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Results mixed on shareholder 'say on pay' for top executives

by Gillian Brianna White
June 07, 2012


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Executive compensation -- what's it made of?

Executive compensation at a glance

  • Compensation packages saw decreases of 6.8 percent and 10.3 percent in 2008 and 2009 respectively
  • Tim Cook of Apple Inc. was the highest paid CEO in 2011 with a $378 million compensation package
  • As of mid-May, 515 companies had over 90 percent shareholder approval for compensation votes compared with 723 companies last year.


When the economy went belly up in 2008, even more maddening than the notion that financial institutions had gambled away client funds on risky investments was the fact that their high-ranking executives continued to pocket millions of dollars in salaries, bonuses and other compensation perks while betting the farm. 

So it came as little surprise when executive pay was one of the first issues to be put on the table when regulators began crafting new rules aimed at preventing another financial meltdown. The result was the so-called “say-on-pay” provision of the Dodd Frank Act of 2010.

Rule 14a-21(a) of the Securities and Exchange Act meant that shareholders were now allowed to vote yay or nay to executive compensation at a company’s annual shareholder meeting. While not technically binding, shareholder votes would exert pressure on companies and their boards of directors to hold executives to higher performance standards.

“2012 clearly is the year of pay-for-performance,” according to Jim Barrall, a partner at Latham and Watkins LLP, because companies spent the past two years working out what exactly would be required under Dodd-Frank’s say-on-pay clause. 

Barrall’s prediction seemed to bear out early on. The 2012 proxy season started out with a bang when Citigroup Inc. shareholders shot down the proposed $15-million pay package for Chief Executive Officer Vikram Pandit.

Citigroup profits rose only 4.4 percent in 2011 and missed fourth-quarter earnings expectations, yet Pandit was awarded a massive compensation package. (He abstained from taking a salary the previous two years.) With a majority vote of 55 percent, shareholders voted “no” to the package.

Days later, Citigroup and its board were sued by shareholder Stanley Moskal. In his lawsuit, Moskal said the rejection of the CEO pay package, a rare occurrence at major firms, signified a larger problem and “has cast doubt on the board's decision-making process, as well as the accuracy and truthfulness of its public statements.”

Just when it seemed that shareholders would hold executives’ feet to the fire, the opposite happened at J.P. Morgan Chase and Co.

Days after the company announced it had gambled away over $2 billion on a trade gone awry, JP Morgan hosted its annual meeting. Among the proposals was shareholder approval of executive compensation packages. With 91.5 percent approval, shareholders voted in favor of awarding CEO Jamie Dimon compensation worth $23 million.

While it’s true that many proxy votes were likely cast before the firm announced its loss, there was little to no evidence of shareholder outrage over the incident. It might have helped that Dimon, a popular CEO on Wall Street, had issued a self-flagulating mea culpa: “These were grievous mistakes, they were self-inflicted, we were accountable and we happened to violate our own standards and principles. This is not how we want to run a business.”

According to John Berlau, senior fellow for finance and access to capital at the Competitive Enterprise Institute, the likelihood of shareholder revolt, especially when it comes to a beloved CEO, is minimal. “People would rather sell the stock than mount a challenge against the CEO in a lot of cases,” Berlau explained. 

By the close of April, only about four of over 200 proxy votes had ended with shareholders objecting to an executive pay package.

So is it that simple? If you’re a beloved CEO you’re relatively safe, but if you’re not the most charismatic guy on Wall Street, you should watch your back and your pockets? There’s certainly more to it than that.

Shareholders may have yawned at JP Morgan Chase’s $2 billion loss in part because it paled in comparison with the bank’s $19 billion profit in 2011.

When shareholders do act, the results are far from conclusive. A negative vote for executive compensation does not automatically mean that payment will be withheld, but instead means the company will look into the way it determines its compensation.

