Following the recent financial crisis and government bailouts of major U.S. financial institutions, the federal government has gradually facilitated a power shift from companies and their officers and boards of directors to their shareholders. A prime example of this is the recently enacted “say-on-pay voting” requirements. Through provisions of the Dodd-Frank Act which was passed in July 2011, Congress directed the SEC to adopt rules requiring public companies to give their shareholders a vote, on an advisory basis, on the approval of executive compensation (“say-on-pay”). The implemented rules also require public companies to hold an advisory vote on the frequency (“say-on-when”) with which the say-on-pay vote would occur. Taking into account the results of the say-on-when vote, companies determined whether to hold say-on-pay votes on an annual, biennial, or triennial basis, with most electing to hold annual say-on-pay votes. Despite these shareholder votes being advisory, and as we explained in a previous blog, these votes may actually be more impactful than originally anticipated due to the effect of poor or failed say-on-pay votes on the recommendations from proxy advisory firms, such as ISS. For example, a “poor” (i.e., less than 70% shareholder approval) or “failed” say-on-pay vote result (i.e., less than 50% shareholder approval) could lower one or more of a company’s ISS “GRId” scores (or other proprietary proxy advisory firm corporate governance rating scores) which would negatively impact the recommendations published by the proxy advisory firms with respect to the election of directors and other corporate governance matters being put to a vote of the shareholders at the annual meeting. By way of example, if a public company receives less than 70% shareholder approval for executive compensation, the company must show that it took steps to address its perceived executive pay shortcomings, otherwise ISS will recommend a “withhold” vote for the directors up for re-election at the next annual meeting.
Going one-step further, however, the United Kingdom announced on June 20, 2012 that it will be implementing a binding say-on-pay vote requirement for public companies. According to the Department for Business Innovation and Skills, the U.K. government will “introduce a new binding vote on companies’ pay policies in order to empower shareholders and encourage improved dialogue with the companies they own. This vote will require the support of a majority of shareholders voting to pass.” Once the new rules are fully implemented, U.K. public companies will be required to disclose their pay policies in a specified tabular format to their shareholders in the annual proxy statement. The say-on-pay vote will be an annual requirement unless companies do not alter their pay policies, in which case the vote must be held at least every three years. Additionally, any change in a public company’s pay policies will require shareholder approval. In addition to the U.K., the European Union may also be considering initiatives to further involve shareholders in the executive pay process in member countries although no formal action has been taken yet.
While there is no expectation that the U.S. will move to the U.K. approach and begin requiring binding shareholder say-on-pay votes at any time in the near future, public companies should keep a watchful eye on developments in this area in the U.K. Additionally, this should further incentivize public companies to carefully review and evaluate their pay practices in light of their say-on-pay vote results and take appropriate actions on their own initiative when appropriate. Not only will such initiative be viewed positively by proxy advisory firms for purposes of determining their annual meeting voting recommendations, wide-spread meaningful responsiveness by U.S. public companies to say-on-pay vote results might also serve as evidence that the implementation of binding say-on-pay votes in the future is unnecessary.