Early Results from 2011 Proxy Season Show Trends on “Say-on-Frequency” Resolutions

Charles Nathan is Of Counsel at Latham & Watkins LLP and is co-chair of the firm’s Corporate Governance Task Force. This post is based on a Corporate Governance Commentary by Mr. Nathan and James D.C. Barrall of Latham & Watkins, and David S. Drake, Steven Pantina and Rhonda L. Brauer of Georgeson Inc.

According to our research, more than 300 companies subject to Dodd-Frank’s say-on-pay vote requirements have filed proxy statements thus far this year. Of those, 125 companies have held shareholder meetings at which shareholders have voted on advisory resolutions on the frequency in which say-on-pay resolutions should appear on the proxy ballot (commonly referred to as “say-on-frequency” or “say-WHEN-on-pay”), including 77 companies in the Russell 3,000 index and 55 companies in the S&P 1,500 index. Of the 125 votes submitted to date, more than 50% of companies have recommended triennial say-on-pay votes to their shareholders.

Breakdown of Management Recommendations on Say-on-Frequency through February 2011

Annual Biennial Triennial No Rec.
All Companies 27% 8% 57% 8%
Russell 3,000 30% 9% 49% 12%
S&P 1,500 31% 9% 51% 9%

Although most companies have recommended to their shareholders that they support triennial votes, less than a majority of companies that recommended such have had their resolution receive at least a plurality of votes cast in favor. Moreover, the vast majority of those that received majority support for a term other than annual were smaller companies outside of both the S&P 1,500 index and Russell 3,000 index. In fact, of the S&P 1,500 companies that have recommended shareholders adopt triennial votes and have reported results (24 companies), only five have received plurality support for their respective option. We note, though, that three of the five companies had a significant portion of their outstanding shares held in friendly hands or had a second class of stock with superior voting rights that was controlled by management.

Companies Recommending Triennial Votes on Say-on-Frequency

# Recommending Triennial Votes # That Received Plurality Support % That Received Plurality Support
All Companies 45 21 46.6%
Russell 3,000 29 7 24.1%
S&P 1,500 24 5 20.1%

The early results from the first two months of the 2011 proxy season are likely instructive of how the season will progress going forward. While a handful of institutions have decided to support triennial votes, including a few of the more prominent institutions such as BlackRock International and Capital Group, a majority of institutions that develop and follow their own in-house proxy voting guidelines have decided to support annual votes on say-on-frequency resolutions. Given the voting guidelines and preferences we have observed thus far, including both ISS and Glass Lewis recommending shareholders support annual resolutions, it appears that achieving a plurality in support of triennial say on pay votes will be a challenge for most companies.

Average Votes on Resolutions Recommending Triennial Votes on Say-on-Frequency

Annual Biennial Triennial Abstain
All Companies 43.1% 1.8% 53.2% 1.9%
Russell 3,000 55.9% 1.6% 41.4% 1.1%
S&P 1,500 58.0% 1.4% 39.4% 1.2%

That said, Georgeson firmly believes that companies should evaluate their own pay philosophies, plans and shareholder composition as they decide which preference best suits their circumstances and recommend that preference to their shareholders. As a general rule, there appears to be a direct correlation between the percent of shares held by institutional investors and the likelihood that shareholders will support annual votes on executive compensation. However, to the extent that a portion of shares are held by one or more of the larger institutions that support triennial votes, by directors and officers, in an employee plan or by retail investors (retail investors have traditionally supported management on corporate governance matters), triennial votes may receive majority support.

Making recommendations on say-on-frequency. Many clients have asked whether recommending triennial rather than annual votes will in itself be viewed as an indicator of poor pay practices. We continue to believe that this is not the case. However, we also believe that companies which have been historically challenged by shareholders on compensation issues need to consider this issue before embarking on a proactive campaign to adopt triennial SOP voting.

Proxy card set-up.We remind companies that most proxy tabulation systems include the flexibility to order the choices on the frequency vote to align with a board’s recommendation. We advise companies, particularly those with sizeable retail investor bases, to make sure that their proxy cards reflect the order of preference, if any, of the board, e.g., boards recommending triennial votes should order the voting options on the proxy card as such:

Triennial Biennial Annual Abstain

The effect of GRid on say-on-pay and say on pay frequency. Additionally, some clients have questioned whether the ISS Governance Risk Indicators (“GRid”) influence or are otherwise correlated with the vote recommendations made by ISS analysts on either the frequency vote or the actual Say on Pay referendum. The answer is clearly “no.” Thus far, we have seen several instances of ISS recommending “against” on the referendum despite an indication of “Low Concern” on the compensation portion of the ISS GRid. This is because GRid has not historically reflected the “pay for performance” test that results in the lion’s share of ISS “against” recommendations on SOP votes. Similarly, ISS’s across-the-board support for annual SOP votes is not influenced by the ratings.

The importance of pay for performance. The early results from this proxy season clearly show that the companies that are most likely to receive negative ISS recommendations on their say-on-pay votes and are most at risk of losing such votes are those companies where executive officer pay (especially that of their CEO) was not aligned with the company’s financial performance in 2010. Companies that failed ISS’s pay for performance policy in 2010 because their TSR performance in the one and three year periods ending in 2010 were in the bottom half of their S&P GICs category and whose CEO total direct compensation did not significantly decline are at special risk and should be prepared to deal with this issue in their 2011 proxy CD&A. They should also be prepared to reach out to their largest shareholders to prevent a failed vote.

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