Shareholders can voice their support for, or concerns with, a company’s executive compensation program through a non-binding advisory vote on executive compensation, commonly referred to as “Say on Pay”. One shortcoming of Say on Pay is it does not allow shareholders to provide specific input on pay program design and pay practices. Since executive pay programs are a management tool to support business strategy, where there is not agreement on business strategy there may be a fundamental disagreement between a company and certain investors regarding incentive plan performance metrics, goals, etc.
In our experience, “activist investors” were more vocal and influential in boardrooms during 2015 than during other recent years. As a result, Compensation Advisory Partners (“CAP”) analyzed circumstances at nine companies that had proxy contests in 20151 where in each case, one area of activist focus was executive compensation. We found that executive compensation issues were often supportive and complimentary to other, larger internal issues at the target companies. While these activists may have targeted executive compensation, this was not the main driver in engaging with the company. Activist complaints tend be more focused on strategic/financial issues and they use compensation as a point of discussion to identify where their views differ. For example, if return on capital is not a utilized metric in incentive plans and the company has completed several low return acquisitions, the activist may use this as support that strategy is flawed and that compensation reinforces that flaw.
“Activist investors” are individuals (i.e. hedge fund managers) or groups (i.e. alternative investment companies) who purchase a stake in a target company’s outstanding equity shares with the end-goal of influencing company decision making by acquiring seats on the Board of Directors. Once on the Board, activists will try to effect changes (i.e., by divesting or acquiring a business segment, cutting expenses, increasing distributions to shareholders, etc.) that ultimately increase the company’s value and the value of the activist’s investment.
What We Found
Compared to prior years, 2015 saw an increase in proxy contests. Among companies in the Russell 3000 Index, there were 20 proxy contests initiated by activist investors during 2015. This compares to 14 proxy contests in 2014 and 16 in 2013.
Of the 20 proxy contests initiated by activist investors in 2015, nine (45 percent) specifically took issue with the executive compensation program at the target company. In each case, “issues” with executive compensation were a part of the supporting statements for the dissident slate of directors. This is a stark contrast to 2014 and 2013, where 4 (29 percent) and 1 (6 percent) proxy contests took issue with executive compensation, respectively.
Specific compensation practices highlighted in 2015 include:
Executive Compensation Issue |
Number of Companies (n=9) |
Percentage of Companies |
Pay for Performance Misalignment |
7 |
78% |
High CEO Compensation |
4 |
44% |
Choice of / Adjustments to Performance Metrics |
4 |
44% |
Weak Corporate Governance Structure |
3 |
33% |
High / Increase to Board of Director Compensation |
3 |
33% |
Awards of Special Grants to Executives |
2 |
22% |
Outsized Peers |
1 |
11% |
Ultimately, we found that activist investors frequently use executive compensation and pay for performance disconnect as levers to bolster their argument for receiving seats on the target company’s Board of Directors.
Target Companies
Of the nine activist campaigns which specifically took issue with executive compensation practices, the companies that were being targeted generally had lagging TSR performance, both in absolute terms and relative to competitors. Further, low Say on Pay results in 2014 also provided activists with an additional reason for targeting certain companies.
As the below table demonstrates, where activists were successful in securing Board seats, the most recent Say on Pay support was generally low and either the company’s 1-year TSR, 3-year TSR, or both were relatively low.
Successful Activist Campaigns
Of the nine proxy contests that specifically targeted aspects of executive compensation, four ultimately resulted in the activist investor gaining Board seats at the target company. The four companies, which are noted in the chart below, include: Myers Industries, Imation Corp., The Children’s Place2 and Shutterfly, Inc.
The main common denominator, from a compensation perspective, among the successful activist campaigns was a perceived disconnect between executive pay and financial performance at the target company. More specifically, at Myers, Imation and The Children’s Place, the activists were able to show that, despite poor TSR (in both absolute and relative terms), the executives at these companies were still being rewarded either through salary increases, above target annual incentive payouts or equity grants.
Company Name |
Say on Pay Results |
Total Shareholder Return |
|||
2013 |
2014 |
2015 (Year of Proxy Contest) |
1 Year * |
3 Year CAGR * |
|
Activist Gained Board Seat (n=4) |
|||||
Myers Industries Inc. |
75% |
75% |
60% |
-17.8% |
12.6% |
Imation Corp. |
95% |
50% |
34% |
-17.8% |
-12.9% |
The Children's Place, Inc. |
17% |
61% |
94% |
13.8% |
6.3% |
Shutterfly, Inc. |
55% |
50% |
22% |
-18.3% |
22.4% |
Activist Did Not Gain Board Seat (n=5) |
|||||
Hill International, Inc. |
n/a (triennial) |
54% |
n/a (triennial) |
-0.3% |
-9.3% |
Ethan Allen Interiors Inc. |
86% |
92% |
80% |
-14.1% |
5.1% |
E. I. du Pont de Nemours and Company |
95% |
98% |
96% |
14.4% |
17.3% |
Biglari Holdings Inc. |
33% |
31% |
50% |
-21.7% |
2.8% |
Select Comfort Corporation |
98% |
93% |
96% |
26.9% |
6.7% |
* As of Fiscal Year End
Further, with regard to Shutterfly’s executive compensation program, activists made the case that executives were being rewarded for performance against metrics that were not “shareholder friendly” (i.e. metrics focusing on top line growth as opposed to earnings growth). In response to the activist criticism, Shutterfly’s Compensation Committee established several changes to their 2015 and 2016 executive compensation program performance targets to “further reflect shareholders views”. However, the lead activist investor (Marathon Partners) ultimately deemed these changes inadequate and requested further, more fundamental, adjustments to the entirety of the compensation program, namely, to begin prioritizing profit over scale.
