As the income gap in America continues to warrant headlines, executive compensation at publicly-traded companies remains in the spotlight for investors and other important stakeholders. For institutional investors, it’s still a top governance issue; in the 2018 Edelman Trust Barometer Special Report: Institutional Investors, respondents indicated that “aligning executive compensation with investor interest” was the top corporate governance practice that impacts their trust in a company. Excessive compensation packages, and those uncoupled from shareholder returns and operating performance, could reveal larger governance issues, raising a red flag about the relationship between a company’s board of directors and its CEO.
Beyond shareholders, other parties such as employees and the media are paying increased attention to executive pay, fueled in part by a recent regulatory development. The CEO Pay Ratio disclosure went into effect in 2018, requiring public companies to report the median annual total compensation of all employees, excluding the CEO; the annual total compensation of the CEO; and the ratio between the two. If the latter is an outlier from a company’s peer set, it will draw unwanted attention.
In the last two proxy seasons, local media across the U.S. has homed in on seemingly outsized gaps between CEO and median pay at local companies, sometimes drawing the ire of employees, customers and the broader community. These developments mean that compensation committees’ decisions – and how they communicate them – are taking on increased importance and creating further reputational risk.
Shareholder activists and executive compensation
Shareholder activists have long raised issues with the level and mix of executive pay packages. Though rarely the central focus for economic activists, they have pointed to excessive or misaligned management pay to argue that boards are failing in their supervisory duties or are under the influence of an imperial CEO. These critiques are often meant to garner support from proxy voters at passive funds.
Icahn Capital’s attacks on SandRidge Energy in 2018 offer a prime example of an activist using excessive managerial compensation to portray a board as out of touch with shareholders. In highlighting the company’s “long history of excessive compensation” and a “king’s ransom” in severance paid to a former CEO, Icahn argued that the incumbent board could not be trusted to maximize shareholder value. The activist later received five board seats in a settlement agreement.
Beyond traditional activism, in recent years an increasing number of environmental, social, and governance (ESG)-focused investors have been pushing companies to align pay with issues they care about, or to otherwise introduce changes into the development of executive compensation packages, usually through shareholder proposals. While these proposals often fail to achieve majority support, companies are increasingly opting to settle with the activists to remove the proposal from their proxy ballot and avoid reputational risk.
For example, last proxy season Trillium Asset Management reached a resolution with Procter & Gamble (P&G) after the activist had raised a proposal calling for the company’s compensation committee to consider the pay grades and/or salary ranges of all classifications of P&G employees when setting target amounts for CEO compensation. Trillium noted that the proposal would encourage the committee to consider whether the CEO’s compensation is internally aligned with the company’s pay practices for its other employees. As part of a resolution, P&G agreed to add language to the proxy indicating that the CEO-to-worker pay ratio is one of the factors considered in determining executive compensation.
Key takeaways for communicators and investor relations officers
In addressing executive compensation with external audiences, boards and management may consider the following:
- Make executive compensation a key agenda item for shareholder engagement. Companies with shareholder engagement programs – formal or otherwise – should ensure that they discuss their philosophy around executive compensation, and detail how the specifics of executive pay packages align with this philosophy. Gathering feedback to address shareholder concerns is equally critical.
- Ensure the compensation committee has a visible role in communicating executive compensation. While management may provide input to a company’s compensation program, companies must avoid the appearance that executives – on the board or not – have outsized influence over compensation decisions. A member of the compensation committee should be able to lead the discussion and answer tough questions (within reason) from investors regarding executive remuneration.
- Be prepared to explain and defend peer group selection. Activists often claim that target companies have cherry-picked the peer groups in their proxy to make otherwise excessive compensation practices more palatable to investors. Companies need to be prepared to explain why the selected peers make sense for benchmarking purposes, and to justify any recent changes to the peer group.
- Simplify your executive compensation discussion and analysis in your company proxy. In “Pay Without Performance,” Lucian Bebchuk and Jesse Fried’s 2004 seminal book on executive compensation, the Harvard Law professors distinguish between disclosure and transparency. While disclosures have improved in recent years, transparency has not, with pay packages becoming ever more complicated. We believe an appropriate standard for companies to strive for in preparing their CD&A and other communications around their executive compensation program is whether a well-informed investor can understand each named executive officers’ compensation package, including its mix and incentives.
Effectively communicating executive compensation can make companies less vulnerable to activist attacks. It can also help boards and management win the trust of investors and other important constituencies, which is at the heart of the communications and investor relations functions.
Julia Sahin is vice president, Financial Communications & Capital Markets, New York.
Patrick Ryan is vice president, Financial Communications & Capital Markets, New York.
Jeremy Cohen is vice president, Financial Communications & Capital Markets, Chicago.