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Sanjay Shirodkar, DLA Piper US LLP
Christopher K. Davies, Office Depot

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

Say on Pay: Considerations Before Adopting a Policy

What have Say on Pay (SOP) proposals requested, and what’s the background?

Over the past three years, shareholder groups and other activists have made a concerted effort to seek an annual shareholder vote on executive compensation as a means to control or influence senior executive pay. The votes generally are on a nonbinding proposal requesting that the company seek approval of certain portions of a company’s executive compensation disclosed in its proxy statement. Such a proposal is also known as Say on Pay (SOP). SOP proposals have been gaining in popularity. Indeed, it is very likely that, in the near future, many public companies will present some form of SOP proposal annually in their proxy statements.

SOP proposals have requested that the board of directors of a public company institute annual, non-binding advisory shareholder votes on the executive compensation package disclosed in the company’s proxy statement. The American Federation of State, County and Municipal Employees submitted the first stockholder SOP proposal in the U.S. to eight public companies for their 2006 annual shareholder meetings.

Why should a company consider adopting an SOP policy?

For the 2009 proxy season, it is estimated that more than 100 companies received SOP proposals. It would be an error to regard SOP proposals as a passing fad. When Senators Charles Schumer (D – NY) and Maria Cantwell (D – WA) introduced the Shareholder Bill of Rights Act of 2009, SOP was among the numerous hot corporate governance issues it addressed. The Obama Administration has also announced that it intends to work with Congress to pass certain changes to executive compensation practices; part of that goal would be a requirement that public companies include an SOP proposal annually in their proxy statements. In fact, the House Financial Services Committee plans to meet next week to consider a bill drafted by its chairman, Rep. Barney Frank. This bill is similar to legislation that was approved by the House of Representatives in 2007. Also, the Senate Banking Committee is expected to consider SOP proposals as part of a hearing on corporate governance matters set for next week.

How can a company implement a policy addressing SOP?

Subject to any regulatory changes that may arise, a company has total flexibility on the ways it can adopt a policy addressing SOP. Such a policy can be adopted either formally, by amending a company’s governance documents or policies, or informally, via a press release. For example, in November 2008, Verizon Communications Inc. published a press release noting that its board of directors had adopted a policy providing for an annual advisory vote beginning in 2009 related to executive compensation.

Is there a specific format for SOP proposals?

The format and components of SOP proposals adopted by public companies vary quite a bit. We have seen several variations of SOP proposals:

•    Proposal with one general resolution:
Example: Resolved, that shareholders of ABC Company urge the Board of Directors to adopt a policy that ABC shareholders be given the opportunity at each annual meeting of shareholders to vote on an advisory resolution, to be proposed by ABC’s management, to ratify the compensation of the named executive officers set forth in the proxy statement’s Summary Compensation Table (SCT) and the accompanying narrative disclosure of material factors provided to understand the SCT (but not the Compensation Discussion and Analysis).

•    Proposal with two resolutions:
Example: (1) RESOLVED that the shareholders approve the Company’s overall executive compensation philosophy, policies and procedures, as described in the Compensation Discussion and Analysis (Sections I and II) in this Proxy Statement and (2) RESOLVED that the shareholders approve the compensation decisions made by the Board with regard to NEO performance for 2008, as described in the Compensation Discussion and Analysis (Sections III and IV) in this Proxy Statement
.
•    Proposal with three resolutions:

Example: (1)    Resolved that the shareholders approve the Company’s overall executive compensation philosophy, policies and procedures, as described in the Compensation Discussion and Analysis (Sections I and II) in this Proxy Statement.
(2)    Resolved that the shareholders approve the compensation decisions made by the Board with regard to NEO performance for 2007, as described in the Compensation Discussion and Analysis (Sections III and IV) in this Proxy Statement.
(3)    Resolved that the shareholders approve the application of the Company’s compensation philosophy, policies and procedures to evaluate the 2008 performance of the Company’s executives and compensation based on, certain key objectives, as described in the Compensation Discussion and Analysis in the Proxy.

Why do some SOP proposals include multiple proposals?

Most companies present a single SOP resolution. However, some companies are choosing to present multiple SOP resolutions. It is possible that these companies believe that including multiple resolutions enables them to elicit information from their shareholders regarding different aspects of their executive compensation programs.

There are potential disadvantages in presenting broadly worded resolutions or multiple resolutions. While most SOP proposals have focused on past practices of a company, it is possible that shareholders may be asked to cast an advisory vote on a company’s current compensation practices. For example, RiskMetrics Group, Inc. (the parent of ISS Governance Services) presented three separate SOP-related resolutions to its shareholders at its annual meeting in June 2008, including the application of its compensation philosophy, policies and procedures relating to the company’s current executive compensation policies. Interestingly, for its annual meeting of shareholders on June 16, 2009, RiskMetrics did not include the third proposal in its proxy materials.

What is the practical effect to a company if the shareholders do not approve such a proposal?

SOP proposals are presented as nonbinding, or advisory, proposals. This means that, whether the proposal is approved or rejected, a company will not be required to take any action based solely on the outcome of the vote. Due to the recent introduction of such proposals into the U.S., there is not much evidence of what the rejection of an SOP proposal might mean to a public company. Practically speaking, however, it is likely that the rejection of an SOP proposal may be viewed as a vote of no confidence in the company’s executive compensation program. Anecdotal evidence from overseas suggests that a rejection could have negative consequences to a public company and its management team.

What are some things public companies should be considering now?

SOP proposals have existed in the U.S. for a relatively short time. Very few public companies have either put an SOP policy in front of their shareholders or adopted such a policy. We have seen some companies including multiple SOP resolutions or including SOP proposals that could be interpreted as seeking a vote on the company’s prospective executive compensation practices in the proxy materials sent to their shareholders. Each of these approaches has significant drawbacks and should be carefully considered. It is therefore important to have a carefully worded SOP proposal that is consistent with a company’s executive compensation policies. It also helps to consult with counsel and the primary proxy advisory services, along with initiating a dialogue with a company’s shareholder before taking any definitive actions on any such proposals.

Sanjay Shirodkar is in the Corporate Securities Group at DLA Piper US LLP and can be reached at sanjay.shirodkar@dlapiper.com. Chris Davies is the Senior Managing Counsel, Corporate and Securities, at Office Depot and can be reached at Christopher.davies@officedepot.com. The views expressed herein are those of the authors and do not represent the views of DLA Piper US LLP or Office Depot.