Press release: Institutional Investors, Proxy Advisors Fail To Use Economic Value Creation As Major Factor In Say-on-pay Voting
Study by Investor Responsibility Research Center Institute and Organizational Capital Partners
New Research Consistent With Recent Findings that Value Creation Is Not the Dominant Driver of Executive Compensation
New York/Geneva - December 22, 2014 - – A new study finds that economic value creation is not a major factor in institutional investors’ Say-on-Pay voting, nor in the recommendations of the two largest proxy advisors that counsel investors how to vote. The research reveals that there is no material difference between institutional investors’ Say-on-Pay voting for those companies that create economic value as compared to those that destroy value.
The Alignment Gap Between Say on Pay Voting and Creating Value is authored by Organizational Capital Partners and was commissioned by the Investor Responsibility Research Center Institute (IRRCi). It analyzed the most recent Say-on-Pay votes for more than 100 institutional investors with approximately $13 trillion in total global assets under management at a sample of 128 S&P 1500 companies. Download the study here.
More specifically, the study finds:
- The average Say-on-Pay support vote across the sample was 82% for 32 low performing companies (return on invested capital – or ROIC – less than the cost of capital and negative relative total shareholder return) and 84% for 32 high performing companies (ROIC greater than the cost of capital and positive relative total shareholder return).
- The median vote was 90% for the low performing companies and 96% for high performing companies.
- There was not a meaningful difference between the recommendations of the two major proxy advisor firms, ISS and Glass Lewis. ISS recommended for 84% Say on Pay approval at value destroying companies and for 81% of value creating companies. Glass Lewis recommended for votes at 72% of the value destroying companies and 81% of the value creating companies.
"It’s time for institutional investors to step up and recognize that they also contribute to short-termism and sub-optimal value creation," said Jon Lukomnik, IRRCi executive director. "The report suggests that using value-based performance metrics such as ROIC as part of Say-on-Pay voting analysis would help move the focus of executive compensation from short-term alignment with stock market swings to long-term corporate economic performance," he added.
"Corporate disclosures of balance sheet and capital efficiency performance metrics – coupled with inclusion of these measures in long term incentive plan design – would provide significant insight into a company’s capacity to create positive ROIC. Ultimately, this will help drive long term value," said Mark Van Clieaf, report co-author and partner with Organizational Capital Partners.
"Institutional shareholders and proxy voting advisors can significantly enhance voting execution so that it’s better aligned with long-term corporate value creation. Additionally, implementing a pay-for-performance analytical model that incorporates fundamental finance and value creation principles like positive ROIC greater than the cost of capital and growing five year economic profit would create a more direct line of sight alignment between operating performance and sustainable shareholder returns," Van Clieaf added.
In the U.S., Say-on-Pay is an advisory vote by shareholders on the executive compensation design of named executive officers, including the CEO. Institutional investors and proxy voting advisory services may consider a broad range of factors in their overall Say-on-Pay voting decision. This might include compensation policy, change in control provisions, internal pay equity, use of performance metrics, performance analysis and pay-for-performance alignment as measured by total shareholder return (TSR). Some institutional investors may also use the Say-on-Pay vote as a way to communicate their evaluation of the company’s strategy, business model and performance.
This report looks at how more than 100 of the largest mutual fund families in the U.S. cast those votes for some of the largest value creating and value destroying companies in the S&P 1500 over 5 years. In the aggregate, those fund families control more than $11 trillion in global assets under management. In addition, the report data set includes 11 of the largest North American pension funds with nearly $2 trillion in assets under management, as well as the voting recommendations of the two largest proxy advisory companies (Institutional Shareholder Services and Glass Lewis) that are widely considered the most resourced and sophisticated Say-on-Pay voters and advisors.
Today’s report is the second in a series of two on performance measurement, value creation, long-term incentive plan design and pay-for-performance. The first report, The Alignment Gap Between Creating Value, Performance Measurement, and Long-Term Incentive Design, focused on performance measurement, value creation, long-term incentive plan design, and pay for performance. The first study found a major disconnect between corporate operating performance, value and incentive plans for executives for the vast majority of S&P 1500 companies. The analysis identified that 47% of the S&P 1500 did not generate a positive ROIC or positive cumulative economic profit over the five-year period of 2008 to 2012. The research identified that 85% of companies did not disclose any type of future value type performance metrics such as innovation as part of long term incentive pan design. It also detailed an over-reliance on accounting metrics that do not measure capital efficiency, and how TSR obscures a line of sight to the underlying drivers of economic operating performance.
The Investor Responsibility Research Center Institute is a nonprofit research organization that funds academic and practitioner research that enables investors, policymakers, and other stakeholders to make data-driven decisions. IRRCi research covers a wide range of topics of interest to investors, is objective, unbiased, and disseminated widely. More information is available at www.irrcinstitute.org.
Organizational Capital Partners is a global strategy consulting firm that delivers client impact through aligning shareholder value with, innovation, structure, and incentive design to implement value creating business strategy. More information is available at http://www.orgcapitalpartners.com/.
Press release: DEEP MISALIGNMENT BETWEEN CORPORATE ECONOMIC PERFORMANCE, SHAREHOLDER RETURN AND EXECUTIVE COMPENSATION
Study by Investor Responsibility Research Center Institute and Organizational Capital Partners
Only 12% of CEO Pay Determined by Economic Performance; More than 75% of S&P 1500 Companies Not Equipped to Measure, Manage Key Factors Driving Sustained Corporate Value
Webinar to Review Findings at 11 AM ET on Monday, November 24th
NEW YORK/GENEVE - NOVEMBER 17, 2014 - For the vast majority of S&P 1500 companies, there is a major disconnect between corporate operating performance, shareholder value and incentive plans for executives. New research details an over-reliance on accounting metrics that do not measure capital efficiency, and how total shareholder return obscures a line of sight to the underlying drivers of economic performance. Economic performance explains only 12% of variance in chief executive officer (CEO) compensation.
