Companies, investors and other key stakeholders acknowledge that executive compensation programs are often complex, multilayered and challenging to describe or explain succinctly. The Compensation Discussion & Analysis (CD&A) section of proxies, required of most U.S. companies since 2006, as well as Say on Pay votes, required of most U.S. companies since 2011, have been major motivators and opportunities for companies to more clearly explain their executive pay programs, including the vehicles, their rationale, related performance metrics and their rigor. While most companies claim to have a “pay for performance philosophy,” this promise rings hollow unless accompanied by detailed explanation of how it works in practice.
Another common investor inquiry, that started as early as two decades ago, is how a pay program supports business strategy. It makes sense that investors want to see C-suite and other executives incentivized and rewarded for behaviors and achievements aligned with major elements of a company’s business strategy. Unfortunately, until recently, such clear explanations have been the exception and not the rule. The good news is this appears to be changing, and over the past couple of years, we have seen an encouraging increase in the prevalence, quality and accessibility of such disclosures.
Major institutional investors understand the importance of pay programs as incentives for appropriate achievements and drivers of shareholder value. Despite the complexity of many pay programs, these investors do attempt to cast thoughtful, company-specific pay and other votes.
Investors owning thousands of U.S., and even more global, companies are challenged to perform detailed analysis of every portfolio company proxy and pay program. For this reason, some report using proxy advisors, such as ISS and Glass Lewis, as data aggregators and screening tools, to help them identify companies and proxies for more in-depth scrutiny. When proxy advisors recommend against Say on Pay proposals, for example, many of these investors will then turn to the proxy—treating it more as a reference than a reading document—to see what added context or rationale these companies provide about their pay programs. If what they find is relatively opaque or boilerplate, it doesn’t provide much ammunition for them to ignore the proxy advisor recommendations. However, when they do find succinct, clear and credible discussions of the alignment of the pay program with company strategy, these investors then have more context and rationale to support the company, despite administrative or other features the proxy advisors may have objected to. Mitigating over-reliance by investors on proxy advisor recommendations is a major objective for many companies, and clear disclosure—explaining the “why” and not just the “what” about pay programs—is one way to achieve that.
Increasingly, we are seeing CD&As structured in the following way:
These disclosures can manifest themselves in several locations or sections of the proxy including:
While a rigorous, scientific sample does not yet exist, we are seeing a correlation between companies providing such credible discussions of pay and strategy, with lesser vote impact from negative proxy advisor vote recommendations.
Ron Schneider is the Director of Corporate Governance Services for DFIN. He can be reached at email@example.com.