Lessons Learned from Say-on-Pay-The 2011 Proxy Season: How Companies Can Better React to Dodd-Frank's Say-on-Pay Mandate

Bloomberg Law®, an integrated legal research and business intelligence solution, combines trusted news and analysis with cutting-edge technology to provide legal professionals tools to be...

Contributed by Richard J. Grossman and J. Russel Denton, Skadden, Arps, Slate, Meagher & Flom LLP


The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) added Section 14A to the Securities Exchange Act of 1934, requiring companies to hold a non-binding, advisory vote on executive compensation and a separate non-binding, advisory vote on how frequently advisory votes should be held (with options for 1, 2, or 3-year frequencies). Enacted in the wake of strong negative public opinion towards escalating executive compensation practices, say-on-pay was viewed by lawmakers as a way to make companies bring executives’ performance interests and benefits in line with the performance of the company and the state of the economy.

The results of Dodd-Frank’s say-on-pay mandate have affected numerous companies’ executive compensation practices and will likely continue to shape such practices in the years to come. While the shareholder votes required by Dodd-Frank are merely advisory in nature, the potential for damage to a company’s public image and public relations in connection with strong shareholder opposition proved to provide sufficient motivation for companies to revisit their compensation practices and to actively seek shareholder approval of the say-on-pay proposals.


The significant influence of proxy advisory firms, including Institutional Shareholder Services Inc. (ISS) and Glass Lewis, in the say-on-pay votes was made clear by the effects that their voting recommendations and the methodologies relating to those recommendations had on the say-on-pay proposals. Because of the significant number of institutions that follow ISS’s (and, to a lesser extent, Glass Lewis’) voting recommendations, a company that received a negative recommendation was much more likely to face difficulty in achieving shareholder approval of its say-on-pay proposal.

Through September 1, 2011, ISS recommended in favor of 85 percent of say-on-pay proposals at S&P 500 companies, 88 percent of Russell 3000 companies (exclusive of S&P 500 companies) and 93 percent of non-Russell 3000 companies.1 It appears that institutional investors are relying heavily on the advice of proxy advisory firms. For the say-on-pay proposals that ISS supported, 83 percent received over 90 percent approval and 95 percent received more than 80 percent approval.2

However, even though 340 companies received negative recommendations from ISS, only 38 failed to receive shareholder approval.3 87 percent of the Russell 3000 Companies that received negative ISS recommendations still managed to receive shareholder approval, but every company that did not receive shareholder support for its say-on-pay resolution had received a negative ISS recommendation.4 Based on this information, it appears that receiving a negative ISS recommendation is a necessary, but not a sufficient, condition for failing to receive shareholder approval.


Given the importance of ISS’s recommendations in determining whether or not a company’s say-on-pay vote will be approved, companies must be mindful of ISS’s policies when making decisions with respect to compensation practices. ISS’s voting guidelines state that it generally will recommend “against” a say-on-pay vote at companies that have “a misalignment between CEO pay and company performance” or that maintain “problematic pay practices.”5

During the 2011 proxy season, the most common reason that ISS recommended “against” a say-on-pay vote was because of a perceived disconnect between pay and performance, with 52 percent of ISS’s negative recommendations being made for this reason.6 In considering pay and performance alignment, ISS focused on whether a company’s one and three-year total shareholder returns were in the bottom half of the company’s Global Industry Classification Group and whether a CEO’s total compensation (as long as the CEO served at least two years) was aligned with the company’s total shareholder return.7 If a company’s performance was below its GICS median, then ISS generally looked for a reduction in compensation between 2009 and 2010 or else it would recommend an “against” vote.8

Additionally, ISS viewed certain pay practices as not sufficiently performance based, such as time-based restricted stock, stock options, and any discretionary payment awards.9 Generally, ISS viewed awards that were not tied to the achievement of any specific measures, including alternative triggers, as discretionary compensation which was more likely to lead to a negative recommendation.10 Companies that had high cash to stock option compensation ratios, as well as ones that offered stock option grants with relatively short vesting periods, were also often criticized for their reliance on such arrangements, which ISS views as not being aligned with the long-term interests of shareholders.

