This week the SEC approved the non-binding Say-On-Pay rule. This is one component of the executive compensation provision of the Dodd Frank Act, a comprehensive financial regulatory reform enacted due to the collapse and near demise of many industry giants, like Lehman Brothers and AIG. The executive compensation provisions are intended to discourage companies from awarding lucrative packages that encourage risky behavior. Other components of the executive compensation provision include clawbacks (e.g., recouping executive compensation in the event of an accounting restatement), compensation committee and adviser independence, enhanced compensation disclosures, and corporate governance.

Shareholders can now vote on executive compensation packages, at minimum, once every three years. They also will have separate nonbinding votes on golden parachutes, which are compensation arrangements with executive officers in connection with merger transactions. The timeline for implementing the new rules is set for 2011 annual meetings for public companies with public investors owning greater than $75 million worth of shares. Smaller companies will have until 2013.

Although the Say-On-Pay rule is nonbinding, companies must disclose in public filings whether they followed the shareholder vote. If the Board does not make adjustments to executive compensation based on the shareholder vote, it may face negative repercussions like dissension between the Board and shareholders, the wrath of major shareholder advisory firms, a negative impact on investor confidence and public image, and directors may not get re-elected. In the UK, a similar rule has been in place since 2002 and, as a result, has more effectively linked pay to performance, improved communication among boards, management, and institutional investors, and aligned shareholders and management.

Currently, there are some 80 companies that have already implemented Say-On-Pay prior to this recent SEC approval. To date, shareholders at only three companies — Motorola, Occidental Petroleum, and KeyCorp — have voted against executive compensation packages.  Shareholders have voted against tax gross-ups, in which executives receive compensation to reimburse them for taxes on perquisites.

How should companies prepare to implement say-on-pay?

  • Establish formal communication plans
  • Proactively identify potential executive pay issues and concerns in advance
  • Make transparent the rationale behind their executive pay programs in the proxies’ Compensation Discussion and Analysis section
  • Partner with proxy advisors
  • Work with key institutional shareholders