We believe executive compensation plans should be structured to create long-term alignment between shareholders and the management of the companies in which we are invested. As long-term investors, we see the importance of incentive awards designed to encourage management to perform at the highest levels. These programs need to align with appropriate performance criteria that are both challenging and reflective of the company’s strategy and objectives over the long term. They should reward executives for long-term value creation rather than short-term gains.
Meeting these goals is easier in theory than in practice. Given the rising pace of innovation, disruption and uncertainty, compensation committees face several challenges in designing plans that are in long-term alignment with shareholders. We are therefore not prescriptive in our evaluations and recognize boards need flexibility when formulating a compensation plan. We also acknowledge some discretion is needed when evaluating management performance towards realizing long-term outcomes.
While we acknowledge the challenges in creating a compensation plan that aligns executive compensation with shareholder experience, we frequently come across practices we find problematic.
2021 engagement case studies
Biogen, US
Issue
We had concerns about compensation practices at this US biotechnology company. We identified issues around severance benefits paid to the outgoing CFO, as well as the complicated nature of ongoing compensation plans and whether these appropriately align management with shareholders.
Action
At the company’s 2021 annual meeting, we voted against the compensation plan, which failed to garner significant shareholder support with only 51% of shareholders supporting the plan. The compensation committee underwent necessary refreshment with a long-time board member joining the committee in 2020 and becoming its chairman in 2021. We engaged with Biogen to improve its program and develop better long-term alignment with shareholders.
In engagement with the company, we highlighted three issues with Biogen’s long-term incentive plan:
The awards are too complicated: in any given year, seven different tranches are granted. This makes it challenging to track how awards are being paid out.
Part of the awards are settled in cash rather than stock.
Awards have tranches that use one, two, and three year performance periods. This results in awards overweighting the first year and overemphasizing short-term performance.
We recommended they simplify the plan, remove cash-settled payouts, and move to three-year performance measures.
Outcomes and next steps
The company appreciated our feedback and demonstrated positive reforms. We will evaluate plan changes made and anticipate a plan more aligned with shareholders.
Marathon Petroleum Corp, US
Issue
We raised concerns with the granting of a significant one-off equity award to the outgoing CEO at this energy company. Where companies grant one-off awards we would seek to engage to better understand the rationale for such grants.
Action
The company provided the outgoing CEO a USD 6 million equity award the day before his retirement in recognition of the progress he made advancing the divestiture of a business. The company also noted the award was meant to promote his continued support for the executive leadership transition. We engaged with the company, both before and after the annual meeting in April 2021, to understand better the rationale behind the grant and express our point of view that those responsibilities fell inside the normal duties for a CEO and should, therefore, not require a special grant. We also noted that, the divestiture appeared to be at risk at the time of the grant of award. We commended the company on the positive changes they had made to their compensation program, such as better defining its peer group, eliminating a discretionary portion of the annual bonus, incorporating ESG metrics into compensation, and increasing the use of PSUs. However, we continued to note our concern on the one-off award.
Outcomes and next steps
While we acknowledged the positive changes made by the company, the special grant was unjustified in our view and we escalated our concerns by voting against the executive compensation resolution. Despite our actions, the resolution was passed. Following board refreshment and transitions in the CEO and CFO positions, however, the board has made changes to the compensation program that we believe improves the alignment with shareholders.
Veolia Environnement, France
Issue
We had concerns with a number of companies making modifications and adjustments to compensation plan metrics and targets due to the financial impact from COVID-19. This French utility company was impacted by the COVID-19 pandemic, which resulted in it lowering its financial targets and drawing on state support through the crisis.
Action
The company’s share price underperformed the wider market and its industry peers. Despite this, the board proposed a significant pay award to its Chief Executive Officer for 2020 performance. We were not satisfied with the way that the revised financial goals enabled a significant outperformance by the CEO versus these new, lower targets. The company capped the maximum payout, but we still considered the pay high and misaligned with the shareholder experience. We engaged the company before the vote to hear its explanation, including on the determination of the lower targets and payout to the CEO. We were not sufficiently convinced of the rationale by the company in relation to the adjustments made.
