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Feb 18, 2015

Shareholders still unhappy with proxy disclosures

Explanations of rationale for executive pay are inadequate and proxies are unwieldy, hard to read, finds Stanford investor survey

Companies are still falling short when it comes to explaining the rationale for their executive pay programs, according to the results of a new research survey by the Corporate Governance Research Initiative at Stanford University’s Graduate School of Business, in collaboration with Equilar and RR Donnelley. The survey of 64 asset managers, which collectively control $17 trillion in assets, finds that just 38 percent of institutional investors believe information about executive compensation is clear and effectively disclosed in companies’ proxy statements.

Drilling slightly deeper, 65 percent of respondents say the relationship between compensation and risk-taking behavior is ‘not at all’ clear, while 48 percent say it’s ‘not at all’ clear whether the size of executives’ pay packages is appropriate, and 43 percent believe it’s ‘not at all’ clear whether performance-based compensation plans are based on rigorous goals.

That could have an adverse impact on support levels for companies’ say-on-pay plans this proxy season.

To the extent that the survey shows investors are dissatisfied with both the level of rigor in companies’ financial performance goals and the relationship between compensation and risk, it's fair to wonder if there might be an inherent contradiction between wanting companies to set more aggressive goals and wanting to ensure pay plans aren’t incentivizing excessive risk-taking behavior.

‘If you push a company to set aggressive goals to get a payout and the executive sees the only way to get that payout is to engage in risky behavior, then potentially you run that risk,’ says Aaron Boyd, director of governance research at Equilar. ‘That’s part of the compensation committee’s role, to manage risk in compensation and to make sure it isn’t setting goals in a way that encourages those sorts of behavior.’

As for the view among some observers that companies aren’t aggressive enough in setting performance goals, Boyd says ‘a lot of investors’ complaints are centered more around [the idea that] all they have to do is show up to work and they’re going to reach that number anyway, so it really doesn’t take any effort on an individual’s part to achieve that goal.’

He doesn’t believe investors want performance goals to be set excessively high; rather, they want to make sure executives ‘are performing in a way that’s creating value and not just being the beneficiary of external factors.’ Boyd also concedes that setting financial goals can be quite difficult in many circumstances, given macroeconomic influences and choosing specific financial metrics, especially where the payout is determined by how the company performs relative to goals that were set three years earlier.

One of the top things investors are looking for is disclosure about performance metrics and how pay plans actually work, says Ron Schneider, director of corporate governance services at RR Donnelley. ‘Most mainstream investors are focused on how pay, however it’s delivered, is aligned with the company’s business model and how it will deliver long-term value.’

But it’s often hard for companies to satisfy investors’ desire to better understand why certain financial metrics were chosen for aligning pay with performance, says Boyd. Companies are concerned that explaining certain metrics were picked because they’re the ones that will be affected most by the company’s plan to expand into new markets will reveal too much about their business strategy to competitors, he explains.

The survey also finds that a majority of institutional investors believe typical proxy statements are too long, while nearly half find them difficult to read and understand. The ideal length of a proxy is given as 25 pages, compared with the average of 80 pages produced by companies in the Russell 3000 Index. But length itself isn’t a problem as long as a proxy can be navigated easily, says Schneider.

Many of the Canadian proxies he’s seen over the past year are notable not just for being aesthetically pleasing but also for being ‘structured in a more modular fashion than US proxies,’ he says. ‘Some have seven sections and will have a mini-table of contents before each of those sections. It’s all about navigation. There are different ways to do it.’

And companies that tell him they would like to add more detail about what’s within the compensation discussion and analysis (CD&A) section but don’t want their table of contents to run into two pages are good candidates to expand on the CD&A detail in a separate table of contents at the beginning of that section, he adds.

David Bogoslaw

Associate Editor and Online features producer for Corporate Secretary