The California Public Employees’ Retirement System’s 2018 proxy season voting policies ramped up votes against management proposals “to hold corporate boards accountable for board diversity, board independence and executive compensation”.
The big one among this trio is voting on executive compensation. CalPERS implemented what it called “an enhanced voting practice” on Say on Pay votes this year, voting against 43% of such proposals, compared to 18% in 2017 and a 5-year average of 16%! It says that the failure to align pay with performance was the primary reason for against votes.
Under the Dodd-Frank Act, companies must hold a say-on-pay vote at least once every three years.
RI spoke to Simiso Nzima, CalPERS investment director, corporate governance, to find out how and why.
“CalPERS’ Governance & Sustainability Principles and Investment Beliefs guide our voting process and practices,” said Nzima. “The principles are reviewed annually, and we have certainly made changes to them this year, but in this case, it has been the application of these principles that has changed.
“If, for example, a data provider points us to a misalignment between executive compensation and total shareholder return (TSR), we must ask: what are we missing? To identify these companies, we look at the analyses of ISS, Equilar and Glass Lewis, among others, to provide us with an analysis of company performance relative to the performance of peers, using operating metrics, cashflows, TSR, return on equity, and return on assets.
“If we find that they are being paid well above their peers in comparison to the performance they have been delivering, then we conduct a qualitative analysis of the disclosures in the proxy; for example, looking at the performance metrics chosen, the design of the plan etc. Because of this qualitative analysis using our voting guidelines, it has given us a higher probability of voting against, for example, a company with a ‘C’ Pay-for-Performance grade that would not normally have been considered a failing grade.”
Nzima continued: “We use third party data providers to help point us to compensation issues that may be of concern out of the 10,000+ companies that we invest in. We look at a mosaic of factors and research because we don’t want to miss anything, but the final judgement is ours and is based on our digging deeper into compensation policy at the company.”
RI asked how CalPERS’ voting record compared to those of its advisors. “The main proxy advisory firms typically recommend voting against 15% of Say on Pay resolutions,” he said. “Those are much lower figures than our against vote of 43%.”In answer to a question about what drove the substantial change in the application of the voting guidelines, Nzima said: “We need to make sure that these companies are managed in such a way as to create long term value for shareowners and enable us to meet our pension liabilities. Our analysis looks at a company’s long-term strategy and its execution of that strategy and whether the compensation plan reflects an alignment with that strategy, which is then reflected in a return to shareholders.”
Nzima crystallised the key concern of most shareholders over executive pay design: “Executive compensation is where wealth transfer from shareowners to management occurs. We have to ensure that compensation is driven by long-term value creation and aligns management and shareowner interests.”
“We look at a mosaic of factors and research because we don’t want to miss anything”
In addition to the votes on Say on Pay, in July 2017, CalPERS wrote letters to 504 companies in the Russell 3000 about lack of diversity on their boards urging them to improve. In December last year, it wrote follow-up letters to companies that had failed to respond, warning them that it would use its proxy votes to hold boards accountable. The engagement had results. Some 30% of engaged companies added a ‘diverse director’ to their boards; 151 of 504 companies at the end of July 2018. But, in addition, the fund voted against 438 directors at 141 companies with poor responsiveness, including board chairs, committee members and long-tenured directors with greater than or equal to 12 years’ board service. It also ran proxy solicitations on diversity proposals filed by other investors at two of these unresponsive companies. This voting practice will continue in future proxy seasons, as will collaborations with “other investors and strategic partners to improve corporate board diversity”.
CalPERS also amended its proxy voting practice for Japan in 2017 to vote ‘against’ non-independent directors when board independence is less than a third. This entailed voting against 6,509 non-independent directors at 864 companies out of around 1,200 and writing letters to inform them of its voting rationale and encourage the appointment of more independent directors to reach the fund’s threshold. The practice continued for the 2018 season, when the fund voted against 6,124 non-independent directors at 794 companies. Again, the policy is bearing fruit. Some 90 companies from the 2017 season have since increased board independence to at least a third.