Barbara Novick of BlackRock, Inc., one of the largest and most powerful institutional investors in the world, wrote about CEO pay and the role of shareholders. Of particular note is her assessment of proxy advisors, making it clear that proxy advisor clients appreciate the analysis and recommendations but have their own views.
Proxy advisors are a critical component of the proxy voting system as they affect both the design of compensation packages and the vote outcomes for ‘say-on-pay’ votes and director elections related to compensation decisions. This contributes to the considerable influence that proxy advisors can have in executive compensation matters, as it has been estimated that due to the mechanical voting of some institutional investors, recommendations by proxy advisory firms can determine between 15-25% of a say-on-pay vote.  For more information on the role of proxy advisory firms, please see our recent ViewPoint, The Investment Stewardship Ecosystem.
The major proxy advisors have established compensation guidelines that are focused on ‘pay for performance’ relative to a peer group determined by the proxy advisor. Importantly, proxy advisor peer groups may differ from the peer groups identified by the Board and its compensation consultant. Failure to clearly link executive compensation to performance, or the use of weak performance standards, can result in a negative vote recommendation from proxy advisors on the say-on-pay ballot item. Other compensation practices, such as the inclusion of tax gross-up rights or single trigger severance arrangements, can also result in a negative recommendation. In some cases, the negative recommendation goes beyond the say-on-pay vote and includes a recommendation to vote against directors on the compensation committee or even directors at large. Some believe that over time, deference to the proxy advisors’ models and policies has led to more standardization and fewer compensation programs tailored to the particular circumstance of the company and the executives that the compensation policy is intended to incentivize. This homogeneity can reduce the effectiveness of pay plans and their alignment with corporate performance.