The Rite of Spring: Preparing for the 2016 Proxy Season

2015 Proxy Season Highlights

As we look ahead to the 2016 proxy season, we can glean a few takeaways from last year's proxy season:

1. Engagement. The 2015 proxy season began with a letter from Vanguard's Chairman and CEO to hundreds of independent directors encouraging them to be proactive in reaching out to shareholders. As an increasing number of companies seek to bolster those connections, the challenge has been building engagement processes that create open and effective lines of communication with this broader constituency. As issuers and investors seek to balance large numbers of engagements with quality discussions, it will critical for corporate boards and management teams to prepare well for each meeting.

2. Proxy Access. After decades of debate among companies, shareholders and management, proxy access emerged this year as one of the most prominent topics, prompted in part by a shareholder proposal campaign led by the New York City Comptroller's office. In January, the Comptroller's office announced that it had filed 72 proxy access shareholder proposals guaranteeing the matter will stay front and center throughout 2016. Proxy access gained support from many institutional investors more quickly than prior trends such as declassified boards or majority voting, but it remains a largely untested shareholder right, with just 131 companies adopting it to date.

3. Shareholder Proposals. Investors, many of whom are very small, continue to use shareholder proposals as a means to prompt engagement and catalyze governance changes. Proxy access and independent chairman proposals were the most prevalent ballot initiatives in 2015, followed by requests for greater disclosure of lobbying activity and requests for written consent rights. These topics will likely remain popular in 2016. In this U.S. presidential election year, political contribution and lobbying proposals may also become more prevalent.

Executive Compensation

Executive pay will remain a hot-button issue with many top investors as they continue to refine their analytical capabilities around say-on-pay voting and the alignment of executive compensation with company performance. While most companies received high levels of support in 2015, approximately 300 companies received votes of 70% or lower in 2015.

As investor and proxy adviser thinking evolves on executive pay matters, both investors and proxy advisory firms have been advocating for a better discussion of both the metrics selected and the targets set for purposes of incentive compensation programs. That said, there are challenges with disclosing such information, including sending signals to the market about expected performance. We have some recommended approaches for handling this challenge and staying ahead of potential problems.

SEC Rules Related to Compensation Disclosure

Four new SEC rules are at the center of the executive compensation discussion again in 2016, but only one of the four (pay ratio) has been adopted in its final form by the SEC, and the compliance date for that rule does not go into effect until 2017. Colloquially referred to as the “Gang of Four,” each rule is required by the 2010 Dodd Frank Wall Street Reform and Consumer Protection Act. When in place, the rules will provide new information for investors to consider when voting on executive compensation topics. A lot of questions remain, however, about how the rules will look in final form and how investors will incorporate new data into their analyses. With respect to each rule, it is critical for issuers to address them directly through engagement with investors to understand if and how they will use them and what form of related disclosure will be most relevant for investors.

Following are points to consider about each of the rules heading into the 2016 proxy season:

Pay ratio. Starting in the 2018 proxy season, issuers will be required to disclose the ratio of CEO compensation to median employee compensation for the 2017 fiscal year. This controversial rule will provide investors with a new data point when analyzing executive compensation and though it is popular among some elements of the investor community (notably public pensions), it is unclear if and how traditional institutional investors will incorporate pay ratio into their analyses. Some seem very supportive, since it provides them with a standardized way to assess relative magnitude of pay, but others question how useful it will be.

Recoupment or “clawback” policies. Clawback policies have long been popular with investors and many companies already have them in place in some form. These policies are considered a best practice and seen as helping align pay and performance. The SEC's rule proposal, put forth in July 2015, would require policies that go further than those of most issuers' current clawback policies so it remains to be seen how the policies will evolve under the rules. It is unlikely the rules will be in place for the 2016 proxy season, but issuers should stay aware of how these rules could shape clawback policies in future years.

