Shareholders Begin to Discuss Fairness in Proxy Voting Guidelines
One of the things that drew me to the topic of CEO pay, wage justice, and income inequality is my conviction that fairness is a goal worth fighting for. For many years the only time fairness appeared in investor guidelines was in the context of making sure executives were paid fairly in relationship to their peers. However, in recent years I’ve seen the discourse grow as pay inequality grows exponentially and recognition dawns that systemic issues of inequality affect us all.
The unequal effects of the pandemic added new scrutiny to the increasing income inequality between executives and employees. Subsequently, investors began to more explicitly consider the issue in their guidelines.
Aviva, with an AUM (Assets Under Management) of $414B, was one of the largest funds to take on the issue. A new sentence added to the Aviva Investors Global Voting Policy when it was updated in January 2021 stated: “A strong tone from the top in sharing the burden of austerity is essential in maintaining staff morale during challenging periods. Fairness and equality need to be more prominent principles in shaping the culture of executive pay.” This made more explicit a principle that had been stated in the prior guidelines as well: “Boards should also show more restraint in approving significant pay-outs or increases to pay opportunity during periods of low wage inflation, cost cutting initiatives and when there has been a loss in shareholder value.”
Railpen’s guidelines explain one of the reasons shareholders focus on the issue: “Fair pay is a key element in ensuring a motivated and engaged workforce.” The railway workers pension fund, with an AUM of over $38B, updated its guidelines this year noting that, “In 2021, RPMI Railpen expects, “Boards to balance the need to appropriately compensate leaders who successfully and safely steer companies through Covid-19 with an awareness of the experiences of the wider workforce at this time” and said they would vote against executive compensation plans, “which are not aligned with the approach taken to employee remuneration more broadly.” In other words, the fund expects burdens to be shared fairly. The guidelines also discuss the need for an analysis of gender pay gaps and ethnicity pay gaps where possible. Diversity, Equity and Inclusion has become a growing concern among shareholders and we saw changes in a number of guidelines on that issues. For more on As You Sow’s work on the issue see here.
The guidelines of NEI Investments also discuss the issue explicitly, and go beyond just fairness. “We believe that increasing pay disparity within companies is not only a fairness issue, but also a potential business risk.” Specifically, they note, “A disconnect between executive compensation and salaries at lower levels of the company may de- motivate employees, and thus undermine the strategic objective of attracting and retaining talented people. Concerns have also been raised that compensation design and high pay levels for top executives do not take into account how people are actually motivated and lead to needlessly complex pay disclosure in proxy circulars.” In its Q1 2021 Active Ownership report NEI offers examples of specific companies where it engaged on inequality issues specifically, noting that while there was some disagreement on thresholds for identifying excessive CEO pay, “None of [the companies] pushed back on the idea of income inequality as a systemic risk.”
Candriam, a New York Life Investments company, added the following to its guidelines this year: “More specifically and as a matter of fairness, Candriam will not accept changes in performance-based policies based on multi-year performance cycles, if the sole given reason is to reduce the impact on compensation of a particularly unfavorable year.” While this change may have been inspired by the pandemic, it presumably can apply to other situations.
Gam Switzerland may vote against executive compensation if: “Pay arrangements for Executive directors, in particular salary increases or pension benefits, are not aligned with the rest of the workforce.”
Pay ratio:
What is deemed fair is a subjective concept, but one way to analyze it is consider the ratio of the highest paid to the lowest paid in a society or a workforce. Compensation consultant Graef Crystal, who late in his career advocated against generous CEO pay packages, said in 1998, “Plato told Aristotle no one should make more than five times the pay of the lowest member of society. J.P. Morgan said 20 times. Jesus advocated a negative differential--that's why they killed him.”
In recent years – including in the U.S. under Dodd Frank – more disclosure on pay ratio has been required. French asset manager Groupama AM’s 2021 voting policy notes that it has been required in France, since 2020, having previously been adopted in the UK and US. One of the fundamental principles in executive compensation is, “Any increase in the fixed part of the compensation must be explained and linked to the evolution of the pay ratio.” With multiple years of data since required corporate disclosure began to appear, investors are now able to track changes over time. Groupama notes, “the evolution of this ratio must be consistent with the evolution of performance. An unjustified increase of this ratio is likely to motivate a negative vote on a proposal to increase the fixed compensation of executives.”
The State of Vermont’s guidelines state that the fund begins compensation analysis with a, “threshold query” on whether pay reflects performance, but that many other elements will be considered as well. This year it added, “The ratio of pay to the CEO as compared to the average worker will also be taken into consideration as well as whether companies adjust diversity metrics and the robustness of the explanatory disclosure.”
Aviva, described more above, also includes, “Unjustifiable increase in the executive pay ratio relative to the median for the workforce” as something they will look at.
Socially Responsible Investing Funds lead the way
Not surprisingly, SRI funds have led the way on the specific use of pay ratios. Trillium, which generally follows ISS’s SRI policy, votes outside the policy on the issue. Since 2019 the fund has voted against pay when, “the company CEO worker pay ratio exceeds 50:1.”
Northstar Asset Management first principle commitment outlined in its voting guidelines in Pursuing Solutions to Economic Inequality, noted that, “We also believe that economic inequality is both an ethical and financially material problem for companies to address.” It was one of the first funds to include pay ratio in its analysis; voting against compensation proposals where the ratio of CEO to median worker pay was greater than 100. As early as 2017, prior to the proxy disclosure requirement of company specific data, NorthStar used Bureau of Labor Statistics to identify ratio. For 2021, NorthStar implemented a policy they described as more stringent taking, “an especially close look at named executive officer equity compensation as it compares to compensation of employees. NorthStar will only approve executive compensation packages in which equity, stock options, bonuses, and benefits packages for all nonexecutive employees is equivalent to that of executive officers.”
Castlefield Investment Partner LLP, a privately owned investment manager that specializes in responsible and sustainable investment, has a section in its guidelines on quantum of pay that also uses pay ratios as a reason to vote against pay. “Where executive base salary is in excess of between 30-35 times the UK median salary and 60-65 times that of the lowest paid employee, executive pay should be deemed excessive and remuneration should be voted AGAINST. The lower multiple should be enforced where the company in question is not a living wage employer.”
What happens Post-COVID
We expect to see more funds expand their focus on this issue in their guidelines, though some funds referenced fairness only in COVID specific language. In its February 2021 update to its guidelines, T. Rowe Price included a short section on “The Impact of the Pandemic on Pay Decisions.” It stated, “For our 2021 proxy voting decisions, alongside our traditional assessment of pay-for-performance alignment, pay practices and absolute level of pay, we will also assess pay outcomes through the lens of fairness.”
The pandemic has certainly drawn attention to the disproportionate effects experienced by different groups. But we think it goes beyond that. There is growing awareness that systemic inequality is a global concern. The charge that companies “privatize the profits and socialize the costs” is most often used in an environmental discussions, but applies on larger societal issues as well. We believe that fairness is an appropriate lens in any year. We will continue to try to keep track of how the issue is discussed by funds, and welcome any additional examples.