2011 SAY-ON-PAY RESULTS AND WHAT THEY MEAN

The 2011 proxy season is winding down and, with it, the majority of companies will have to interpret the results of Say-On-Pay (SOP) proposals for the first time. In addition, companies will have to determine what actions to take, both in relation to the results of their SOP vote and the vote on the frequency of SOP proposals (or Say-When-On-Pay) going forward. For some companies, which received particularly high or low approval levels, these results will be unambiguous. For other companies the results will best be interpreted by understanding the overall approval levels of companies across the spectrum and in relation to their peers. Companies should also have an understanding of when and what actions activist investors may take given those results (For more information and an overview of Say-On-Pay, please see the article on 2011 Proxy Updates contained in the Registrar and Transfer Company 2010 winter newsletter. This can be found under the News icon at the R&T website, rtco.com.)

SOP Results

Interpreting SOP Results

At first glance, SOP proposals received an overwhelming amount of support from shareholders. The support for SOP proposals was generally high in all industries. With an average approval of almost 90% from shareholders, and less than 2% of companies receiving less than 50% support, the majority of companies should have little to worry about going forward regarding pay issues that will carry over to next year. However, we believe that these numbers should be taken with a grain of salt.

Because such a large number of companies received more than 90% support from shareholders, and an even larger number of companies received over 80% support from shareholders (84%), we believe that many activist shareholders will view anything below 75-80% approval from shareholders as a red flag. In addition, issuers should be aware that activist shareholders could also use lower than average support levels as a tool to achieve goals unrelated to pay issues. While not all companies that received support levels in this range or lower will be targeted by investors, it would nonetheless be prudent for many issuers to be aware of the possibility and act accordingly.

In addition, we believe that it is important to note that negative vote recommendations from proxy advisory services were not predictive of a negative shareholder vote in all situations. For instance, in the 2011 proxy season (as of June 17) ISS recommended that shareholders vote against 276 SOP proposals. However, only 36 of these companies received negative (below 50%) SOP votes. This should not be interpreted as an indication that companies should ignore negative vote recommendations from ISS or other proxy advisory services. On the contrary, we note that the chance of a company failing its SOP vote was 8 times more likely in cases where a company also received a negative recommendation. As such, it is recommended that all companies that received a negative vote recommendation from a proxy advisory service treat such events as a red flag, regardless of actual support at this year’s annual meeting. Unless pay issues are addressed, negative recommendations from advisory services are likely to stay the same and could gain shareholder support(See “Suggested Actions” below for more information).

SWOP Results

Interpreting SWOP Results

Early in the beginning of the 2011 annual meeting season, there was a good deal of concern regarding what management should recommend for the frequency of SOP proposals (every one, two or three years). Issuers spent a significant amount of time and effort trying to determine what was best for shareholders and what was the preference of their larger shareholders. In the end, most companies’ shareholders voted for annual votes, regardless of management recommendations. It should be noted that both major proxy advisory services announced at the beginning of the season that that they would recommend that shareholders vote in favor of annual frequency. As such, there was some concern among issuers that recommendations other that for an annual vote could result in negative treatment by advisory services going forward. As of this date, there is every indication that this will not be the case…. so long as companies follow the frequency recommendation supported by at least a plurality of the votes cast at the meeting. If issuers go against clear shareholder support at next year’s annual meeting, however, it is likely that the board will meet significant resistance from proxy advisors and shareholders alike. This resistance could lead to significant withhold votes in director elections as well as other far reaching effects, up to and including potential proxy contests and, in a few instances, legal disputes. We recognize that some small number of issuers will feel that they have legitimate and necessary reasons to deviate from shareholder recommendations. In these instances, we would recommend extensive shareholder outreach programs.

Suggested Actions

Regardless of the level of support that an issuer received, it will be important for issuers to review their pay practices (as always) and be aware of pay concerns of major shareholders. In addition, companies will need to be aware of recommendations and analyses made regarding their pay practices by major proxy advisory services, as these can be key to anticipating future problems as well as addressing current ones. As noted above, companies should always treat certain vote results as a red flag. Critical among these will be shareholder support below 80% or negative vote recommendations by advisory services. While these may not always warrant or result in major policy changes, issuers should still treat them as potential warning signs.

In general, companies that wish to have future success with SOP votes should begin to actively engage shareholders. There are a number of actions that companies should initiate now, and going forward, to achieve this.

• Companies should disclose how often they intend to hold the SOP vote. (This is a legal requirement and should be done no later than 150 days after the annual meeting.)
• Given past results, and taking into account “red flags”, companies should consider engaging their largest shareholders in a continuous dialog, both to be aware of shareholder sentiment and as a way for those shareholders to express frustrations in a way that does not result in casting a negative vote.
• Companies with higher than average negative votes should actively identify shareholders (this can be done through a proxy solicitor) that cast negative votes and directly address their concerns. This should include identifying negative recommendations from advisory services and the underlying reasons for these recommendations. (Pay for Performance, poorly designed pay practices, insufficient disclosure, etc.)
• If warranted, companies should make changes to pay practices and take credit for making the changes and communicate those changes to shareholders.
• For the 2012 annual meeting and proxy statement, companies should continue to review the CD&A, discuss how the SOP results of 2011 were taken into account and what changes were made if any. Companies should always strive to make the CD&A as clear as possible in its disclosure. Providing a lucid, concise Executive Summary of the CD&A may assist analysts in the review of the CD&A and foster better understanding of the proxy statement.

Smaller companies

Companies with market capitalization below $75 million are not anticipated to have to include SOP proposals until at least 2013. The most recent annual meeting season experienced by their larger cousins should contain a number of valuable lessons for these companies. Smaller issuers should start to consider and implement practices that will prepare them for the additional pressure and disclosure that will be necessary when tackling SOP issues. Good investor relations should not be taken for granted and a small shareholder base should not be mistaken for a happier one. These companies should begin the process of adjusting their pay practices to reflect current best practices and compensation committees should remember that employment agreements with executives entered into today will affect potential SOP votes for years to come.