2014 Proxy Season Issues: Compensation Disclosures and Shareholders’ Proposals

May 1, 2014

5273Reporting companies are advised to carefully consider several issues as they prepare for and complete their 2014 proxy seasons.  First of all, while “say-on-pay” votes by shareholders (for discussion see Business Transactions Solutions §106:61) are only advisory under US law (i.e., shareholder approval of executive compensation is not required in order for payment arrangements to be effective), companies should nonetheless take into account the opinions of their shareholders regarding the fairness of executive compensation arrangements.

In general, shareholders of Russell 3000 companies that had say-on-pay votes in 2013 endorsed executive compensation proposals, often by overwhelming margins—91% of the companies received approvals from over 70% of their shareholders.  However, some proposals, albeit a small percentage of companies (2.5%) did not garner majority approval and all companies are well advised to ensure that they invest time and resources in shareholder outreach to explain executive compensation programs and make full disclosure regarding those programs in proxy materials.  In addition, the likelihood of shareholder is improved to the extent that it is clear that pay is closely related to performance and companies should seriously consider making equity awards to senior executives contingent upon attainment of objective performance-based milestones.

A second issue for companies to monitor is the increasing activism with respect to inclusion of shareholder proposals in proxy statements.  While labor unions have previously been the primary sources for shareholder proposals, hedge funds and religious groups have become more prominent in the movement and shareholder proposals typically fall into one of three areas: shareholders’ rights (e.g., board declassification; majority voting in the election of directors; proxy access; and elimination of supermajority provisions to amend company bylaws); corporate governance (e.g., board diversity, board leadership; and term limits for directors); and social and environmental issues (e.g., human rights; environmental sustainability; and limits on corporate political activities).

Companies should be mindful that the leading proxy advisory firm, Institutional Shareholder Services, has announced that it will carefully monitor how companies respond to majority-supported shareholder proposals and will continue to review how well companies are doing with respect to aligning executive compensation with the company’s performance as measured by the investment returns enjoyed by shareholders.  In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) requires that the SEC adopt “pay-for-performance” rules (for discussion see Business Transactions Solutions §106:61) that would force companies to disclose material information that shows the relationship between compensation actually paid to executives and the financial performance of the company, with performance measured in part by reference to changes in the value of the company’s stock and dividends paid by the company.  The content of these rules will not only impact the disclosure process but should also be borne in mind by compensation committee members as they establish compensation packages for company executives.  Dodd-Frank also includes a requirement for new “pay ratio” disclosures that would obligate companies to inform the investment community about the ratio of the compensation of the company’s principal executive officer to the median compensation of all employees of such company, excluding the principal executive officer; and a mandate to the SEC to direct national securities exchanges to refrain from listing companies that that do not develop, implement and disclose compensation “clawback” policies that provide for recovery of compensation that any current or former executive officer of the company was erroneously awarded in the event the company is required to restate its financial statements due to “material noncompliance” with any financial reporting requirement under the securities laws.