The Dodd-Frank Wall Street Reform and Consumer Protection Act, which became law in July 2010, requires public companies to include in their 2011 proxy statements a non-binding shareholder vote on the compensation of their top executive officers. Dodd-Frank also requires public companies to conduct a separate shareholder vote on the future frequency of the say-on-pay vote (every one, two or three years), known as "say-when-on-pay."
While the U.S. Securities and Exchange Commission's (SEC) rulemaking schedule to implement Dodd-Frank has already been delayed several times, the new say-on-pay rules represent the major regulatory change for corporate boards and general counsel this proxy season. The SEC proposed rules to implement these requirements on Oct. 18, 2010 and the final rules were adopted on Jan. 25, 2011.
This will be the first time many shareholders are considering say-on-pay proposals and their resources to engage may be strained if they are casting multiple votes on public company ballots. Clear and illustrative explanations of pay policies are critical so investors can quickly evaluate a company's pay practices and how well they align with performance. In describing executive compensation policies and practices, companies can make their disclosures most useful to investors by:
- Ensuring proxy materials demonstrate a clear relationship between company performance and compensation paid or awarded
- Detailing how compensation plans, programs and designs facilitate the achievement of the company's strategic objectives
- Highlighting the "good" or "best practices" the company has embraced in compensation disclosures
- Dealing head-on with any controversial or "hot-button" pay practices and providing the company's rationale for maintaining such practices
- Utilizing tables, charts and graphics to help tell the company's story to shareholders
- Understanding the perspective of key shareholders on compensation issues and any warning signs based on how they've historically reacted to pay practices
How often investors vote on pay has also created a debate surrounding the annual, biennial and triennial options. The decision of which say-on-pay frequency to recommend should be made by each company's management and board based on the company's individual circumstances, such as the nature of the company's shareholder base (i.e., number of institutional versus retail shareholders) and the general level of shareholder satisfaction with company performance and executive compensation practices.
Many shareholder groups and proxy advisory services are strongly recommending annual votes. Arguments supporting this option include:
- From a corporate governance and shareholder communications standpoint, annual votes should help provide management with closer to real-time and more direct feedback on the company's current compensation practices.
- Many practitioners and commentators believe that annual votes will become more routine from the perspective of shareholders and thus will not engender as much institutional shareholder (or special interest group) scrutiny.
- Some commentators believe that, in off years of biennial or triennial say-on-pay votes, institutional shareholders may be more likely to express any dissatisfaction over executive compensation by increasing their withhold/against votes for compensation committee members.
Companies must weigh these factors against arguments supporting a biennial or triennial say-on-pay vote. A vote every two or three years may align more closely with the company's longer-term approach toward executive compensation, and may also avoid reactionary shareholder votes responding to short-term stock price drops or unusual company events.
There simply is no "one size fits all" approach to say-on-pay compliance. Even with the additional guidance in the SEC's final rules, companies will need to make a series of important decisions to ensure that their organizations are in compliance while also taking into account the unique needs of investors, board members and management.
This column is the first in a series of articles on the impact of increasing and evolving governmental regulation and reform in the corporate governance arena.
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