ISS also recommended, without consideration of whether executive pay was sufficiently tied to a company’s performance, “against” a say-on-pay vote at a company that maintained what ISS considered to be “problematic pay practices” such as: (1) repricing or replacing underwater equity awards without prior shareholder approval; (2) having “excessive perquisites or tax gross-ups;” or (3) entering into employment agreements that provide for change in control payments of more than three times base salary, that have “single-trigger” change in control provisions or that provide for excise tax gross-ups.11 Indeed, approximately 44 percent of ISS’s “against” recommendations in 2011 were based on these “problematic” pay practices (the remaining 4 percent of negative recommendations were at companies where ISS had concerns regarding both the pay practices and ISS saw a performance disconnect).12 In addition, there was an increased likelihood of a negative recommendation from ISS where companies allowed for personal use of company aircraft, provided for large relocation or home loss benefits or had large pension or supplemental pension agreements.13


Even with the importance of ISS, most companies that received negative ISS recommendations nonetheless received shareholder approval for their executive compensation practices. However, every company that did not receive shareholder support for its say-on-pay proposal received a negative recommendation from ISS. Companies were able to avoid more failed say-on-pay votes largely because companies were able to engage their shareholders regarding compensation practices in order to explain the reasons behind the companies’ compensation decisions. However, companies chose to take two different approaches to this engagement. Some companies that chose to be proactive mailed letters to shareholders and made other public statements to defend their compensation practices, even prior to ISS making its recommendation. On the other hand, many companies instead were reactive and waited until ISS came out with a negative recommendation before making subsequent statements and engaging with shareholders in defense of the companies’ pay practices. Each of these approaches proved that it could be successful, although, on balance, it is better for companies to actively engage with their shareholders early in the proxy season.


Prominent proactive companies from the 2011 proxy season included JPMorgan Chase & Co. (JP Morgan), The Goldman Sachs Group, Inc. (Goldman) and Exxon Mobil Corporation (Exxon).

JP Morgan’s shareholder mailings and public statements in support of its executive compensation practices highlighted: (1) a board of directors with independent oversight of the company’s compensation practices; (2) a disciplined policy that called for a series of reviews and assessments by successive levels of management; (3) pay schemes that were linked to performance based on individual, business, and overall firm performance; (4) compensation measures that were designed to reward sustained performance (based on balanced risk measures and long-term value to clients and shareholders); (5) the use of equity issuances as an incentive plan to further employee retention and create better alignment with shareholder interests; and (6) the issuance of restricted stock units (RSUs) instead of cash. Furthermore, equity related compensation expenses averaged just 11.1 percent of total compensation at JP Morgan.

At Goldman, the compensation landscape was similar to the one found at JP Morgan. Goldman’s proactive statements regarding its executive compensation practices included: (1) reiterations of its minimal use of guaranteed employment contracts; (2) the presence of a policy that cash compensation should decrease as a percentage of total compensation with increases in an employee’s variable compensation; (3) a system of equity based awards that had long-term vesting qualities; (4) an independent board that oversaw and approved compensation structures; and (5) a general practice that compensation growth should largely be correlated with revenue growth. The use of restricted stock units was also quite common, with nearly 70 percent of 2010 variable compensation to named executives coming in the form of RSUs.

Finally, Exxon mailed shareholders a letter with its proxy materials highlighting: (1) its independent compensation committee; (2) the use of restricted stock units; (3) the prevalence of long vesting periods (compared to comparable companies) for the RSUs that it issued; and (4) annual bonuses whose payouts were directly linked to actual performance rubrics, as reasons stockholders should support its say-on-pay proposal.

In the 2011 proxy season, JP Morgan, Goldman and Exxon all received shareholder approval for their executive compensation practices. In general, in addition to being proactive, these companies tended to issue restricted stock units instead of cash as a component of total compensation, tied benefits and bonuses to actual performance, utilized long-term performance goals, minimally used guaranteed employment contracts for top executives, offered long-term vesting periods for options granted and, perhaps most importantly, articulated a highly transparent compensation policy to shareholders.


