The New SEC Executive Compensation
Disclosures and the 2007 Proxy Season
By David Drake, President, Georgeson Inc.

What’s the most important thing a corporate secretary or an investor relations director needs to know for the upcoming proxy season?  It may just be the telephone number of his or her company’s compensation and benefits director.  With the SEC’s recently expanded proxy statement disclosure requirements of executive compensation, proxy statements will be inflated with charts, graphs, tables and explanations that could increase their length by a good 20 to 30 pages (or more) depending on the size and complexity of a company.

That’s a ton of new information on compensation ranging from descriptions of perquisites to disclosure of potential value of severance payouts to calculations of supplemental executive retirement plans.  Not all of this information is completely new.  For example, severance arrangements have always been disclosed, but companies had not been required to calculate potential payouts until now.  And with institutional investors reading hundreds or even thousands of statements a year, it’s not likely that many of them have done the math themselves.  Now activists can easily collect and compare aggregated compensation calculations and simply rank companies by how much they dole out. 

There is little chance the new disclosures will not result in increased activism – not to mention increased investor inquiries to companies in 2007.  The spate of increased shareholder resolutions that are inevitable will logically start to appear in the fall of this year, when proposal deadlines for next year’s annual meeting season arrive. 

But even now, in the early part of the 2007 season, the new disclosures are fueling increased activist and even political campaigns.  For example, House Financial Services Committee Chairman Barney Frank recently introduced legislation to require public companies to include in their annual proxies a non-binding advisory shareholder vote on their executive pay plans.  The legislation (H.R. 1257), entitled “Shareholder Vote on Executive Compensation Act” would ensure that shareholders have an opportunity to give their approval or disapproval on the company’s executive pay practices, even though the vote would be nonbinding. 

The same basic premise is also the subject of a shareholder resolution making the rounds this proxy season.  The probable success of the proposal will likely be hard to deflect given the robustness of the new required compensation disclosure.  Once shareholders are given a new weapon, in this case more disclosure, you can expect that they will use it.  Making defeat of the proposal even tougher is the fact that Aflac, Inc. has already chosen to adopt the resolution and give its shareholders annual nonbinding referendum on pay beginning in 2009.

For now, corporate secretaries, investor relations officers and others will have plenty on their hands as shareholders begin to react to the rollout of the new disclosures contained in each successive mailing of a corporate proxy statement.

What are some of the hot compensation topics we expect to emerge from shareholder evaluation of the new disclosures?  We think that investors will focus on the following issues:

Deferred Compensation
Be prepared for shareholder overreaction to new disclosures that make it possible to see the cumulative effect of deferred compensation for long-term executives.  Highly paid executives who have been deferring a portion of their compensation over an extended period of time will produce some eye-popping numbers that will attract the attention of activists who will be vocal about these potential “shock and awe” numbers, especially when contacted by the media for reaction. 

Companies should be prepared to explain both in the proxy statement and offline the specific details of how the deferred compensation accumulated.  In many cases, executives legitimately deferred a modest portion of compensation over a long period of time.  Well foot-noted, plain-English disclosures are critical, but don’t count on all investors to read them as carefully as they should, or to come to the correct conclusions.

Supplemental Executive Retirement Plans (SERPs)
SERPs are already the subject of recent shareholder proposals asking for the right to approve the retirement vehicles.  Only a limited number of such proposals have been voted on to date, but support for the seven such proposals voted on last year averaged more than 40% of votes cast according to Georgeson’s Annual Corporate Governance Review (ACGR).

These days SERPs are about as popular as the non-employee director pension plans of yesteryear that became virtually extinct after they were targeted by activists a decade ago.  Whether SERPs survive the current wave of attacks remains to be seen (we think their days may be numbered). 

This year, SERP-related shareholder proposals are attacking SERPs in new ways by focusing on how SERP payouts are calculated. For example, some plans allow newer executives to be credited for “years served.” That can substantially increase the value of SERPS to the employee. 

