Rethinking reputational and talent risk — Where say on pay fits in

The concept of say on pay has always been strongly connected with setting executive pay appropriately. Yet, in the wake of a publicly debated and contentious annual general meeting season in the U.K., there is compelling evidence that shareholders need to reconsider this traditional link.

From now on, we may want to think about say-on-pay efforts as having a direct impact on retention of key talent.

From now on, we may want to think about say-on-pay efforts as having a direct impact on retention of key talent. The balance of reputational and talent risk is playing out in unexpected ways and is something that more companies will want to take into account when determining their own say-on-pay approach. Introduced in the U.S. for financial institutions under the Troubled Asset Relief Program in 2008 and mandated for all public companies by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, say-on-pay votes have now become a fairly routine part of the ambient background noise in corporate America.

Say-on-pay votes almost never fail

The vast majority of U.S. companies — especially the largest U.S. companies — pass their say-on-pay votes with flying colors every year, and relatively few fail to gain the support of a majority of the shareholder votes cast, as Willis Towers Watson’s ongoing say-on-pay research shows.

Source: Willis Towers Watson Executive Compensation Resources analysis of 1,71240 Russell 3000 companies from January 1, 2016 to June 17May 20, 2016 and 2,143 Russell 3000 companies reporting results in 2015. ISS recommendations confirmed using ISS’s Governance Analytics.

Source: Willis Towers Watson Executive Compensation Resources analysis of 1,724 Russell 3000 companies from January 1, 2016 to June 17, 2016 and 2,143 Russell 3000 companies reporting results in 2015. ISS recommendations confirmed using ISS’s Governance Analytics.

Critics of say-on-pay have long contended that these purely advisory votes (in the U.S. at least) are largely meaningless and are designed merely to shame company management and boards in the rare cases where executive pay crosses the line. In fact, the U.S. experience to date suggests that the reputational risk posed by unfavorable say-on-pay votes is relatively low.

Consider the numbers. About 60 companies in the U.S. (give or take a company or two) failed their say-on-pay votes each year since 2011, and a number of these are repeat offenders. Our research shows that 39 companies failed on multiple occasions, and a look at the governance characteristics of those 39 companies offers some clues as to why their leaders have been able to weather multiple failures with apparent indifference for the views of their shareholders. For example, a third of these companies (many of them smaller companies) are led by founder CEOs. What’s more, well over half had the same person serving as both CEO and board chair in the year of their most recent say-on-pay failure, although three have since split these roles.

While proponents of say on pay contend that giving shareholders a voice on executive compensation has helped sharpen the link to company performance and has discouraged the use of the most egregious pay practices (such as so-called “tax gross-ups”), it seems pretty clear that these votes pose relatively little reputational risk for most U.S. companies.

However, there are a number of companies in the U.K. for which the 2016 say-on-pay experience highlights another kind of risk that these votes may carry: talent risk.

Say on pay across borders

The U.S. was actually somewhat of a latecomer to say-on-pay voting, which was first introduced in a number of countries in Europe in the first decade of the 21st century. First mandated for U.K. companies in 2002, a say-on-pay requirement has also been implemented in

  • Australia
  • the Netherlands
  • Norway
  • South Africa
  • Sweden
  • others countries

Read my June 21 update on the topic: U.S. Executive Pay Advisory Votes – A review of key vote results and trends

While most of these laws, like Dodd-Frank in the U.S., require companies to conduct advisory shareholder votes on executive pay, a few have crossed into the realm of requiring binding votes.

For example, the U.K.’s law was amended to require companies to conduct a binding vote on the company’s executive pay program design and structure every three years, followed by advisory votes in the intervening years on the actual pay received by the company’s top executives under the shareholder-approved pay structure.

Australia’s law takes a different tack. In Australia, companies that fail multiple say-on-pay votes are required replace their boards — perhaps the most punitive approach anywhere in the world.

Talent risk of binding say-on-pay: a case study

One company’s recent say-on-pay experience in the U.K. illustrates the talent risk that binding say-on-pay can create, along with the vagaries of an inwardly focused, country-specific say-on-pay system:

The company had received overwhelming shareholder support in its most recent binding vote on the pay program’s structure. However, in the following year, the company’s shareholders very nearly voted down the pay delivered to the top two executives, which received the support of just over 50% of the votes cast.

The reason for this “shareholder revolt,” as it was described in the media, was that the company had granted its CEO a large increase in base salary. “Why would the remuneration committee do such a thing?” shareholders wondered. The answer is a lesson in unintended consequences.

The remuneration committee was forced to use a non- performance-based fixed compensation element (base salary) as their only retention tool.

In the face of M&A activity and the withdrawal of a large U.S.-based acquisition offer, the remuneration committee was concerned that the CEO was at risk and could be a target for other, large globally focused organizations. After all, this CEO had successfully executed on several deals and a strategy re-set that had driven total shareholder return 112% over the past year. However, the binding compensation framework approved by shareholders the year before provided for no flexibility to award any manner of retention compensation above the existing annual compensation package.

Consider the irony of this situation. The U.K. government and shareholders who have largely driven the notion of pay at risk and performance-based pay for top executives have, in effect, constructed a system within which there is no room for exceptions, despite good business reason. In short, the remuneration committee was forced to use a non-performance-based fixed compensation element (base salary) as their only retention tool.

Further, the pushback from certain U.K. shareholders during consultation and the fervor in the press was real and distracting for the company’s executive leadership team and board as the company poured resources into additional investor outreach in order to achieve a razor-thin majority approval of the annual say-on-pay vote.

So, what’s the lesson here? Many countries with binding say-on-pay votes implemented these policies with the best of intentions. Shareholders demand to be heard on executive pay and so they should. However, to the extent that the country’s policy encourages shareholder dialog that is myopic, internally facing and largely ignores the reality of the global system of talent and mobility, the risk of losing that talent — and thereby destroying shareholder value — may pose more of a threat to the organization than the reputational risk of making a one-time compensation decision that, while potentially outside of the local norm, is grounded in good business reason.

While this company’s situation is somewhat unique, its experience shows that managing the reputational risk may not be the only concern with regard to say on pay. We all — companies included — need to think about its impact on talent risk as well.

For a closer look at current say-on-pay voting issues in the in the U.K., see “First 50 analysis finds the 2016 proxy season shaping up to be more contentious in the U.K.Executive Pay Matters, May 5, 2016.

About Jim Kroll

Jim Kroll is a director in Los Angeles who leads Willis Towers Watson’s governance advisory practice for executiv…
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