Words are not Enough

This summer I’ve written a series of blogs on compensation changes disclosed this year, including some positive and significant reforms. However, many of the changes I read in proxy statements this year struck me as being what Mary Poppins called, “piecrust promises: easily made and easily broken.” There was consistently more PowerPoint style than employment agreement substance.

Whether the change was big or small the language was always grand. Mylan, the company with the lowest vote of the season, had language of reform in its proxy: “Based on . . . extensive shareholder engagement, as well as the Mylan Board’s own independent analysis and initiatives, we have implemented numerous robust compensation-related policies.” They had implemented some changes, but Mylan didn’t listen to shareholders overriding concerns, entering into what investors described as a “third new and excessive employment agreement” with Robert Coury.

Bloomberg’s Anders Melin reported that seven S&P companies have failed CEO pay votes this year, more than in the prior few years. What can these losses tell us about compensation reform in general?

The first lesson, that improved disclosure will no longer appease shareholders, is good news. Dressing up a bad plan with a pleasing PowerPoint only takes you so far. ConocoPhillips shared with its shareholders multiple defenses of its pay, without persuading the majority of shareholders to support the plan. The changes the company had made were minor and insufficient to satisfy shareholders in the face of the company’s outsized compensation.

Another lesson, however, is easy to miss. When investors take the time to deeply research and then highlight issues, it appears shareholders are more willing to oppose them. However, the cases where such a deep dive is conducted appear to be minimal. Of companies with failed advisory votes this year several were at companies where shareholders shared their expert analyses on publicly filed SEC postings. Mylan was the highest profile such case, with an effort that included New York City Comptroller Scott M. Stringer, on behalf of the New York City Pension Funds; New York State Comptroller Thomas P. DiNapoli, the California State Teachers’ Retirement System, and PGGM.

FleetCor Technologies also faced a campaign in opposition to its compensation led by an investor, CtW Investment Group, who put in extensive research and filed its critique of the company publicly at the SEC. Subsequently the company lost its second advisory vote in a row.

Southern Company received support of less than two thirds of votes cast on its advisory vote after investors critiqued pay at the company.

The Teamsters’ analysis of McKesson shined a light on one issue in particular that might easily have been otherwise overlooked. The company had been through a series of reforms following other low votes. In its critique of compensation this year the Teamsters highlighted the fact that the company eased away from a TSR units, after they failed to perform. Going forward, rather than just relying on TSR compared to peers, the so-called TSR units now include “three-year Cumulative Adjusted EPS” as a factor. This is the sort of change that would be easy to skim over in a proxy statement, and yet it represents a retreat on prior commitments. To identify this, the analysts needed to read not just the current proxy statement, but prior ones, comparing prior disclosure, benchmarks and outcomes. The finding at McKesson underlines the fact that compensation programs deserve close and specific attention that may be beyond the capacity of some investors, and the will of many more.

Complicated performance-based plans are more common than ever, and messing with metrics can keep compensation consultants fully employed indefinitely. Whether it is ultimately in the best interests of shareholders is another question. Perhaps it is time to consider what is accomplished by the fine tuning and retuning of goals. Steve Clifford in The CEO Pay Machine: How it Trashes America and How to Stop It writes: “All pay-for-performance systems cause more harm than good. They generate perverse incentives, undeserved and often absurdly high bonuses, and damage the companies that use them.”

Performance share units may be an improvement over stock options. However, they are also less straightforward. In years past companies caused the wrath of shareholders to rain down upon them by repricing stock options. That practice, reasonably easy to discover, has essentially been eliminated. Egregious changes going forward, however, are likely to be much more subtle, and easier to miss. A few words in the proxy regarding modifying PSUs or accelerating vesting under certain conditions could mean a windfall for an undeserving executive. By the time the windfall has been received it will be too late for shareholders to take action.

Another example of a piecrust promise: vows to use less discretion. I read many companies who heard from shareholders about frustration with discretion and proudly noted that they had not used discretion this year. Others who heard from shareholders about a particular grant responded that “we have no intention” of using such grants in the future. Whether these companies will honor this intention requires watchfulness.

Engagement seems to be the best beloved word of both boards and institutional investors. On August 31, Vanguard released its Investment Stewardship 2017 Annual Report which noted that executive compensation was a topic at 55% of engagements. Without minimizing the good that can be and has been accomplished in conversations, it is impossible to know what engagement means. If engagement means sending a junior staff member to listen to a company extol its plans in mind-numbing and confusing detail, it is essentially useless. Vanguard has one of the lowest levels of opposition to pay of any of the funds we’ve examined. Even discussions of substance ring hollow when there is no follow-through. Engaging without vigilance and consistent follow up is insufficient. Engagement without a real possibility of voting in opposition is practically meaningless.