Lessons for US investors in Railpen ‘say on pay’ report

A report conducted by the investment division of the ₤15 billion ($24 billion) UK pension fund, Railpen, examines the impact that six years of advisory shareowner votes have had on pay in the UK, leading to some important lessons for contemporaries in the US as they approach a similar regulatory environment and some recent leadership on the matter by large companies such as Microsoft.

Prepared by Deborah Gilshan, corporate governance counsel at Railpen Investments, and PIRC, the report finds that six years of advisory shareowner votes has led to more investor engagement on pay and stronger links between pay and performance.

According to the report, the discipline of going through the annual vote process enriches the understanding that investors have of companies due to the importance of remuneration within the corporate governance risk analysis.

“It is a part of a larger corporate governance process, and not an end to itself.”

However despite greater engagement, compensation levels continue to rise.

Examination of executive pay levels between 2000 and 2008 revealed a sharp drop in fixed base salaries from 2006. This is likely explained by an apparent increase in variable performance based bonus and share incentive remuneration.

“The move to a higher proportion of performance-dependent pay can be seen as a corollary of increased shareholder engagement since the introduction for the remuneration vote that had equipped shareholders with a portal to express concerns that remuneration should have a higher proportion of pay linked specifically to the performance of the company and its associated objectives.”

The report finds positive outcomes from the introduction of an advisory non-binding vote on remuneration including: enriching the dialogue between investors and the company; disclosure has improved so shareholders now have more transparent information; the vote has provided a common platform to engage with companies and improved shareholder democracy; it has de personalised the issue of remuneration, drawing the attention away from remuneration committee members generally; having a vote has focused more attention on remuneration and as a consequence executive compensation can be taken as a proxy for good governance generally.

“The UK’s experience of having a resolution to enable shareholders to vote on remuneration provides many valuable lessons for the US market. Since the introduction of the vote, engagement has been based on a more rounded understanding of remuneration. This enriches both the company and the investor experience. It allows an informed debate to take place about the nature of compensation plans, their structure, the degree of alignment garnered through the plans and importantly how it supports the company’s strategy. It moves the engagement discussion from simply a vote on plan details to a more relevant debate about remuneration practices in the round.

However, there is an important point to make here; the remuneration vote has facilitated better engagement with companies but the vote and engagement should not be seen as mutually exclusive. The vote is the firs tool in the process. However, engagement without voting is engagement without teeth and cannot be taken as an alternative to voting. They must go hand in hand.”

Meanwhile as the US awaits legislation approval in the Senate for the Obama administration’s proposed legislation that would give shareholders at all public companies a nonbinding annual “say on pay” vote, some companies have taken the lead.

The Microsoft board approved a shareholder advisory vote on executive compensation which will allow shareholders to cast a non-binding vote on the company’s compensation of senior executives every three years, starting at its shareholder meeting in November.

Microsoft general counsel Brad Smith said the move would encourage dialogue with shareholders on Microsoft’s compensation approach, which he said was “designed to maximise shareholder value by attracting and retaining world-class leaders and aligning their financial rewards with the growth and success of the company.”

Microsoft said it had adopted “say on pay” after receiving two shareholder proposals.

It worked with a number of shareholders to develop its say-on-pay shareholder vote approach, in particular representatives of Walden Asset Management, Calvert Investments and the United Brotherhood of Carpenters, which had submitted shareholder proposals asking the board to implement say-on-pay votes.

The company also sought input from a number of its largest institutional shareholders, governance advocates and peer companies.