Blog: Investors Challenge Fund Managers On Say-On-Pay Vote Practices

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Support for management on say-on-pay votes for the 2016 season so far (data as of May 18) continues at about the same level as in prior years – a median approval rate of 95% among the S&P 500, according to Compensation Advisory Partners, with only three companies having failed so far to receive majority support.  Among the Russell 3000, according to Semler Brossy (as of the same date), 13 companies had failed say on pay, and the average vote in favor was 91%.  Some investors, however, have expressed displeasure about levels of CEO pay they consider to be excessive and view their mutual fund firms as perhaps somewhat complicit.  Some have even taken steps in an effort to address that issue.

Interestingly, this effort arises in the context of a decline in CEO pay. According to the NYT, for the first time in a long while, CEO pay for 2015 actually fell: the average among the 200 highest paid CEOs at U.S. companies with annual revenue of at least $1 billion that filed proxies by April 30 was $19.3 million, down 15% from the $22.6 million average paid in 2014, based on an Equilar survey for the NYT. Commentators cited in the article observed that compensation committees “seem to have a lot more steel in their backs.” And it wasn’t just the top 200 that experienced a decrease; according to Reuters, CEOs of S&P 500 companies experienced a similar decrease of about 13.5% last year, from an average of $13.5 million down to $12.4 million. The AFL-CIO attributes the lower average CEO compensation primarily to a decline in the present value of future pension benefits; the NYT attributes the decline more broadly to the impact of the “weak stock market,” which “pulled  down the value of executive pay packages.”  In any event, these declines in 2015 executive compensation made only a small dent in the CEO/employee pay ratio.  Reuters reports that, last year, the average S&P 500 CEO made 335 times the pay of the average worker, which represented a dip from a multiple of 373 in 2014, according to a study from the AFL-CIO, based on U.S. government reports.  Average worker pay increased by only about $900 last year.  These ratios are destined to become even more of a flashpoint when the Dodd-Frank-mandated SEC rules requiring disclosure of pay ratios take effect for most companies in 2018 proxy statements.  (See this Cooley Alert.)

The NYT also asserts, perhaps too simplistically, that “the relation between pay and performance remains tenuous at best,” as, in some cases, CEO pay for 2015 fell “despite gains in the price of shares of their companies,” and some CEOs “reaped huge windfalls, even while presiding over precipitous declines in total shareholder return.”  (For discussion of an academic  argument that it’s misguided to insist that CEO pay be tied to performance, see this PubCo post.) The anticipated adoption by the SEC of final rules on pay versus performance, also mandated by Dodd-Frank, will certainly reignite discussions of executive pay in relation to financial performance as reflected (or not) in “total shareholder return.” (See this Cooley Alert.)

According to a national Reuters/Ipsos poll described in this Reuters article, 59% of investors in U.S. mutual funds said CEOs at S&P 500 companies were paid “too much” and 56% said “mutual fund firms ‘should challenge executive pay more often.’” However, the poll also showed that 30% said CEO pay was “about right” and 21% considered the firms’ approaches to be correct. The poll surveyed 1,024 people who said they invested with one or more of the top five asset managers and, for the second question, 722 people who also said “they had at least some understanding of what a fund manager is.” In separate interviews, some respondents expressed concern that “the government might step in to regulate executive pay, “ while others, unprompted, raised the issue of income inequality. The article observes that, according to the trade group Investment Company Institute, asset managers hold about 30% of U.S. shares, and, of the almost $16 trillion invested in mutual funds, 89% is held by retail investors. While all of these asset managers emphasize the importance of pay for performance, the article contends that “[t]heir voting history… shows that they rarely use their ballots to challenge compensation packages for perceived underperformance. Last year, the firms cast their advisory ‘say on pay’ votes in support of senior executives 96 percent of the time or more at S&P 500 firms, according to research firm Proxy Insight.” Of course, the big funds take a variety of approaches in making voting decisions on say-on-pay proposals, including private engagement with management and the board as well as consideration of other factors such as shareholder return.  BlackRock, for example, reportedly engaged with about 700 U.S. companies, focusing on executive comp in 45% of those meetings.

Former Congressman Barney Frank has suggested that, because some fund executives may make tens of millions each year themselves, they “make poor overseers of CEO pay.” (Of course, some might argue that those highly paid fund executives are not the ones making the day-to-day voting decisions on the thousands of management say-on-pay proposals, as illustrated below.)  However, a governance officer for a state retirement fund contended that, if investors “want funds to take a harder line,” that position “has got to be driven by their clients.”

Some investors are doing just that. This proxy season, a BlackRock client and shareholder submitted a shareholder proposal requesting that BlackRock’s board issue a report to shareholders evaluating “options for bringing its voting practices in line with its stated principle of linking executive compensation and performance, including adopting changes to proxy voting guidelines, adopting best practices of other asset managers and independent rating agencies, and including a broader range of research sources and principles for interpreting compensation data. Such report should assess whether and how the proposed changes would advance the interests of its clients and shareholders.”  The proponent argued that BlackRock has a duty to vote to ensure that CEO pay “is sufficiently tied to performance and discourages excessive and unwarranted CEO pay,” but that it approved 99% of CEO pay packages among the S&P 500 (actually closer to 97%), an approval level higher than that of many other investment managers.  According to this article in the Financial Times, an online petition supporting the objective of the proposal was signed by more than 4,000 BlackRock clients and over 75,000 BlackRock shareholders.

BlackRock initially sought to exclude the shareholder proposal from its proxy statement on the basis that it was false and misleading and related to the company’s ordinary business operations, but the SEC refused to grant its no-action request.  In its statement in opposition to the proposal in the proxy statement, BlackRock countered that its proxy voting decisions are made by a professional, independent team within the BlackRock investment function based on a published set of voting guidelines and policies that “provide a detailed description of its approach to analyzing and assessing compensation policies and outcomes.” If the team has concerns about a company’s compensation policies or practices, its first step is typically engagement; however, if it is ultimately not satisfied, the team “will consider voting against compensation and against the re-election of the compensation committee members.” BlackRock also maintained that, in its view, additional reporting on the team’s approach to compensation policies was not warranted nor would it add value.  BlackRock also expressed concern that the shareholder proposal, if implemented, would jeopardize the team’s “ability to engage with the management of companies and exercise their professional discretion on behalf of clients” and impose a level of “intrusive oversight” by BlackRock’s board that “would place undue influence” on the team and “threaten the independence of its function.”

Both ISS and Glass Lewis agreed with BlackRock, and recommended voting against the shareholder proposal.  With a vote of only 4.4% in favor, the proposal was soundly defeated at the annual meeting on May 25. Notably, however, in his blog, James McRitchie, who, along with John Chevedden, is part of a group of the most prolific proponents of shareholder proposals, observed about this proposal to BlackRock, “I love it and plan a few similar proposals.”  So stay tuned  — we can expect to see more action on this front in the future.

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