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Article | Executive Pay Memo North America

2022 Proxy season: Back to business with an ESG flair

Governance Advisory Services |Executive Compensation
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By Don Delves , Robert Newbury and Brian Myers | July 28, 2022

Over the past several years, the focus on ESG factors in incentive plans seems to be shifting from early adopters into a standard practice for most companies.

When we look back to late 2020 and early 2021, and review actions taken in the early stages of the pandemic, most companies and proxy advisors were focused on whether and how to exercise discretion in making executive pay decisions.

The core notion was that making executives whole at the expense of broader stakeholders would be problematic. Though this seemed to be a fairly bright-line in nature, we saw a true case-by-case approach with a willingness to examine company-provided disclosure and the rationale of actions taken in response to the pandemic and economic instability.

Fast forward to 2022, and we have seen a back-to-business approach characterized by scrutiny in the typical key areas, including poor disclosures, one-time special awards, changes to in-cycle long-term incentives and responsiveness (or lack thereof). As we move beyond the 2022 proxy season, we expect the scrutiny to continue to tighten. Though investors and proxy advisors understand the economic uncertainty in the market, there is an expectation that companies have established guiding governance principles to move forward through the chaos.

While the “E&S” of Environmental, Social and Governance (ESG) are receiving attention, we believe the big “G” is always important, and not just during challenging times or when the investor spotlight is on. Those companies and compensation committees with a strong track record and a good governance framework will tend to be viewed more favorably by investors and proxy advisors over time — whether it pertains to robust goal setting, responsiveness, limited evidence of problematic pay practices, or adjustments to prevent or mitigate windfall gains during market rebounds.

To date, there has been a muted response to inflation and the tight labor market, particularly in terms of disclosed actions that apply to executives. The presumption is that many actions are happening below the executive level or for targeted key groups but aren’t being disclosed because they don’t impact executives. The answer might be different at the beginning of next year when new filings provide the full picture. For now, the lack of knee-jerk responses to these issues speaks volumes toward the back to business approach.

In the early days of say-on-pay responses during the pandemic, we saw proxy advisors and investors target the larger, higher-profile companies with “no” votes for problematic pay practices in hopes that the messages (company precedent and principled governance, importance of clear and compelling disclosure, and engagement and responsiveness) would trickle down to smaller companies.

This approach has been fairly successful, with most companies across the spectrum considering rationale and disclosure when altering pay programs in the face of say-on-pay scrutiny and increased shareholder engagement. Interestingly, S&P 500 companies have shown more scrutiny in 2022. In fact, these companies have accounted for almost one-third of the year-to-date say-on-pay failures. The average support level for the largest companies has been 87%, lagging behind the broader Russell 3000 (90%).

Throughout the proxy season, we have seen shareholders target say-on-pay and director nomination votes to “speak” to companies on an expanding number of issues. While this isn’t necessarily a novel approach, the trend is for a growing group of shareholders to use this tactic and, in doing so, expand the list of topics or issues that may impact vote outcomes. This, in part, has led to the increased opposition and failure rates on say-on-pay for the larger companies.

The use of ESG-related factors in executive incentive plans continues to evolve, particularly environmental and human capital-related measures. We have been tracking the increased use of ESG factors in incentive plans over the past several years. What stands out is we seem to be entering a stage where the use and focus has shifted from early adopters and into a standard practice for most companies.

In the 2021 proxy season we were in a “just wait, it’s coming” phase of companies reacting to stakeholders requesting a greater ESG-based focus. This year there is a much higher level of investor scrutiny on ESG factors, with key stakeholders analyzing and reacting to what companies are actually adopting. The number of shareholder proposals on inclusion and diversity issues filed and voted on dropped significantly year-over-year, while investors have pushed for about the same or slightly more environmental-related proposals.

However, support for proposals coming to a vote on these issues has dropped materially year-over-year. We have also witnessed investors seeking greater disclosure of underlying performance toward ESG goals. This suggests a more robust engagement process that, so far, is working sufficiently enough to appease the majority of stakeholders. We expect to see much more robust disclosure and shareholder engagement around ESG incentive factors in the coming year.

A version of this article appeared in Workspan on July 21, 2022. All rights reserved, reprinted with permission.

Authors

Managing Director, Executive Compensation and Board Advisory Practice Leader - North America (Chicago)

Senior Director, Global Executive Compensation Analysis Team (Columbus)

Governance Team Lead, North America & Director, Executive Compensation and Board Advisory (Arlington)

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