In contrast, some companies chose to issue statements in defense of their executive compensation programs after the issuance of particularly negative ISS reports. Companies such as The Walt Disney Company (Disney), General Electric Company (GE) and Northern Trust Corporation (Northern Trust) fell into this category. These companies made adjustments to their compensation practices to make them meet ISS’s guidelines, made public statements which generally were designed to defend and counter ISS’s commentary and argued against certain of ISS’s methodologies which these companies believed to be inappropriate.

In the case of Disney, following receipt of a negative ISS recommendation, it amended the terms of the employment agreements of certain of its senior executives to remove gross-up provisions for excise taxes due upon a change of control. In addition, Disney sent a statement to shareholders that clarified a mistake that ISS had made in its analysis of the earning per share component of Disney’s performance tests (ISS had criticized Disney for having a one-year test when in fact the test was a three-year performance test). Overall, the language of Disney’s responsive materials was designed to present evidence that Disney’s compensation practices conformed to ISS’s guidelines. Disney’s approach was successful and shareholders approved its say-on-pay proposal, with the proposal receiving approval of approximately 76.8 percent (based on the total number of votes for, against and abstentions).

GE also changed its compensation practices in light of ISS’s negative recommendation by conditioning the vesting of one million stock options to GE’s CEO on a higher standard for GE’s cumulative industrial cash flow from operating activities for a three-year period; and an additional one million options were set to vest only if the total shareholder return for GE met or exceeded that of the S&P 500 over the same period. GE also faulted ISS for not looking at compensation practices over time, but rather on a year-over-year basis, explaining that its CEO had not received a salary increase since 2005 and had not received a bonus since 2007, so that a comparison of its CEO’s salary from 2009 to 2010 was not appropriate and that ISS should have compared the 2010 bonuses with those from 2007, which was the last year that bonuses were actually given to its CEO. GE also criticized the method that ISS used to value options, including the assumptions that ISS used in the model which valued the options. Following the changes to compensation practices and GE’s outreach to shareholders, its say-on-pay proposal received approximately 78.1 percent of support.

Finally, Northern Trust, a company that received a favorable recommendation from Glass Lewis but a negative one from ISS, sent a mailing to its shareholders arguing that ISS’s recommendation was incorrect in its analysis that there was a “pay for performance disconnect.” Northern Trust argued that its compensation program was centered on incentive compensation with 90 percent of the CEO’s compensation being variable, incentive-based compensation, with 65 percent of the CEO’s compensation being long-term, equity-based incentive pay. Northern Trust also pointed out that its short-term cash incentive awards were tied to the Company’s performance. Finally, Northern Trust argued that it was inappropriate for ISS to use companies with the same GICS code as Northern Trust as peer companies, because such companies included companies that were in different lines of business than Northern Trust and companies that Northern Trust did not consider to be competitors. Northern Trust argued that instead of using a GICS classification, ISS should have compared the company’s performance with that of large banks and financial institutions; and in such case the company’s performance compared favorably with what Northern Trust believed to be its peer institutions. While Northern Trust ultimately secured shareholder approval of its say-on-pay proposal, at approximately 66.0 percent of the vote, it did so with lower approval levels than GE or Disney.


There was a significant amount of criticism of the methodology ISS used in making its voting recommendations, and this criticism was not limited to companies that received a negative recommendation from ISS. The most common criticisms of ISS’s methodologies were that (1) it used a single, short-term performance metric (i.e. whether a company’s one or three-year total shareholder returns were below peer group median); (2) it used GICS for peer groups, which made the peer groups overly broad and not focused on the industry that a particular company was in; and (3) it valued equity awards using an inappropriate method, which overstated compensation relative to what was disclosed in the companies’ proxies and did not reflect the true accounting costs of the awards.14

In response to some of these criticisms, ISS has updated its methodology for the 2012 proxy season. In a policy update report issued on November 17, 2011, ISS indicated that it will use two separate metrics for its pay-for-performance analysis going forward. In addition, on December 20, 2011, ISS issued a white paper providing additional guidance with respect to how it conducts its compensation analysis.

