Blackrock, Vanguard, and State Street (the “Big Three”) are among the largest and most influential institutional investors in the world with current assets under management (AUM) of $10.0, $8.2, and $4.1 trillion respectively. Given their size, they have ownership stakes in many U.S. publicly traded companies. As a result of their holdings, the Big Three have the power to influence proxy voting outcomes, and any policy update, should be closely monitored by companies.

For the 2022 proxy season, the Big Three released their proxy voting guidelines and engagement priorities. These updates are a way for the public, and companies to understand the Big Three’s positions and priorities for 2022.

In the following chart we summarize a variety of policy updates from the Big Three that focuses on executive compensation, Compensation Committee voting, human capital management, board composition and board of director overboarding.

As summarized above, there has been a focus over the last few years on ESG, particularly on diversity among the board of directors and workforce, human capital management and climate change (not summarized above). The Big Three believes companies that focus on these issues will enhance a company's ability to maximize long-term shareholder value.

This article highlights select changes and updates to the Big Three's voting policies. For full detail related to all the proxy voting guidelines, please visit:

Blackrock:

• BlackRock Investment Stewardship – Proxy Voting Guidelines for U.S. securities
• BlackRock Investment Stewardship – Engagement Priorities

Vanguard:

• Proxy voting policy for U.S. portfolio companies

State Street:

• Proxy Voting and Engagement Guidelines – North America (United States & Canada)
• CEO's Letter on Our 2022 Proxy Voting Agenda
• Guidance on Diversity Disclosures and Practices
• Guidance on Managing Director Time Commitments
• Guidance on Human Capital Management Disclosures & Practices

Say on Pay arrived in 2011, born out of the SEC’s rule-making efforts to reform corporate governance under Dodd-Frank after the financial crisis. This non-binding advisory vote, which is an annual event at most companies, allows shareholders to cast votes for or against Named Executive Officer (NEO) compensation. While earning simple majority support is technically a passing result, most companies strive for and achieve significantly higher levels of support. Investor support of compensation programs is influenced by many factors, which primarily include magnitude of pay, pay practices, and stock price performance.

In 2020, COVID-19 significantly disrupted the global economy, causing many companies to re-evaluate their compensation programs. Proxy statements filed in 2021, which will discuss compensation during the COVID pandemic year, will depart from previous norms. In anticipation of these filings, CAP has reviewed Say on Pay voting results at Russell 3000 companies in 2020, and since inception, to gauge the current landscape with an eye on what may occur with 2021 Say on Pay results.

Say on Pay Overview

Russell 3000 Historic Results

2020 marked the 10th year of Say on Pay voting. To date, voting results have generally been very consistent over time. Median support among Russell 3000 companies has been approximately 95% in each of the past 10 years. Most companies receive support from over 90% of shareholders, with an average of 74% of companies receiving support in the 90-100% range. Consistent vote outcomes are seen at the top and the bottom end of the range. The percentage of companies falling in each range shown below has been consistent throughout the 10-year history of Say on Pay voting.

Only 2.2% of companies failed to receive majority support for Say on Pay votes in 2020. The number of companies that have failed the Say on Pay vote has also been very consistent over the 10-year period, with an average of 2.0% of companies failing over the past 10 years. For companies that failed in 2020, the median level of support was approximately 38%, mirroring historical results.

Proxy Advisor Impact

Proxy advisors have a substantial impact on the Say on Pay vote for companies. The most influential proxy advisory firm is Institutional Shareholder Services (“ISS”) which grades companies on a pay-for-performance scale to determine if, in their view, CEO pay and company performance are well-aligned. ISS will then issue a recommendation “For” or “Against” the NEO compensation program, ISS’ vote recommendation often has a substantial impact on the vote result, as outlined below.

The two main inputs that ISS looks at are CEO compensation and Total Shareholder Return compared to an ISS-defined peer group based on company size and industry. Companies will then receive a “Low”, “Medium” or “High” concern level that determines whether ISS performs a qualitative evaluation of the compensation program. The overall concern level drives ISS’ ultimate recommendation For or Against the Say on Pay resolution. Historically, approximately 95% of companies with a Low concern receive support from ISS, compared to about two-thirds of companies rated Medium concern and roughly half of the High concern companies. Often, shareholders will reference the ISS recommendation (i.e., For or Against) when casting their vote on Say on Pay; however, many institutional investors have their own proprietary tests to evaluate compensation programs at companies.

ISS has consistently recommended Against Say on Pay for approximately 12% of companies per year, over the last decade. Among companies that have failed Say on Pay, the vast majority, 96% on average, have received an Against recommendation from ISS. In 2020, roughly 20% of companies that received an ISS Against recommendation ultimately failed the vote and for all companies with an Against recommendation from ISS, the median level of support was only 67%.

As shown below, the percentage of companies with an ISS Against recommendation, at each support level range, has been generally consistent since the Say on Pay vote was established.

