pre-suit demand was not excused.
Although only approximately 2 percent of companies received a failed SOP vote in 2011, proxy advisers issued negative recommendations ranging from 13 percent to 17 percent of the total proxies reviewed in 2011. Proxy advisers have a significant influence on the outcome of voting and companies became increasingly vocal in 2011 by filing public responses to negative recommendations, especially on pay-for-performance issues. The 2011 proxy season also brought the added risk of costly shareholder litigation in the event of a failed SOP vote and the uncertainty surrounding the court’s application of the business judgment rule. Companies are expected to communicate directly with shareholders early and often to ensure that they have accurate and complete information when casting their SOP votes in 2012 and future years.