Council Advises Shareholders to Engage on Dodd-Frank Say on Pay

By James Hamilton, J.D., LL.M., Principal Analyst, CCH Federal Securities Law Reporter; and CCH Derivatives Regulation Law Reporter; Co-author, Sarbanes-Oxley Manual: A Handbook for the Act and SEC Rules, Dec. 7, 2010.

Armed with an advisory vote on executive compensation bestowed on them by the Dodd-Frank Wall Street Reform and Consumer Protection Act, shareholders now have an attention-getting way to signal their displeasure with a portfolio company’s compensation practices, said the Council of Institutional Investors in a white paper on executive compensation at financial institutions and securities firms. While calling a say-on-pay against vote a blunt instrument, the Council advised shareholders voting against compensation to explain their objections in a letter to the company. The letter should be addressed to the chairman of the board compensation committee, said the Council, with copies to the board chairman and corporate secretary. This should be the first step in the process of shareholder engagement, advised the Council, and should be followed by in-person meetings. If change is still not forthcoming, shareowners can let the company know that they will vote against the reelection of compensation committee members. As a last step, shareholders should consider filing a shareowner resolution seeking improvements in specific pay practices.

In deciding whether to approve an executive pay package, noted the Council, shareholders should benchmark the executive pay against a number of best practices. For example, there should be multi-year performance metrics to measure sustainable long-term shareowner value growth, not simply short-term stock price gains. Similarly, there should be economic profit metrics that require the return on capital to exceed the cost of employing capital, which should be considered alongside more commonly used operational metrics, such as net income, revenue and ROE. In addition, the majority of incentives should be delivered as equity and the majority of vested and realized equity should be deferred into retirement. The incentive compensation should be subject to clawback in the event of financial restatement or major loss regardless of whether an executive has committed fraud. Finally, base salaries should not exceed the $1 million deductibility cap set by the Internal Revenue Code on pay that is not performance-based.