Under a peer group alignment test, ISS will consider (1) the degree of alignment between the company’s total shareholder return rank and the CEO’s total pay rank within a peer group, as measured over one-year and three-year periods (weighted 40 percent and 60 percent respectively), and (2) the multiple of the CEO’s total pay relative to the peer group median. ISS indicated that, going forward, it will select peer groups of between 14-24 companies that are selected using market cap, revenue (or assets for financial firms), and GICS industry group.

In an absolute alignment test, ISS will consider the absolute alignment between the trend in CEO pay and company’s total shareholder return over the prior five fiscal years. The policy update describes this as the difference between the trend in annual pay changes and the trend in annualized total shareholder return during the period.

If these analyses demonstrate a “significant unsatisfactory long-term pay-for-performance alignment,” ISS will look to the following qualitative factors in making its voting recommendation: (1) the ratio of performance-based to time-based equity awards; (2) the overall ratio of performance-based compensation to overall compensation; (3) the completeness of disclosure and rigor of performance goals; (4) the company’s peer group benchmarking practices, actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc. both absolute and relative to peers; (5) special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (e.g., biennial awards); and (6) any other factors that ISS deems relevant.

In addition, ISS has indicated that it will employ a higher level of scrutiny when determining its vote recommendations regarding say-on-pay proposals and the re-election of compensation committee members (or, in exceptional cases, the full board) where the prior year’s say-on-pay vote received the support of less than 70 percent of the votes cast.15 This higher level of scrutiny will take into account the company’s response to concerns raised by shareholders in the previous year, including disclosed engagement efforts with major institutional investors regarding the issues that contributed to the low level of support and specific actions taken to address the issues that contributed to the low level of support, the company’s ownership structure, and whether the issues raised are recurring or isolated. Additionally, where a company did not receive support for its prior say-on-pay vote, ISS has indicated that it expects companies to show significant responsiveness to shareholders. ISS has indicated that companies should avoid “boilerplate” disclosure, and that the specific actions that companies take to address the issues that resulted in significant opposition votes should be new actions rather than a reiteration of existing practices.


Even though Dodd-Frank’s say-on-pay vote is non-binding and advisory, there is a threat of litigation at companies that do not receive shareholder approval. Claims for breach of fiduciary duty, corporate waste, unjust enrichment and breach of contract have already been brought at companies that failed to receive shareholder support, including Beazer Homes USA, Inc. (which was dismissed), Jacobs Engineering Group Inc., KeyCorp, Occidental Petroleum Corporation, Cincinnati Bell Inc. (which settled in December 2011 in exchange for increased compensation disclosure), Hercules Offshore, Inc. and Janus Capital Group. Even though these cases are unlikely to be successful on the merits and will likely settle in the long run, they are an unwelcome distraction that could cause other companies to rethink their compensation practices, as well as their efforts to obtain shareholder approval of their say-on-pay vote in order to minimize the risk of distracting litigation.


Even though a relatively small number of companies failed to receive shareholder support for their say-on-pay proposals in 2011, it is advisable for companies to take into account the viewpoints of the proxy advisory firms when making compensation decisions. In light of the fact that a negative recommendation from ISS is more likely to lead to lower shareholder support (companies receiving negative recommendations from ISS had average support of approximately 70 percent on last year’s say on pay proposals16) coupled with the fact that ISS has indicated that it will subject companies receiving less than 70 percent approval of a say-on-pay vote to heightened scrutiny in the following proxy season, a negative recommendation from ISS could easily lead to heightened scrutiny in the next proxy season (along with a potential impact on ISS’s director recommendations). In order to receive favorable ISS recommendations, a number of criteria should be considered, including stock price analysis, total shareholder return (both absolute and relative), peer performance and compensation comparisons, the level of disclosure and performance goals, the timing of bonuses, the vesting periods for options and the relative cash/stock compensation breakdown.