Pay versus performance rules. The theme of relative pay for performance is central to investors' and proxy advisers' say on pay analysis. As say-on-pay enters its sixth year as a mandatory ballot item for U.S.-listed companies, investors continue to seek more helpful disclosure that shows pay for performance alignment. In 2015, the SEC proposed a new pay versus performance rule that would require issuers to disclose the relationship between compensation “actually” paid and the relative stock market performance. Although not in place for the 2016 proxy season, once (and if) adopted, the rule will result in new disclosure about the relationship between executive compensation and company performance that investors will surely incorporate into their analysis of compensation-related proposals. It is critical for issuers to monitor this matter through 2016.

Hedging disclosure. The SEC has proposed rules for disclosure of hedging arrangements, but they are not likely to be finalized by the 2016 proxy season. Most institutional investors are strongly in favor of anti-hedging policies and many companies already have policies in place, but policies might have to be adjusted once SEC rules are finalized.

Preparing for Say on Pay in 2016

Advance planning for say on pay votes and monitoring related regulatory developments remains critically important. Although the new compensation-focused SEC rules will not likely be in place for the coming proxy season, many of the topics covered by the rules are nonetheless important to investors. As such, issuers need to stay on the front foot with investors to avoid pay-related challenges. To do so, issuers should ensure they publish well-crafted proxy statements and supplemental materials, prepare a well-planned engagement strategy, have a clear understanding of investor and proxy voting guidelines on say on pay, and start early on both disclosure and compensation committee reviews of pay structures.

Hot Topics

The proxy voting landscape continues to evolve with certain headline issues cropping up year after year. While proxy access is the shareholder right at the forefront of the discussion in 2016, and executive compensation remains a key area of focus where there is a perceived misalignment of pay and performance, there are a few areas where every issuer should focus their efforts as the 2016 proxy season approaches.

Board Composition

Shareholder rights, compensation topics and contested matters often steal the headlines, but investors look for a well-structured board of directors first and foremost when evaluating good corporate governance. Investors regularly seek new and heightened disclosure about who is on the board and why, as well as details around the process for selecting and evaluating directors. Some issuers have responded in recent years with new disclosure that is focused on the collective director skill set (e.g., with a matrix of skills) while others have relied on a more robust discussion of each director's contribution to the boardroom. Either form of disclosure is effective as long as it provides investors with insight about the skills each director brings to the boardroom.

Board Tenure, Succession and Diversity

In addition to ensuring issuers select directors with the proper skills to guide and oversee management, investors are increasingly focused on topics of director tenure and diversity. Although virtually all U.S. institutional investors have stopped short of endorsing a formal tenure limit or specific diversity requirements, they are looking closely at average tenure of directors relative to market standards (about eight to nine years currently for the S&P 500) and looking for boards to demonstrate tenure and refreshment are considered proactively.

Cyber Risk Disclosure

Following the financial crisis in 2008, investors and regulators have had a heightened focus on board-level risk management and related disclosure. After a number of high-profile and costly data breaches in recent years, investors have turned their focus on this matter to enhanced processes and disclosures related to cyber risk. Issuers are increasingly engaging and adding disclosure around this important topic.

2016 Proxy Statement Drafting Tools and Tips

The proxy statement continues to evolve beyond a regulatory and compliance audience into a powerful communication tool for a wide audience of shareholders, potential investors, government agencies, proxy advisors, research institutions, and the broader investing public. As you draft your proxy statement this year, here are a few tips to consider:

Start Early with a clear project plan. Modern proxy statements touch on a wide range of subjects, including the traditional legal and regulatory topics, executive compensation, corporate strategy and performance, board letters, environmental and social policies, shareholder engagement and more. An early start can help ensure the right parties have ample time to contribute and review.

Assemble a Team of Experts beyond your external law firm to ensure the proxy is readable, accessible, and effective at delivering your message to the governance community.

Consider Your Expanded Audience that will likely be reading the report. Governance analysts who will make voting decisions are reading the materials more closely than ever before.

Use Graphics and Charts, But Don't Overdo It. A well-designed graphic can be powerful, but crisp, clean text can be highly effective. The best proxies integrate both into a larger narrative.

Chris Wightman, Partner, and Juan Bonifacin, Principal, are with CamberView Partners, LLC.