Christopher Earnest, Partner, Houston Office of Compensation Advisory Partners
A slew of companies have been in the crosshairs of proxy advisors due to their approach to so-called Say on Pay practices. In the energy sector, for example, the likes of Halliburton, C&J, and Parker Drilling faced criticism for failing to conduct appropriate shareholder outreach regarding executive compensation. Schlumberger, meanwhile, has a significant percentage of performance parameters that ISS considers to be overly subjective.
In part because of the risk of such criticism, there may be a conflict of interest when a proxy advisor such as ISS offers consulting services to corporate clients. That’s according to Christopher Earnest, a partner in the Houston office of Compensation Advisory Partners, which provides advice on executive pay to boards and senior management teams. Mr. Earnest, whose focus includes the energy sector, said that proxy advisors should increase the level of transparency in their methods and disclose conflicts of interest.
CorpGov: Tell us a bit about the history of the influence of the proxy advisors. Did their power increase gradually over time or was there a key event to keep in mind?
Mr. Earnest: Proxy advisors have been around for a long time, but the passage of Dodd-Frank and the requirement in 2011 for public companies to hold a shareholder Say on Pay vote significantly boosted their influence. ISS & Glass Lewis recommendations for and against Say on Pay proposals solidified their position with institutional investors looking for voting guidance on executive compensation proposals. The Say on Pay vote also opened the door of opportunity for ISS to sell consulting and advisory services to companies.
CorpGov: Are there any key instances where you believe the proxy advisors used their power to the detriment of stakeholders, even if it was unintentional?
Mr. Earnest: I don’t know of any cases where proxy advisory firms have abused their influence or used it in a way that specifically was to the detriment of shareholders. We all have experienced instances where ISS or Glass Lewis made a mistake or mischaracterized programs or grants. The limited ability for companies to have a meaningful dialogue with them in these instances is very frustrating, but I wouldn’t go as far as to say they have abused their power.
I do however believe ISS’s consulting and advisory services offered to companies is problematic. It is a conflict of interest and quite frankly I’ve heard it described in the boardroom as blackmail. The perception, although technically incorrect, is that ISS will provide a more favorable review of your compensation practices if you pay for and subscribe to the services provided by their advisory arm. This casts a shadow of skepticism over the entire review and recommendation process and this view carries over to Glass Lewis who, to their credit, does not sell advisory services and have even spoken out against it publicly.
CorpGov: What’s the case for scaling back the role of the proxy advisors?
Mr. Earnest: I honestly do not believe it’s a matter of scaling back their role, but requiring them to disclose conflicts of interest, increase their efforts to ensure the accuracy of analysis, and offer a greater level of transparency and disclosure of methods for determining proxy recommendations. Glass Lewis, for instance, provides very little insight into their pay for performance assessment leading to a “black box” issue.
CorpGov: You’ve said that the shareholder advisors may apply a framework that’s too rigid. How could they replace the one-size-fits-all approach with a more flexible one?
Mr. Earnest: There is a perception that it is too rigid. The framework in place, however, is probably ok. The problem, in my opinion, is that they quite simply don’t have enough people with industry knowledge to handle the rush of proxies filed within a matter of weeks during the spring each year. This leads to the one-size-fits-all approach and probably has the greatest negative impact on smaller companies who tend to get less individual attention.
CorpGov: How do you feel about the proxy advisors’ treatment of compensation issues?
Mr. Earnest: I think that proxy advisory firms have done a good job of developing a fair way of best practices for compensation committees and executive teams to operate within. Key among those practices is their emphasis on performance-based pay.
They have, however, also developed certain quantitative tests for assessing “pay for performance” that are very sensitive to peer-company selection and total shareholder return (TSR) performance. The peer companies selected for analyzing relative pay and performance tend to change from one year to the next, creating a bit of a moving target. This has, on occasion, been responsible for adverse recommendations. The over-reliance on TSR performance by proxy advisors can also lead to frustrating recommendations, particularly in volatile industries where market influences or commodity prices can be as – or more – responsible for stock-price fluctuations than management decisions. They do include other financial performance measures in their analysis, but the use and weighting are a bit unclear and secondary to TSR.
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