May 31, 2024 Executive Compensation Resilience Articles

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Evaluating Executive Compensation in the Age of Activism Boards must acknowledge exec comp's impacts and take steps to mitigate effects on the company.

Several high-profile activist campaigns over the last few years have kept shareholder activism top of mind for board members. Individual activist investors and campaigns vary in nature — from constructive, low-profile dialogue to less cooperative and more combative approaches.

Understanding how these influential external groups view executive compensation can help boards rethink the narrative around executive pay in the event of future activist involvement. While compensation design and outcomes are generally not the primary driver of activist campaigns, executive pay often serves as a means for activist shareholders to highlight perceived mismanagement or misalignment with shareholder interests in key areas.

Semler Brossy studied 30 activist campaigns between 2021 and 2023 to evaluate the relationship between core campaign objectives and executive compensation programs. We found that activists commonly use executive pay criticisms to back their campaigns. These criticisms are often consistent with typical proxy advisor commentary. However, in at least a few cases, the campaigns focused on outcomes differently from how proxy advisors typically would review them. Interestingly, prior say on pay votes or proxy advisor recommendations do not reliably predict future issues despite the overlap in focus areas. 

A strategic and business-oriented approach to executive compensation helps prevent potential challenges in an activist scenario. One strategy to help achieve this outcome is periodically reviewing executive pay program design, outcomes and disclosures through the lens of potential activists, similar to that of other critical areas, such as capital allocation, dividend policy or strategic positioning when considering external vulnerabilities.

Activists use regular executive pay criticisms to back their campaigns. 

In our analysis, 70% of campaigns cited executive compensation as an issue and 43% of these campaigns recommended specific changes to current compensation practices or program design. The focus areas in Figure 1 are interrelated and often do not diverge meaningfully from standard proxy advisor policies. The commentary on executive pay almost always focused on the magnitude of pay and/or above-target incentive payouts over time, especially if shareholder returns and financial performance suffered.  

Figure 1

In some cases, public campaigns also suggested changes to executive compensation program design, although this was less common. These suggestions primarily focused on enhancing the alignment between incentive plans and shareholder experience by advocating for the incorporation of formulaic measurement of financial and returns metrics alongside total shareholder return (TSR). In one example, investors pushed for simplification of an incentive plan by streamlining the number of operational metrics and focusing on three to four metrics more closely aligned with shareholder value. In another example, the commentary focused on eliminating metrics tied to actions (e.g., complete transactions, implement systems) and shifting to results-based metrics (e.g., TSR, financial goals).

However, executive compensation can sometimes be used in unexpected ways. In a third example, an activist used a history of below-target incentive payouts as evidence that the management team was underperforming the board’s expectations and a new management team was needed. This example illustrates the importance of an annual review of the executive pay program for potential vulnerabilities through the lens of an activist investor; not just relying on a list of typical issues or proxy advisor policy.

Activist campaigns result in lower approval rates for executive pay. 

Given the frequent overlap between activist commentary and proxy advisor policy, we sought to identify potential warning signs in proxy advisor recommendations or say-on-pay vote results. Surprisingly, we did not identify a significant correlation that could provide advance warning to boards.

That said, activist campaigns still considerably impacted vote results in the subsequent year after initiation of a campaign. Controlling for the impact of adverse proxy advisor recommendations, our analysis indicated that votes were 12% lower on average in the year following an activist campaign. The failure rate in the year after a campaign initiation also rose significantly, as shown in Figure 2.

Figure 2

With a notable decline in average vote results and an increase in failure rates following campaign initiation, it’s evident that activist concerns can manifest in other areas, even if the overall campaign is not successful.

Strategies for Board Defense

To help avoid these issues, boards should consider adopting proactive approaches to defend against potential criticisms. In the same way that the full board might allocate a meeting every year to address broader shareholder and strategic issues, the compensation committee should dedicate one meeting per year, usually in quarter two or quarter three, to reviewing the pay program.

These meetings should focus on how well the program supports business priorities, alignment of pay and performance, congruence of metrics with externally communicated goals and strategy and assessment of the rigor of the goal-setting process. The committee should also evaluate areas where the program could make the company more susceptible to unwanted attacks by activist shareholders, such as consistently low incentive payouts over time.    

As activism remains top of mind, boards and management teams must acknowledge executive compensation’s potential impact and take proactive measures to mitigate its effects. While our research indicates that activist investor preferences related to executive compensation often do not diverge significantly from typical institutional investor and proxy advisor policies, focusing on transparent, performance-driven compensation design and being thoughtful about potential vulnerabilities can reduce the likelihood that executive compensation is used in an activist campaign and help remove one arrow from the activist quiver.

View the full article as it was originally published.

Greg Arnold

Kristofer O’Toole

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