Beware of disclosures that show a new executive with SERP calculations that put him or her on a par with similarly compensated executives with much less time served.  It may be too much to ask for a perfect explanation that will satisfy all shareholders.  Generally, time for years served is added for older executives who may have forfeited substantial benefits when coming to a new company.  But without a satisfactory explanation, you are simply setting your company up to be a target.

Severance Agreements
Shareholder proposals seeking limits on severance pay without shareholder approval were among the most successful of the executive compensation proposals submitted to a vote, with nearly half of them achieving a majority vote (Georgeson’s 2006 ACGR).  In this year’s new disclosure, shareholders will have a better idea of how much severance packages are really worth.  While the totals may alone spur some shareholders to action, disclosure of what gets included in those agreements may prove even more troublesome. 

Companies that provide executives with tax gross-ups and substantial post-employment perquisites and benefits will have more explaining to do.  Good disclosure that shows the reasonableness of a company’s practices helps, but companies should think about whether the limits on the multiples of salary and bonus are in line with peers and today’s best practices.  An increasing number of companies are implementing limits of one or two times annual salary and bonus, down from the traditional 3x golden parachute agreements.

Option Vesting and Grant Timing Issues
Companies gave a collective sigh of relief (matched only by the collective groan of activists) when the SEC decided to require companies to disclose the value of grants at the time they vest rather than on grant date.  However, the change in reporting may be a boon for some and a bane to others. 

One compensation and benefits lawyer recently told us about a successful CEO that had a substantial vest of options due to occur in 2006 after a strong run-up in his company’s stock price.  Fearful of the impact of the disclosure of the value of his grant, the CEO decided to ask his board to extend the vesting date for the awards, in effect putting the options at risk again and therefore avoiding the discomfiting disclosure. 

We imagine that a trend of “re-vesting” might be welcomed by activists.  The bottom line is that disclosure of option values upon vesting may be considered preferable to grant date values, but each comes with its own set of challenges that companies should be prepared to address.

Option grant timing is also a critical issue brought into focus both by the SEC required disclosures and the continuing headlines regarding option backdating scandals.  Several activist funds have submitted resolutions requiring companies to stick to a strict calendar for option grants as a best practice.  Companies, whether or not they have been on the receiving end of this proposal, should be ready to explain their option grant scheduling practices to provide additional comfort to the marketplace.

Thumbs up (or down) on Disclosure
The focus on executive compensation disclosure will no doubt be a critical component of the 2007 proxy season.  Shareholders are asking for even more information than the SEC has required.  A number of large capitalization companies recently received a request from a consortium of state and union pension funds asking for fuller disclosure of the companies’ business relationships with its compensation consultants. 

Do consulting firms that do multiple types of management consulting for companies recommend richer pay packages than those that consult exclusively on pay issues? Some companies have already responded, telling shareholders what they had hoped to hear – that no other relationship with compensation consulting firms exist.  And one company recently responded by dropping its relationship with its compensation consulting firm to avoid the appearance of a conflict caused by other work the firm was doing for the company.

Companies would do well to sharpen their pencils and make sure their disclosures are not just accurate, but satisfactory to investors.  Consider what the vote would look like if, like Aflac (and some UK and Australian companies), your company agreed to put its compensation disclosure to a shareholder referendum.   If such a practice were required of U.S. companies, would most companies get a thumbs up?  The 2007 proxy season will tell whether companies merely complied with the new rules, or used them to communicate the right message to shareholders.

About Georgeson
Founded in 1935, Georgeson assists more than 1,000 corporations annually in both routine and contested proxy solicitations. Additionally, Georgeson provides M&A advisory services, strategic corporate governance consulting, PostMerger CleanUp™*, small shareholder oddlot programs and shareholder identification. Clients include 47% of the Dow 30, 42% of the S&P 500, 30% of the NASDAQ 100, 35% of the TSX top 100 and 47% of the ASX 200. Georgeson is a Computershare company.
*PostMerger CleanUp is provided by our broker dealer Georgeson Securities Corporation.

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