Public Company Comp in 2012

At the April Breakfast Meeting of the New England Chapter of the National Association of Corporate Directors, a panel of public company directors faced “the Enemy” in the person of Pat McGurn, who represents the ISS.  For the uninitiated, ISS stands for Institutional Shareholder Services, the company that advises institutional shareholders in public companies as to how they might want to vote on director elections and other proxy issues.

McGurn noted that in 2011 the ISS made a favorable recommendation on “say-on-pay” votes in 88% of public companies (that is, ISS recommended that in 7 out of every 8 public companies the shareholders vote in favor of the compensation arrangements proposed by management and the board of directors in the advisory, non-binding shareholder votes mandated by Dodd-Frank).  Although it is early in the current proxy season for 2012, he noted that so far ISS has recommended favorably in 86% of the companies that have come before them.

It should also be noted that historically most companies pass the say-on-pay test with an average positive approval of over 90% of the shareholder votes; in 2011 only 41 companies, or less than 2% of the Russell 3000 Index, actually failed.  Early indications indicate that similar results will obtain in 2012.

McGurn noted that in 2013 the Dodd-Frank Act say-on-pay provisions become applicable to low cap companies for the first time, which may result in different statistics.  That is, if there is no change in the Federal administration, the suggestion being that a Republican victory might lead to a delay in implementation.  He noted that the April 5th JOBS Act signed by the President delayed many otherwise mandated compensation disclosures for newly registered companies with sales below $1,000,000,000 which is, after all, most of them.

What was the effect of a negative ISS recommendation in 2011?  According to McGurn, all but a small handful of boards receiving negative ISS recommendations, whether or not they received negative shareholder votes, responded in some fashion.  Almost all companies changed their compensation to link it better to actual performance.  Each of the three companies who received negative votes in 2011 and who have already had their 2012 annual meetings have received over 90% approval in their 2012 say-on-pay votes by the shareholders.

The key is not only changing compensation to link it to company performance; the key is also outreach to investors to understand and meet their reactions.  Disclosure is much better of course, and this facilitates communication, but some companies also have been doing formal compensation roadshows.

The problems with compensation are no longer extra perks, severance and the like, which McGurn described merely as “irritants.”  The issues now are actually tying compensation to performance, and addressing executive compensation which is a multiple of peer group mean compensation.

There is something of a contrast between this relatively self-satisfied ISS report, on the one hand, and the extensive article in this past Sunday’s New York Times Business Section concerning executive pay.  Discussing pay for the top fifty public company executives whose information has already been reported in this proxy season, the Times article concludes that while executive compensation growth may have leveled off, it has leveled off at an extremely high point in terms of absolute dollars.  Even taking Apple’s CEO out of the equation (earning something in excess of $378,000,000, although most of it was indeed in stock and not cash), CEO compensation in numerous business sectors was significant.

The panelists, chairs of compensation committees of public companies, had differing reactions.  One panelist noted that, in a highly successful company where compensation was discretionary (but it turns out not above mean), there was resistance to having ISS force mathematical metrics into the equation in order to define and calculate appropriate compensation.  There was also criticism of an over-emphasis on “total shareholder return” which is an important ISS metric; in technology companies with high potential volatility, an executive can be doing an excellent job and yet profitability can take a short term beating because of the realities of the marketplace.

The ISS response was that they have lengthened their time horizon by which they are comfortable in measuring corporate performance, to take pressure off the very short term, but McGurn did note that his clients (ISS’s clients) are long-term investors, and at some point total shareholder return on investment becomes “the” metric in which his clients have an interest.

There was also discussion of the somewhat opaque selection of peer groups in which ISS places each company (so that compensation can be measured against what are putatively the company’s peers).  McGurn noted that each company is placed in a peer group wherein that company is placed near the mean in terms of size, further noting that one of the largest determinants of absolute compensation is indeed the size of enterprise.

In 2012, ISS sees as its hot spot the payment of executive compensation above the peer mean by companies showing mediocre performance, although McGurn assured the group that ISS has no particular performance metric and that each company is entitled to have its own metrics; what he is looking for, he says, is “evidence of intelligent design” as opposed to a rote set of numbers.

Finally, the panel noted that an effort was being made to address the ratio of CEO compensation to the compensation paid to the rest of the executive team; they declared an end to “the rock star CEO.”  That announcement may come as a surprise to readers of the New York Times CEO survey.

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