2015 Investor Survey: Deconstructing Proxy Statements — What Matters to Investors

2015 Investor Survey: Deconstructing Proxy Statements — What Matters to Investors

David F. Larcker, Ronald Schneider, Brian Tayan, Aaron Boyd
Stanford University, RR Donnelley, and Equilar. February

In the fall of 2014, RR Donnelley, Equilar, and the Rock Center for Corporate Governance at Stanford University surveyed 64 asset managers and owners with a combined $17 trillion in assets to understand how institutional investors use the information in corporate proxies to make voting and investment decisions.

Only 38 percent of institutional investors believe that corporate disclosure about executive compensation is clear and easy to understand.

“Shareholders want to know that the size, structure, and performance targets used in executive compensation contracts are appropriate,” says Professor David F. Larcker of Stanford GSB. “Our research shows that, across the board, they are dissatisfied with the quality and clarity of the information they receive about compensation in the corporate proxy. Even the largest, most sophisticated investors are unhappy.”

“With new pressure from activist investors and annual ‘Say on Pay’ (SOP) votes, it is more important than ever that companies explain to their shareholder base why the compensation packages they offer are appropriate in size and structure,” says Aaron Boyd, Director of Governance Research at Equilar.

“Investors are noticing the wide range in quality and clarity among various companies’ proxies. They want companies to communicate and explain, rather than simply disclose,” adds Ron Schneider, Director of Corporate Governance Services at RR Donnelley Financial Services Group. “This represents a significant opportunity for many companies to improve the clarity of their proxies.”

Key findings include:

Investors are Deeply Dissatisfied with Compensation Disclosure

Less than half (38 percent) of institutional investors believe that information about executive compensation is clear and effectively disclosed in the corporate proxy. Responses are consistently negative across all elements of compensation disclosure. Sixty-five percent say that the relation between compensation and risk is “not at all” clear. Forty-eight percent say that it is “not at all” clear that the size of compensation is appropriate. Forty-three percent believe that it is “not at all” clear whether performance-based compensation plans are based on rigorous goals.

Significant minorities cannot determine whether the structure of executive compensation is appropriate (39 percent), cannot understand the relation between compensation and performance (25 percent), and cannot determine whether compensation is well-aligned with shareholder interests (22 percent). “Corporations must do a better job of articulating the rationale behind plan design,” says Mr. Boyd. “It is not enough that disclosure in the Compensation Discussion & Analysis (CD&A) section of the proxy meets regulatory requirements. Companies should take renewed effort to be clear and concise in explaining their choices.”

Proxies are Too Long and Difficult to Read; Investors Rely on Only a Small Fraction of the Information

Fifty-five percent of investors believe that a typical proxy statement is too long. Forty-eight percent believe that a typical proxy is difficult to read and understand. Investors claim to read only 32 percent of a typical proxy, on average. They report that the ideal length of a proxy is 25 pages, compared to the actual average of 80 pages among companies in the Russell 3000. “Lengthy disclosure does not necessarily equate with clear and digestible disclosure, and can actually impede rather than improve shareholder understanding of governance choices” observes Mr. Schneider. “Plain English language which is well-organized and easily navigated, coupled with simple design elements to draw the reader to key content, are much more effective in conveying information.”

Investors are most satisfied with disclosure relating to director nominee descriptions and qualifications, director independence, and shareholder-sponsored proposals. They believe that disclosure relating to pay ratios (the ratios of CEO pay to median employee pay and CEO pay to other named executive officer pay), corporate political contributions, corporate social responsibility and sustainability, and CEO succession planning are least clear.

Investors Believe the Proxy Voting Process is a Valuable Exercise …

Eighty percent of investors believe that proxy voting increases shareholder value. Their confidence level that proxy voting increases value averages 7.2 on a scale of 1 to 10, with nearly a quarter of respondents (24 percent) assigning a confidence level of 10. Institutional investors are most likely to read the summary section of the proxy (if included), total compensation tables, and disclosure on long-term incentive plans. Investors also highly value a table highlighting significant changes from the previous year. For proxy voting decisions, investors rely most heavily on disclosure relating to pay-for-performance alignment, performance metrics used in compensation plans, and director independence.

In addition to proxy statements, investors are most likely to rely on internal policies or analysis (73 percent), third-party proxy advisors (63 percent), and direct engagement with the company (58 percent) to make voting decisions.

…However, Portfolio Managers are Only Moderately Involved in Voting Decisions

Seventy-six percent of institutional investors report that portfolio managers are involved in voting specific proxy items for the companies their organization is invested in. However, among those portfolio managers that do participate in voting decisions, the level of engagement is very low. A typical portfolio manager is involved in only 20 percent of voting decisions. Among large institutional investors [assets under management (AUM) greater than $100 billion] engagement is even lower: portfolio managers are involved in only 10 percent of decisions.

Portfolio managers that participate in voting tend to weigh in on major issues: mergers and acquisitions (89 percent), director nominations in a contested election (82 percent), executive compensation “say on pay” (75 percent), and proposals to approve or amend equity compensation plans (70 percent).

Two-thirds of respondents (68 percent) report that portfolio managers are involved in establishing their firm’s proxy voting guidelines.

Proxies are Less Frequently Used for Investment Decisions

Fifty-nine percent of investors use proxy information for investment decisions. In making investment decisions, they rely most heavily on disclosure relating to performance metrics used in compensation plans, pay-for-performance alignment, the corporate governance profile of the firm (including shareholder rights and anti-takeover measures), and risk oversight.

Investors are Lukewarm that “Say on Pay” Leads to Tangible Improvement

A slight majority (54 percent) of shareholders believes that proxies allow them to make informed votes on executive compensation (“Say on Pay”). A similar percentage (58 percent) believes that “say on pay” is effective in influencing or modifying pay practices.

Complaints about disclosure might be related to dissatisfaction with pay practices in general. Only one-fifth (21 percent) of institutional investors believe that CEO compensation among companies in their portfolio is appropriate in size and structure. Twenty-one percent believe that CEO compensation among companies in their portfolio is clearly linked to performance. Only a quarter (26 percent) are able to understand the payouts that executives stand to receive under long-term performance plans.

“These are significantly negative perceptions of executive compensation,” observes Professor Larcker. “’Say on Pay’ is having some effect, engaging shareholders in a discussion about plan design. However, investors are still frustrated with pay levels overall and whether the packages awarded today are justified.”

View the related Stanford Closer Look publication, which explores what information shareholders would like to see in the “ideal” proxy statement.