It is not surprising that activist investors are most successful at winning Board seats at their target companies when they can tie executive compensation to the poor financial performance of the company. If shareholders are not realizing a desired return on their investment in any given company, it is reasonable to expect that they would show more support for an activist investor hoping to gain access to the target’s Board if it could potentially lead to financial improvement. When executive compensation can be tied to poor financial results, it simply provides activists, and shareholders alike, with another reason as to why a shift in leadership could be desirable or change in strategy could be advisable (e.g. CEO change).
ISS also tends to influence the outcome of these proxy contests. ISS supported at least one of the nominees on the dissident slate of directors at each of the four companies that lost at least one Board seat to the activist investor.
Ultimately, of the four companies who lost Board seats to activist investors, three companies (Imation Corp., Myers Industry and Shutterfly) have made changes to their executive leadership teams as these CEOs have stepped down. Further, while DuPont was able to win its proxy contest and keep dissident nominees off of its Board, five months after the Annual Meeting, the CEO announced her retirement.
Conclusion
We are seeing increased activity where activist investors are accumulating stakes in companies with the intention of agitating for change. Their hope is to make changes that will enhance the company’s value. While our analysis reflected proxy contests specifically focusing on executive pay (e.g. pay for performance misalignment), there are a number of circumstances where companies settle with the activist investors, avoiding a contentious public battle, and allow the activist a seat or multiple seats on the Board. Some examples include Baxter International settling with Third Point LLC, Freeport McMoRan settling with Icahn Enterprises and Citrix Systems settling with Elliott Management.
In order to be well positioned, Boards and Compensation Committees should be proactive:
- Ensure the Company and Board have a clear strategic focus and stick to it
- Make sure the metrics used in incentive plans align with the company’s strategic vision
- Confirm the Board has a game plan for shareholder and activist engagement
- Encourage the Company and Board to use external advisors to provide guidance
- Highlight company performance against goals
- Emphasize pay for performance relationship through the validation of relative performance and pay positioning
- Proactively seek feedback from shareholders throughout the year
- Assess program features which may not have a lot of value to executives but are viewed as problematic pay practices (i.e., eliminate excise tax gross-up, eliminate / reduce perquisites, move from single to double trigger equity vesting in the event of a change in control)
It is critical for the Board to work with management to ensure pay practices are defensible and supportable in light of company performance and good governance standards.
Appendix
Summary of Activist Campaigns
Company |
Activist |
Executive Compensation Issue Highlighted By Activist |
Contest Result |
Hill International, Inc. Program and project management company |
Bulldog Investors, LLC ISS supported both dissident director nominees |
|
No dissident nominees elected to the Board |
Ethan Allen Interiors International interior design and manufacturing company |
Sandell Asset Management Corp ISS supported 3 of 6 dissident director nominees |
|
No dissident nominees elected to the Board |
E.I. Du Pont International science and technology company |
Trian Fund Management ISS supported 2 of 4 dissident director nominees |
|
No dissident nominees elected to the Board CEO stepped down 5 months after the conclusion of the contest |
Biglari Holdings Owns and operates Steak N’ Shake |
Groveland Capital ISS did not support dissident director nominees |
|
No dissident nominees elected to the Board |
Myers Industries International manufacturing and distribution company |
GAMCO Asset Management ISS supported 1 of 3 dissident director nominees |
|
Three dissident nominees elected to the Board CEO stepped down |
Imation Corp. Data storage and information security company |
Clinton Group ISS supported all dissident director nominees |
|
Three dissident nominees elected to the Board CEO stepped down |
Select Comfort Corporation Designer, manufacturer, retailer and services of a Sleep Number beds |
Blue Clay Capital ISS did not support dissident director nominees |
|
Activist dropped proxy contest before it went to shareholder vote |
The Children’s Place (settled proxy fights prior to Annual Meeting) Children’s specialty apparel retailer |
Macellum Advisors GP and Barington Capital Group ISS supported 1 of 2 dissident director nominees |
|
Settled prior to contest – activist received one Board seat |
Shutterfly, Inc. Manufacturer and retailer of photo-based products |
Marathon Partners ISS supported 2 of 3 dissident director nominees |
|
Two dissident nominees elected to the Board CEO stepped down |
Note: The comments in the above chart are paraphrased or direct quotes from activist investors’ proxy contest materials/filings and do not reflect the view of CAP.