For example, Citigroup released the following bland statement to shareholders after they voted “no” to Pandit’s pay package:

“Citi’s Board of Directors takes the shareholder vote seriously, and along with senior management will consult with representative shareholders to understand their concerns. The Personnel and Compensation Committee of the Board will carefully consider their input as we move forward.” 

While the public-at-large becomes angered by huge dollar amounts in executive pay, for shareholders, the fight is more about aligning executive pay with the performance of the company.

The purchasing of stock is predicated on the notion that shareholders exchange their hard-earned cash for partial ownership of a company. So technically, the CEO works for anyone who has purchased a share of the company that they lead. But according to executive pay consultant Robin Ferracone, some companies foster a different mindset.

“Many firms lack a culture that allows productive discussions and plans for setting bonuses,” Ferracone explained. “These same firms foster a culture of ownership among firm leaders rather than shareholders.”  Ferracone adds that the most important measure of long-term success and test of executive performance is total shareholder return.

So what happened in 2011? Revenues among S&P 500 companies were up 8.7 percent and earnings climbed 10.2 percent in last year, but thanks to market volatility total shareholder return was nearly flat, rising a paltry 0.3 percent.

CEO pay among Standard and Poor’s 500 companies rose 6.2 percent to $9.6 million for the average company. Still, this was a small gain compared with 2010, when compensation climbed over 20 percent. During the severe recession years of 2008 and 2009, compensation growth shrunk along with the economy.
According to executive pay experts at Equilar, an executive compensation data firm, recent increases in compensation were largely doled out in the form of performance-related equity. Stock awards increased nearly 11 percent while bonus payouts decreased by 5.4 percent.

“As companies are looking to tie more and more pay to performance, they’re granting more of their pay in equity, in the form of performance shares,” said Aaron Boyd, head of research at Equilar. Executive pay in the form of performance shares in particular, increased by 62.5 percent last year.

The increase in compensation awards that are tied to company performance may have played a role in a proxy season that proved to be less tumultuous than many expected. 

Some firms also took the initiative in the last two years to put more stringent executive compensation rules in place prior to being required to do so, including throwing clawback clauses into their compensation agreements.

Clawback provisions allow companies to pull back previously awarded performance- or incentive-based pay such as stock options, if an executive fails to meet the company’s ethical standards.

Morgan Stanley was one of the first major banks to implement clawback clauses in its corporate compensation practices and announced in 2012 that it had broadened the criteria under which clawbacks could be triggered. The company now retains the right to pull back compensation on all long-term incentive payment and executive pay can be taken back or cancelled for additional reasons, including substantial losses and the failure to adequately manage.

JP Morgan Chase also has a clawback provision in place that could be used to collect past compensation from the executives responsible for the bank’s recent trading loss.

Many shareholders have looked to the recommendations from proxy advisory services, most notably Institutional Shareholder Services, or ISS, and Glass Lewis, for guidance about how to vote on executive compensation packages. For better or for worse, the recommendations from these organizations hold a large amount of influence and require pay-for-performance tests.

“While these firms have no sanctioned powers, their influence cannot be ignored by boards and companies,” said Susan O’Donnell, managing director at Pearl Meyer and Partners. Overall, she said, companies with an ISS “against” recommendation received an average of 68 percent shareholder support, compared with 92 percent at companies that received ISS support.

Additionally, this proxy season proved that say-on-pay does not always have to be punitive. In the case of Caterpillar Inc., the alignment of performance with pay meant a 42 percent pay raise for CEO Doug Oberhelman after revenues at the firm grew at nearly the same clip, topping $60 billion.

According to Latham and Watkins’ Barrall, the most successful system would be one in which companies and shareholders communicate directly with one another. Companies would adopt a corporate pay structure that is in line with peers and rewards executives based on the value they provide not only for the firm but ultimately to the shareholder.

“I think that most reasonable shareholders who want to make money don’t want to get into the nitty gritty,” Barrall said. “What they’re concerned about is their investment. As long as the company’s executive pay is aligned with the performance of the company and their peers over time, that ought to be where the shareholders and the investors who don’t have political agendas stop caring.”