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May 13, 2012

Say on pay: round two

A look at trends and developments in the second say-on-pay proxy season in the US

When Nvidia bought back employees’ underwater options in 2009, the Californian semiconductor manufacturer anticipated a backlash. What it didn’t necessarily envision was that shareholders would revisit the decision each proxy season in the form of an annual say-on-pay vote.

‘We knew in the purest ideological sense that you get a black mark against you for repricing options,’ says Chris Evenden, Nvidia’s senior director of IR.

‘But if someone wanted to get options repriced, the easiest way of doing that was to change companies – so our options had become a disincentive for performance. Sometimes you’ve just got to take your lumps rather than have an outflow of staff.’

Evenden, who has personally made this case to Nvidia’s top shareholders, realizes that the argument rests on industry specifics. In the repricing options debate, it matters, for instance, that star engineers in Silicon Valley can easily find positions at a host of semiconductor competitors.

For IR professionals like Evenden, say on pay is a time-consuming and angst-ridden issue (in 2010, the company received 68 percent shareholder support on pay, just under the 70 percent threshold considered ‘safe’ for future votes), and for the rare marquee-name company that loses a say-on-pay vote, the issue can prove a PR nightmare.

On April 17, for instance, Citigroup made the front page of the New York Times when only 45 percent of shareholders approved the bank’s $15 mn compensation for CEO Vikram Pandit.

Taking the lead

More than 40 percent of IR professionals in the US had some sort of involvement with say on pay during the 2011 proxy season, according to a report published earlier this year by IR Insight, the research arm of IR magazine.

As that report suggests, it is the corporate secretary who most often spearheads a company’s say-on-pay campaign. At Valero Energy, for instance, the corporate secretary takes the lead on say on pay, while Ashley Smith, vice president of IR, handles the company’s outreach to its top 25 holders.

‘Once say on pay becomes an issue with investors, that’s when I get into the mix,’ Smith comments. ‘I start making phone calls to explain the situation, and I try to sway votes.’ He estimates that during November and December, he spent three to four hours a week discussing pay with investors.

The corporate secretary also took the lead at Nvidia, while Evenden contacted the company’s top 20 shareholders, which account for 52.9 percent of the company’s shares.

Evenden quickly learned that the portfolio managers with whom he had a long-standing relationship rarely engaged in the say-on-pay conversation, so the firm had to forge relationships with individuals in various governance departments.

‘The challenge was that we’d never communicated with them before, and we were suddenly obliged to communicate,’ he recalls.

Evenden spends one month a year working on say on pay and coordinating the company’s investor outreach plan. On most calls, he accompanies the corporate secretary and the senior HR person, who is the expert on options and restricted stock units.

Evenden is keen on board involvement because it enables directors to learn first-hand what investors think. He also maintains that institutional investors may feel uncomfortable discussing the CEO’s pay with an IRO, because the IRO is subordinate and will almost inevitably earn less. This awkwardness can be sidestepped when directors and shareholders talk directly to one another.

Other approaches

The corporate secretary-led set-up is far from universal, however. At California-headquartered Autodesk, Dave Gennarelli, director of IR, assumes the lead on say on pay, even though legal and HR are intimately involved.

‘I’m the go-to person for getting it all done,’ he says. Typically, Gennarelli dedicates two to three months of ‘hard labor’ to this issue.

Autodesk, which received 84 percent support for its pay plan last year, has found that there’s no blueprint for how investors handle proxy voting.

‘There are some institutions that are very strict and follow their guidelines to the letter,’ Gennarelli points out. ‘Others put forth guidelines, but the rules aren’t hard and fast. There’s some wiggle room – so opening up that dialogue is key.’

Meanwhile, Consol Energy falls somewhere in between: legal, IR, management, the board and the company’s outside compensation adviser all work closely together on say on pay.

Dan Zajdel, vice president of IR, describes his job as engaging in active outreach to large institutional investors throughout the year.

‘As we move toward the end of the calendar year, we ask whether there are any outstanding issues shareholders wish to discuss with us,’ Zajdel says. Soliciting investor feedback is, for him, the key to understanding issues of importance to shareholders.

Fabrizio Ferri, assistant professor at Columbia Business School, believes facilitating a dialogue is the IR professional’s chief responsibility. ‘The IRO’s job is to promote that conversation in a systematic and organic way ahead of an actual vote,’ he emphasizes.

Avoiding the hot seat

Some companies know they’re facing thorny compensation issues but can still be taken aback when one of the major advisory firms recommends a ‘no’ vote.

Smith faced that situation when Glass-Lewis again issued a critical report on the company’s pay practices in April 2012 – even though ISS had been favorable for the previous two years running.

He finds the mixed messages frustrating: ‘You don’t always know how to get an A,’ he says. ‘It’s all about carrots and sticks, and the big stick is when proxy consultants go after board members. That’s how they flex their muscle.’

Too often, observes Evenden, the arguments about executive compensation hinge on arcane points requiring lengthy explanation. In 2011, for instance, ISS measured Nvidia’s performance on a calendar year rather than the fiscal year used by the company. This meant ISS’ assessment was very different from Nvidia’s (semiconductor stock prices are notoriously volatile).

ISS also penalized Nvidia for dramatically increasing CEO Jen-Hsun Huang’s salary, even though it had returned to usual levels after he received $1 in compensation the previous year. ‘It was touch and go for a while because this registered as a massive pay increase,’ says Evenden.

Performance points

Although many things can trigger say-on-pay woes, poor performance is a factor. Zajdel is hopeful that Consol’s record net income and record cash flow from operations in 2011 will be favorably viewed by shareholders. Last year, Consol received 55 percent support in its say-on-pay vote.

Even with strong performance and no compensation red flags, however, many companies are still dead serious about their say-on-pay efforts.

Microsoft, for instance, received 99 percent support last year for its pay package – and yet twice a year, Bill Koefoed, general manager of IR, and John Seethoff, vice president and deputy general counsel, reach out to the proxy teams at 20 to 30 of the company’s largest investors.

‘Our CEO’s base pay was $500,000 and his bonus was $500,000,’ says Koefoed. ‘Given that we’re a Fortune 10 company, people don’t have a problem with that.’

Inspired by efforts to shore up the company’s say-on-pay vote, Evenden is looking for ways Nvidia can communicate plainly about compensation in its proxy. In this sense, say on pay is proving a resounding success. Evenden also welcomes the new dialogues the issue has sparked, as does Gennarelli.

‘All in all, I’ve developed a much stronger relationship with the voting side of these institutions, which I’d never cultivated before,’ Gennarelli notes. ‘Say on pay definitely spurred that.’

A new dialogue

Ferri confirms that in the UK, where say-on-pay votes have occurred for the past decade, the main benefit has not been lower executive compensation levels (these haven’t budged) but in setting the stage for a constructive conversation.

In the US, where compensation sums have hit astronomic levels unknown elsewhere, say on pay might actually temper corporate largesse, suggests Ferri.

‘The whole point of a say-on-pay vote was to provide the board with the backbone to stand up to the CEO when it comes to compensation,’ he observes. And although one year makes for a very short track record, he’s seen signs that say on pay is achieving this end, too.

Reading the most recent round of proxies, Ferri notes that many companies did address shareholders’ concerns about compensation and altered their pay policies accordingly.

Consol Energy, for instance, froze executive salaries and reduced CEO Brett Harvey’s annual salary by $100,000, moving his payout to more at-risk forms of compensation.

‘What you want is a more constructive conversation about how to turn the compensation scheme into a competitive weapon for a company to perform better,’ concludes Ferri. ‘The anecdotal evidence so far is that companies responded to the votes.’