”The following are our observations on the second year of mandatory “say on pay” votes for U.S. public companies under Dodd-Frank thus far this proxy season.
Results of Vote. As of June 25, 2012, of the companies that have reported results for 2012, 54 have failed their say on pay votes. This is an increase from 2011 and there remain a number of companies left to report. Four companies have failed two years in a row. 396 companies in the S&P 500 have reported say on pay results as of June 22, 2012, of which 384 received majority shareholder support (97%). Similar to last year, the mean level of shareholder approval is 89% and the median level of shareholder approval is 95%.
Influence of ISS. The recommendation of ISS continues to have a measurable impact on voting results. ISS has recommended against say on pay proposals at approximately 14% of the S&P 500 companies as of June 22, 2012. Of companies receiving unfavorable vote recommendations from ISS, 21% of those that had reported results as of June 22, 2012 failed to receive majority support. Companies receiving negative ISS recommendations that have nonetheless received majority support have generally done so with considerably lower margins than those receiving a favorable ISS recommendation. According to a recent study by Pay Governance, a negative ISS recommendation results in an average shareholder support level of 65% versus 95% for those receiving a positive ISS recommendation (for S&P 500 companies, the difference in support levels based on such recommendations is 59% versus 94%). According to the same study, this is a 10% increase over last year’s correlation. During the approximately two years of mandatory say on pay proposals under Dodd-Frank, only one company that received a positive ISS recommendation failed to receive majority shareholder support. The median change in voting results following a year-over-year change in ISS recommendation is approximately 27%.
Reasons for Negative Vote Recommendations. In the vast majority of situations in which ISS has recommended a vote against say on pay, it is because ISS believes that there is a “pay for performance disconnect.” A “pay for performance disconnect” generally exists if, in ISS’s view, (1) there is a lack of alignment between CEO pay and TSR as compared to an ISS-selected peer group over a one-year (weighted 40%) and three-year (weighted 60%) period, and there is a lack of absolute alignment between CEO pay and the company’s TSR over the preceding five-year period and (2) the company does not provide compensation that from a qualitative perspective is sufficiently performance-based.
In determining whether compensation satisfies ISS’s qualitative measures, ISS assesses (1) the ratio of performance- to time-based equity awards, (2) the ratio of performance-based compensation to overall compensation, (3) the completeness of disclosure and rigor of performance goals, (4) the company’s peer group benchmarking practices, (4) actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both on an absolute basis and relative to peers and (5) special circumstances (e.g., a new CEO in the prior fiscal year or biennial equity grants).
Problems with the ISS Methodology. The criticisms of ISS’s methodology are well-known (see our 2011 memorandum, Say on Pay So Far). This proxy season, we witnessed a particular emphasis on one aspect of ISS’s methodology: its selection of peer companies. ..
Read the full entry by Jeremy L. Goldstein, Wachtell, Lipton, Rosen & Katz