Based on the results of 2011′s say-on-pay votes, it is clear that ISS and other proxy advisory firms play a significant role in determining whether or not a company receives shareholder approval of its say-on-pay proposal. However, it is also clear that a negative ISS recommendation is a necessary, but not a sufficient, condition to a company having a failed say-on-pay vote. In order to overcome a negative ISS recommendation, companies must engage in active shareholder relations and communication campaigns early in the proxy season because of the possibility that, following a negative ISS recommendation, it might not be possible to convince shareholders to support their compensation practices. In addition, for companies that received less than 70 percent approval of their 2011 say-on-pay resolutions, it is necessary to engage with shareholders and include a meaningful description of such engagement in the 2012 proxy materials. Furthermore, SEC rules require that disclosure regarding a company’s consideration of past say-on-pay votes is included in proxy statements going forward.

Transparent proxy statements with detailed disclosure regarding compensation decisions and shareholder outreach efforts combined with extensive shareholder outreach efforts and fluid communication are the best ways to ensure that compensation practices receive shareholder approval. Working with shareholders earlier in the process and in conjunction with legal advisors, proxy solicitors and compensation consultants can help identify potentially problematic pay practices and shape a company’s shareholder communications strategy. If a company has not sufficiently engaged its shareholders and principal investors early in the proxy season, it should expect more inflexibility from its shareholders and be prepared to better and more strongly defend its compensation practices. Under ISS’s revised guidelines, the need for shareholder outreach is even more critical given ISS’s policy of employing a higher level of scrutiny in making its voting recommendations at companies which received less than 70 percent of votes cast on the 2011 say-on-pay vote.

Finally, companies should use the results of this past year’s say-on-pay votes to help guide them in future years. While a company should always make decisions that it believes are in its best interests, companies must also be mindful of the risk that there could be a negative ISS or shareholder reaction to compensation decisions if such decisions are not adequately communicated and explained to investors and ISS. Using past say-on-pay votes, performance measures and say-on-pay proposals and results from peer firms can help companies formulate compensation arrangements that are more likely to be viewed favorably by shareholders and ISS, increasing the likelihood of gaining ISS and shareholder approval. If a company becomes the subject of a negative ISS recommendation, it can try to replicate successful strategies that were used in the past by companies that initially received negative ISS recommendations in 2011, including tying option grants to performance, using more restricted stock, removing gross-ups and other “problematic” features from employment contracts and conditioning future awards on performance, in addition to arguing against ISS’s metrics when a company believes they have been improperly applied.

It is likely that ISS will maintain its strong influence in subsequent proxy seasons, particularly with respect to companies making executive compensation decisions that conform to ISS’s guidelines and recommendations in order to avoid the difficulties associated with obtaining shareholder approval in the wake of a negative ISS recommendation. However, it is also possible that the SEC, which is aware of the influence that proxy advisory firms such as ISS have in the process, will impose some regulatory framework on ISS and other proxy advisory firms.

In general, companies should expect more favorable responses to their compensation programs when pay is linked to performance, shareholders and institutional investors are better informed, the communication process with investors begins early in the proxy season and when discretionary compensation arrangements are utilized as little as possible. Companies need to become ever more reliant on communications with shareholders to ensure that shareholders understand a company’s compensation practices. In addition, it is extremely important for companies to analyze whether any changes to their compensation practices would be required in light of ISS’s new metrics.

Regardless of what happens to the say-on-pay landscape in the coming proxy seasons, companies cannot afford to ignore ISS’s metrics when making compensation decisions and companies need to understand when they have adopted compensation practices that might draw criticism from ISS. It is vital for companies to establish a clear set of guidelines that can be easily explained to shareholders and, if necessary, defended against a negative ISS recommendation. Given the number of negative ISS recommendations during last year’s proxy season, it is safe to assume that executive compensation will be highly scrutinized this year, especially for companies that have already received negative recommendations from ISS or received less than 70 percent support for 2011 say-on-pay proposals.

Richard J. Grossman is a partner and J. Russel Denton is an associate in the Mergers and Acquisitions Department at Skadden, Arps, Slate, Meagher & Flom LLP. The views in this article are the authors’ and not necessarily the views of Skadden, Arps, Slate, Meagher & Flom LLP. The authors would like to thank David Jain, a summer associate at Skadden, Arps, Slate, Meagher & Flom LLP, for his assistance.  


This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.  

©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.  

Request Bloomberg Law®