The Alignment Gap Between Creating Value, Performance Measurement, and Long-Term Incentive Design, authored by Organizational Capital Partners and commissioned by the Investor Responsibility Research Center Institute (IRRCi), finds that:
- Economic performance explains only 12% of variance in CEO pay. More than 60% is explained by company size, industry, and existing company pay policy. None of those are performance driven.
- Some 75% of companies have no balance sheet or capital efficiency metrics in their disclosed performance measurement and long-term incentive plan design.
- Only 17% of companies specifically disclose return on invested capital or economic profit as a long-term performance measure for long-term executive compensation.
- Some 47% of S&P 1500 companies over the last five years (2008 - 2012) did not generate a positive cumulative economic profit or return on invested capital greater than their cost of capital.
- More than 85% of the S&P 1500 have no disclosed line of sight process metrics aligned to future value such as innovation and growth drivers.
- Only 10% of all long-term incentives have a disclosed longest performance period for named officers of greater than three years.
- Nearly 25% of companies have no long-term performance based awards at all, relying instead stock options and time-based restricted stock in their long-term compensation plans.
"Too often, the wrong performance measures and wrong incentives are used over too short a performance period," said Jon Lukomnik, IRRCi executive director. "Investors, directors and corporate executive management all want companies to create value. But this report tells us that most companies are not measuring the fundamental drivers of economic performance such as earning a return more than the cost of capital. To compound the problem, companies largely have their longest accountable performance period for named officers at three years or less. Moreover, only a few CEOs are measured and compensated for strengthening the building blocks of long-term value creation such as innovation, research and development, and new product or market development," he said.
"These findings indicate there is a critical need for a fundamental re-examination of measurement and executive compensation so as to incent sustained corporate economic performance." Lukomnik added. "This means reducing the overwhelming dependence of large U.S. companies on total shareholder return (TSR) as a dominant performance and incentive compensation metric. TSR is not a direct measure of operating performance. It is a post hoc measure of alignment with short-term stock market price movements. Top management has limited decision authority over too much of what drives TSR, which can be as varied as Federal Reserve policy, the flow of funds into the stock market and specific industry dynamics as varied as commodity prices or changes in regulation. Disrupting the status quo of performance measurement won't be easy, but the analysis reveals that too many companies are off course," he said.
The study also indicates that:
- TSR is, by far, the most dominant performance metric in long-term incentive plans, present in more than 50% of all plans despite the fact that executives do not have line of sight accountability for key drivers that impact TSR outcomes.
- Nearly 60% of companies changed performance metrics for CEO compensation in 2013, and one-third of companies changed at least 25% of the peer group used for performance benchmarking. That lack of stability of performance metrics can suggest a short-term focus despite the fact that the incentive plans are supposed to be long-term focused.
"Future value is a key input for value creating TSR along with current operating performance" said Mark Van Clieaf, report co-author and partner with Organizational Capital Partners. "A critical role of executive management is to lead the investments that create innovation from new products, new markets, and new business models that drive future revenue growth and positive returns on capital. Yet, the analysis finds that few named corporate officer roles are directly measured and rewarded for the innovation that creates positive economic value over a three to five year or longer innovation cycle," Van Clieaf said.
The study suggests that the majority of companies could enhance long-term value creation and long-term incentive plan design by:
- Applying value-based performance metrics such as return on invested capital (ROIC) and/or economic profit in performance measurement design while migrating away from the dominant use of total shareholder return or earnings per share;
- Adding future value improvement drivers (i.e. innovation, customer loyalty) to the performance metrics mix and long-term incentive plan design;
- Extending the longest accountable performance-period for named executive officers to a period longer than three years;
- Stabilizing the performance metrics and peer groups used in long-term incentive design to the extent possible; and
- Creating coherent and coordinated reporting on business performance, executive rewards, and disclosures for investors based on this framework.
Download the research here.
A webinar is to review the findings and respond to questions is scheduled for 11:00 AM ET on Monday, November 24, 2014. Register for the webinar here.
The Investor Responsibility Research Center Institute is a nonprofit research organization that funds academic and practitioner research that enables investors, policymakers, and other stakeholders to make data-driven decisions. IRRCi research covers a wide range of topics of interest to investors, is objective, unbiased, and disseminated widely. More information is available at http://www.irrcinstitute.org.
Organizational Capital Partners is a global strategy consulting firm that delivers client impact through aligning shareholder value with, innovation, structure, and incentive design to implement value creating business strategy. More information is available at http://www.orgcapitalpartners.com/ or at @OC_partners. To contact the authors directly please contact us by email (North America) or (Europe).
Kelly Kenneally | +1.202.256.1445 | | @irrcresearch
Organizational Capital Partners asked to provide research for New York Times - "Pay for performance - paying for value?"
Experts in corporate finance say that stock price, commonly used in setting pay, is imperfect as a gauge of managers’ ability to create value. We provided the insight for the article published on 13 October 2013 in the NY Times.
Link to the detailed research file here
Link to the article: When the Stock Price Hides Trouble or download the article here or an article by the Cheung Kong Graduate School of Business, China's leading business school which you can download here