Compensation committee members may be targeted for removal by shareholders in the months to come if companies continue to hand out generous pay packages and the economy weakens further. Vanguard, the world’s second largest asset manager, recently revealed publicly that it voted against CEO compensation packages for Uber and Alphabet – but more importantly, the institutional investor explained why it voted against the pay plans. As the reasoning behind what CEOs earn becomes more public, greater pressure is going to fall on compensation committee members to convince shareholders that they are fairly distributing company resources.
In its 2020 Annual Investment Stewardship Report, Vanguard made it clear that the reasons Uber and Alphabet gave for granting tens of millions of dollars in compensation to relatively new CEOs was not acceptable. In the case of Uber, Vanguard argued that although compensating a new hire for stock options that might have been forfeited at his prior employer in order to take the job is reasonable, the one-year vesting period basically guaranteed the new CEO would earn $55 million for just showing up. After all, could the Uber board provide metrics that could prove the company realized $55 million worth of value in the new CEOs first year? In voting against the pay package, Vanguard called the board’s decision “excessive and misaligned with the long-term interests of shareholders.”
Alphabet, the parent company of Google, awarded its CEO, who was hired in 2019, stock awards valued at $276.6 million for 2019. In its report, Vanguard said the Alphabet board granted the compensation due its “confidence in the CEO as the best candidate to lead the company.” Again, Vanguard questioned how shareholders could measure whether the new CEO had delivered $276.6 million in value in one year. In voting against the pay package, Vanguard called it “a misalignment between pay and performance” and suggested the company design compensation packages with “a greater portion of compensation in the long-term plan tied to company performance with links to a more rigorous metric, such as relative total shareholder return.”
With the second largest institutional investor in the world airing its views on board decisions in a more transparent fashion, the influence on shareholders will likely be swift. Expect other large shareholders to be more vocal about board decisions on executive compensation, which may begin to affect shareholder say-on-pay votes.
Additionally, Vanguard noted that it has voted against the pay packages at Alphabet three years in a row and at some point that type of record on compensation may cause problems. While directors at a company like Alphabet may not feel pressure to change because its share price shows consistent gains, the boards of smaller companies with less lofty shareholder returns will get much tougher scrutiny. If shareholders mount a takeover attempt, the public record of Vanguard and other large institutional investors criticizing large compensation packages could potentially be used to target compensation committee members and the board chairman for ouster.
Boards should also be prepared to hear shareholders offer their views on what they believe a fair compensation package looks like. The growing focus on stakeholder capitalism is bringing more attention to the pay differential between the top executives and regular employees. According to an Economic Policy Institute study, CEOs earned an average of $21.3 million in 2019, up 14% from 2018. The study estimates that equates to more than 320 times what the typical worker takes home. More shareholders are asking companies to create value for all stakeholders, and that includes employees, customers and the communities companies serve. Compensation committee members may need to consider being more open-minded about incorporating financial incentives into pay packages that encourage executives to find creative ways to increase profits while enriching all stakeholders. The Aspen Institute and executive compensation consultancy Korn Ferry recently released “Modern Principles for Sensible and Effective Executive Pay,” that the two organizations say offers “a new path for executive compensation that moves from a shareholder-centric approach to including other principles, such as fairness, employee well-being and other commitments to ensure long-term business success.” Compensation committee members should expect to see more such proposals in the future.