5 Mistakes to Avoid in your CD&A Before you File your Proxy Statement

Written By Aileen Boniface, Managing Director, Head of ESG

March 3, 2021

With the deadline for calendar-year companies to file proxy statements fast approaching, now is a good time to review investors’ and proxy advisors’ expectations. Many institutional investors have made it clear they expect changes in executive compensation programs due to COVID-19, but expectations for a reasonable compensation program can vary. Be sure to review voting guidelines from your top holders as some investors have indicated they plan to hold members of the compensation committee, or equivalent Board members, accountable for poor compensation practices.

Below are five mistakes to avoid in your CD&A before filing the proxy statement this year:

  1. Payouts Inconsistent with Headlines
  2. Lackluster Disclosure of Adjustments
  3. Boilerplate Language on Extraordinary or Special Awards
  4. Minimal Shareholder Engagement
  5. Ignore Discussion of Environmental & Social Metrics

Payouts Inconsistent with Headlines

The biggest, and perhaps easiest, mistake a company can make this year is providing minimal discussion of COVID-19 and its impact on executive compensation. The pandemic provided a headwind for some industries and a tailwind for others. Investors want to understand how your company responded to 2020’s volatility to determine whether executives were insulated from last year’s turbulence. If your company suffered mass layoffs or accepted significant federal financial support, be sure the payouts discussion is consistent with headlines, and that any gaps between the two are fully explained at the outset of the CD&A.

Lackluster Disclosure of Adjustments

During normal times, investors and proxy advisors may take a dim view of in-flight adjustments to annual or long-term incentive plans. Some proxy advisors have signaled greater tolerance for in-flight adjustments triggered by COVID-19 this year, but certain investors are less convinced.

Vanguard’s most recent Investment Stewardship Insights states:

Vanguard understands that the [COVID-19] crisis may have hurt companies’ performance. However, we remain steadfast in our view that compensation committees should not retroactively adjust performance targets or time horizons, despite the challenging environment. “At-risk” compensation should remain at-risk, just as the Vanguard funds’ capital does—along with that of other shareholders. We believe that the experiences of shareholders and executives should be aligned in both good and challenging times.

Broadly speaking, we expect greater scrutiny across the board of in-flight adjustments to long-term incentive plans than adjustments to annual incentive plans. Furthermore, adjustments to long-term incentive plans made one or two years into the performance period are likely more problematic than adjustments made to awards during performance periods beginning in 2020.

While changes to annual incentive programs or long-term incentive programs may not automatically trigger an against vote, most investors will be looking for a strong rationale and clear guidance on how the Board reached its final decision. A few examples of rationale that may apply to your company include: retention, continuity, or reorganization.

If adjustments were made to either incentive program, be sure to explain how the changes incentivized management rather than insulated pay.

Boilerplate Language on Extraordinary or Special Awards

Given 2020’s unprecedented challenges, investors will likely be more lenient to COVID-related one-time awards or retention awards — but once again, disclosure is key. Adding a few sentences to last year’s proxy statement about the pandemic will not be sufficient. If an extraordinary bonus is temporary, be sure to note that in the CD&A. And if the award was intended to work as a retentive tool, be sure to amplify features that protect investor interests: for example, longer vesting periods, performance-based vesting conditions, and/or shareholder-friendly guardrails.

Blackrock provides helpful guidance in its Proxy voting guidelines for U.S. securities:

BlackRock believes that there should be a clear link between variable pay and company performance that drives value creation. We are generally not supportive of one-off or special bonuses unrelated to company or individual performance. Where discretion has been used by the compensation committee, we expect disclosure relating to how and why the discretion was used and further, how the adjusted outcome is aligned with the interests of shareholders.

Minimal Shareholder Engagement

Companies should disclose regular shareholder engagement outreach in the proxy statement every year, but for 2020, shareholder engagement disclosures are more important than ever. While ISS and Glass Lewis have historically been interested in this section of the proxy on the heels of a low-support MSOP year, the number of adjustments anticipated in executive compensation programs this year suggest that companies would benefit from pre-emptive disclosure of board-shareholder communications.

This generally includes disclosure of the following:

  • Details and agenda for the engagement and topics discussed
  • Frequency and timing of the engagement (e.g., annual or semiannual )
  • Number and/or percentage of institutional investors contacted versus engaged
  • Company participants in meeting, including Board members
  • Specific feedback received from investors, including investor concerns
  • Specific actions taken by the Board to address investor concerns and/or rationale for non-action

Ignore Discussion of Environmental & Social Metrics

Although investor voting guidelines generally do not expressly require the use of environmental and social metrics in executive compensation programs, it is rare to attend an investor stewardship meeting and not field investor questions on climate change, sustainability, and human capital management. If E&S strategy is not discussed in the CD&A, investors will generally query a company on its plan to align executive incentives with the company’s stated E&S strategy.

In a letter titled CEO’s Letter on Our 2021 Proxy Voting Agenda, State Street Global Advisors noted:

Last year, we wrote you about R-Factor™ — our transparent scoring system based on the Sustainability Accounting Standards Board (SASB) framework, which focuses on financially-material, industry-specific ESG risks. We also announced that starting in 2020 we would be voting against companies in the bottom 10% of R-Factor™ scores that could not articulate a plan to improve their score. We will also be communicating with companies with underperforming scores that have not shown improvement in the coming year.

Whether by highlighting E&S strategy as part of broader business strategy, or including E&S metrics in forward-looking compensation discussions, be sure to discuss E&S in the proxy summary and CD&A.

Contact us if you have questions or need assistance with proxy reviews or proxy-related investor messaging.

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