Expectations for 2021

Institutional Shareholder and Proxy Advisor Commentary

2021 proxy statement disclosures will reflect the impact of COVID-19 on company performance which influenced both executive compensation in 2020 and the development of 2021 incentive programs. While the degree of impact will vary by industry and company, many more companies than usual will disclose adjustments to their compensation programs than in past years. During 2020, shareholders and proxy advisors provided some general guidance on how they will be assessing and evaluating these unique circumstances.

Institutional shareholders and proxy advisors have both stated that they recognize that 2020 was a more challenging year than most due to the impact of COVID-19. Because of this, they will review companies on a case-by-case basis, evaluating the facts and circumstances that went into any adjustments that were made. Guidance has generally encouraged proactive, enhanced disclosure that clearly explains the situation and rationale for COVID-related changes as opposed to generic descriptions of a challenging year, which may be viewed as insufficient.

How shareholders and proxy advisors interpret and assess the COVID-related disclosures and adjustments will ultimately influence Say on Pay votes and recommendations. While ISS and Glass Lewis did not make wholesale changes to their pay-for-performance evaluations for 2021, ISS did call out key disclosure items that would help investors evaluate COVID-related changes. This indicates that there may be more discretion and flexibility applied for companies with more robust disclosure. Even with greater flexibility in the qualitative evaluations, pay-for-performance misalignment will continue to be the main driver for Against recommendations from ISS in the broader market.

CAP Expectations

Since pay-for-performance is expected to remain the primary driver for proxy advisor recommendations, Say on Pay results will continue to depend on the magnitude of pay, pay practices and stock price performance. For companies that may have a pay and performance misalignment, we expect reduced shareholder support if a company has not provided sufficient rationale for the following actions:

• Annual and long-term incentive plan adjustments
• Major employee actions (e.g., layoffs)
• Performance that is dramatically below investor expectations
• Low relative financial performance
• Above-target discretionary adjustments to payouts that previously missed threshold performance
• Awarding one-time special cash/equity grants

Shareholder outreach will be more important in 2021 as companies can use these discussions to supplement their required disclosures. Proactive outreach may help to prevent a significant impact on the Say on Pay result even if proxy advisors recommend Against a company’s compensation program. There will also likely be more disclosure on go-forward incentive programs, as the impact of COVID-19 lingers into 2021.

Say on Pay results in 2021 will likely depart from prior norms. Even if the percentages of Against recommendations and companies passing remains relatively consistent with historic levels, we expect to see a downward shift in the median level of support and in the percentage of companies receiving at least 90% support. For companies that do receive an Against recommendation from proxy advisors, the level of support may decline compared to historic norms if disclosures do not sufficiently justify the actions taken.

Conclusion

2021 Say on Pay results will likely test the “steady state” seen over the previous 10 years. While the full picture will not be clear until later this year, CAP has begun to look at companies with fiscal years ended in late 2020 to get an early read. We will continue to monitor Say on Pay results throughout the year to see how the COVID-19 pandemic shapes these results.

On November 13, 2019, Institutional Shareholder Services (ISS) made two key changes to its Quantitative Pay-for-Performance Screens for 2020.

1. 1. ISS changed the Financial Performance Assessment (FPA) to be based on Economic Value Added (EVA) metrics (EVA Margin, EVA Spread, EVA Momentum vs. Sales, EVA Momentum vs. Capital) instead of the GAAP metrics that were used in 2019. The FPA will continue to be used as a secondary modifier screen affecting a relatively small number of companies.

      ISS will continue to include the GAAP metrics in the report. Though they will not be used in the quantitative assessment, they may be included in the overall ISS evaluation of pay and performance alignment.

      We expect that many companies will engage with ISS to determine their performance on the EVA metrics, given the complexity in replicating the EVA metrics from GAAP financial information.

1. ISS made changes to the thresholds that will trigger concern for the Relative Degree of Alignment (RDA) and the Pay-TSR Alignment (PTA) tests.

These changes will be welcomed by issuers as they lower the likelihood of ISS undertaking a qualitative review of a company’s pay program that may trigger an against recommendation from ISS on the Say-on-Pay vote.

Stock price growth? Meeting the business plan? Beating external expectations? Long-term stability? Companies must consider success across multiple fronts, and boards of directors play a role in defining success by working with management to set the strategic plan and by overseeing how the company progresses toward the achievement of the plan.

Incentive plans are foundational to motivating the senior management team to achieve the goals of a company’s strategic plan. Determining how to best measure and reward performance against these goals is key to designing effective incentive compensation programs that ensure proper alignment of pay outcomes with various degrees of suc- cess against the plan.

To determine how board members measure performance and incorporate it in their company’s incentive compensation plans, Corporate Board Member and Compensation Advisory Partners partnered to survey more than 250 public company directors. In this report, we present our findings and share our perspective on these key issues.

Download the PDF to read the full report.