Since the passage of Dodd-Frank in 2010, public companies must periodically ask their shareholders to approve the compensation of their top executives. While the results of these “Say-on-Pay” proposals are non-binding – companies aren’t required to make any changes to pay practices as a result of the vote results – the disclosures around executives’ pay packages and commentary around the voting results can heavily influence a company’s reputation with institutional shareholders and in the media and create turmoil at the board level and among a company’s employee base. Avoiding these reputational risks requires companies to communicate their executive compensation philosophy and structure carefully and effectively.

Say-on-Pay was introduced following public outcry regarding executive pay during the financial crisis – both regarding overall dollar amounts and the incentives embedded in executives’ packages. It brought new levels of transparency (but not necessarily clarity) to executive compensation programs, both in terms of the amounts paid and the philosophy behind compensation practices. However, compensation disclosures are complicated and often written in “legalese.” Therefore, the big-ticket headline numbers grab attention and many stakeholders do not focus on the underlying long- and short-term incentives and the mechanisms in place to align pay with performance.

Average shareholder support for Say-on-Pay proposals has trended downward in recent years, with notable losses at Apple and Intel. Proxy advisory firms Glass Lewis and Institutional Shareholder Services (ISS) advise that companies with an approval level below 80% and 70%, respectively, address the issue in their subsequent proxy statements by providing disclosures around shareholder outreach, as well as outlining concerns voiced by shareholders and any actions the company has taken to address them.

Say-on-Pay failures hit a record high last year and average shareholder support hit a record low.

In an environment where growing income inequality is a hot-button political issue, communicating a topic as delicate, nuanced and potentially inflammatory as executive compensation can be fraught. The key to success is to clearly frame your approach in order to earn trust – and votes.

Be clear about what is actually paid and what is at risk. Most boards clearly communicate their compensation philosophies, often highlighting a pay-for-performance strategy that aligns an executive and shareholders’ interests. They also take great care to institute performance hurdles, vesting timelines and other mechanisms that are intended to align executive pay with long-term value creation – which can put a meaningful portion of an executive’s pay at risk. However, the Compensation Discussion & Analysis section of the proxy statement is often mired in legalese and, as a result, the care taken to align incentives gets lost in complicated technical rhetoric. Many stakeholders – and media – instead just home in on the headline figure. While the SEC’s recently adopted “compensation actually paid” metric could help address this issue by emphasizing the at-risk nature of an executive’s comp, it could also add to confusion about the “actual” value of grants. Make sure to help shareholders understand how the vesting schedules and mark-to-market calculations work.
Communicate all factors driving pay packages. Compensation programs are meant to incentivize performance and retention – and an excellent executive is often in high demand. If a board is taking practical steps to address a highly competitive market or competitors’ recruitment efforts, that is an important aspect that shareholders need to know and understand.
Read the room. With waves of layoffs in the last year and increased dialogue around income inequality and the shrinking middle class, large executive compensation numbers not only garner negative media attention, but they can also stanch employee motivation and damage morale. Be ready to explain how the board has taken steps to guard against executive overpayment during times of underperformance and to contextualize executive compensation practices amid cost-reduction initiatives and layoffs.
Make sure proxy advisory firms get it right. Proxy advisory firms (ISS, Glass Lewis and Egan-Jones) can heavily influence investors on Say-on-Pay. These firms use specific parameters to judge awards, especially one-time awards. Don’t let proxy advisories take your Say-on-Pay proposal at face value – offer context and reasoning around your company’s compensation practices so that you can achieve an accurate scoring. And if they get something wrong, correct the record.

Scrutiny surrounding executive compensation is not new, but in a challenging macroeconomic backdrop, the issue is even more fraught. A failed Say-on-Pay vote can fuel negative headlines and sow seeds of discord, making fertile ground for an activist investor to wage a proxy fight. Make sure your executive compensation disclosures and stakeholder communications paint the full picture and demonstrate clear alignment between performance and pay to mitigate the pressure you might otherwise face at your next annual meeting.