Outcomes and next steps
As a result of our concerns, we determined to escalate our engagement by voting against the CEO pay at the AGM. However, despite our concerns, the resolution was passed at the AGM. Following the vote, we engaged further with the company to request that compensation policies provide clear visibility and confidence for shareholders in the long-term planning of the company, as well as to establish targets which cannot be adjusted mid-plan. We will continue to monitor and engage the company ahead of the next AGM.
Mondelez International, US
Issue
The incorporation of ESG metrics into compensation plans is becoming increasingly prominent. Many boards have begun including metrics tied to ESG measures in compensation plans, including this US food and beverage producer.
Action
We had discussed with the issuer their decision to incorporate ESG metrics into compensation to better understand which metrics they were planning to use and the rationale for their choices. The company explained that they are now including sustainability goals in annual incentive compensation while taking a gradual approach. The company further noted that similar to the financial metrics, they were evaluating the most important 2025 ESG goals as they relate to the company’s strategy. These will likely relate to sustainability, diversity and inclusion, well-being and portion control snack share. The company elected to put ESG goals into the annual incentive to help achieve progress on a yearly basis. The company noted that goals apply to the business unit level.
Outcomes and next steps
We believe the company is taking a thoughtful approach to introducing ESG metrics into its compensation plan and are generally supportive of this measured approach to incorporation of ESG metrics. We encouraged the company to expand disclosure on how it is progressing against these goals. We will review the next proxy statement and monitor company progress and continued appropriateness of these ESG goals and metrics.
Voting on strategy alignment with the long term
We utilize our engagement and voting power to bring about change where we believe executive compensation plans have not been structured in a way to create long-term alignment between shareholders and company management.
2021 voting case studies
Voting issue: Executive compensation
Starbucks, US
The issuer granted the CEO a large performance-based cash award. The use of cash for such a large award raised some concerns at the international coffeehouse.
Action
The CEO was granted a significant performance-based cash award. Pay out under this award was based on three-year relative total shareholder return (TSR) versus the S&P 500 Index, with a target payout of USD 25 million for a relative TSR in the 65th percentile. Although the award came with performance conditions, we were concerned about the use of cash, when equity would better align the CEO with shareholders and would allow the board to create additional retention mechanisms such as delayed vesting. In our opinion, the company did not provide an adequate rationale for this decision.
Outcomes and next steps
As a result of our concerns, we voted against the executive compensation resolution at the company’s AGM in March. We will continue to monitor compensation practices at the company and seek to encourage what we believe to be better alignment with shareholder interests.
Voting issue: Remuneration policy
AstraZeneca, UK
The issuer sought shareholder approval for a new remuneration policy just one year after receiving shareholder support for the previous iteration of the policy. The changes included a significant increase in potential variable compensation for the CEO.
Action
This was the second year that the company requested investors to shift the forward-looking pay proposal (the remuneration policy) with the current policy having only been approved by shareholders for a three-year term at the 2020 AGM. We prefer these pay policies to be longer-term and preferably to survive three years. The variable pay opportunity was being increased significantly. While there is acknowledgement of the CEO’s performance, we did not believe performance justified an increase from 650% to 900% of salary in two years.
Outcomes and next steps
Despite the important role of AstraZeneca Plc in the COVID-19 vaccine research, development and global roll-out, we along with 40 percent of investors voted against the pay proposal at the May annual general meeting. We will seek to engage the company ahead of the 2022 AGM to understand the company’s response.
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Stewardship priorities
Risk summary
Certain client strategies invest on the basis of sustainability/Environmental Social Government (ESG) criteria involves qualitative and subjective analysis. There is no guarantee that the determinations made by the adviser will be successful and/or align with the beliefs or values of a particular investor. Unless specified by the client agreement or offering documents, specific assets/companies are not excluded from portfolios explicitly on the basis of ESG criteria nor is there and obligation to buy and sell securities based on those factors.