The 2023 proxy season is just around the corner. This quick reference guide, which is intended to supplement Shearman & Sterling's 20th Annual Corporate Governance & Executive Compensation Survey, summarizes themes from the 2022 proxy season and developing trends to consider for 2023. It also identifies possible future changes in disclosure rules that public companies should consider for the upcoming proxy season.
SHAREHOLDER PROPOSALS
The 2022 proxy season was marked by a significant increase in shareholder proposals that went to vote, with a record 941 proposals submitted and with a record 562 proposals proceeding to vote. The overall increase in submissions was primarily driven by the continued increase in ESG proposals.
Increasing emphasis on shareholder engagement and changes to the Securities and Exchange Commission (SEC) approach to allowing exclusion of proposals played a role in the larger number of proposals that went to vote, evidenced by 40% fewer successful no action letters seeking exclusion. This was the first proxy season following the issuance of SLB 14L, which repealed earlier staff guidance that had provided more opportunities to exclude ESG proposals and made the "micromanagement" test a potent tool for exclusion under 14a-8(i)(7). SLB 14L substantially limits the ability to rely on the ordinary business and economic relevance bases for exclusion if a significant social policy issue is implicated by a proposal. In addition, SLB 14L significantly scales back the micromanagement prong of the ordinary business exemption, making it more difficult to exclude proposals on that basis. Investor support for these proposals, however, was more muted than in the 2021 proxy season against a backdrop of economic turbulence and geopolitical instability in 2022.
BlackRock, for example, highlighted the importance of maintaining flexibility for management to address climate related objectives given adverse market conditions and the need to focus on long-term shareholder value creation.
Looking ahead to the 2023 proxy season, companies should be mindful that while institutional investors were less supportive of the more prescriptive ESG shareholder proposals in 2022, there is still significant institutional support for enhanced reporting and transparency, which may lead to additional activism, especially if the SEC's climate change proposal is delayed or faces significant litigation headwinds. Also, ISS and Glass Lewis have both increased their standards for climate change accountability for the 2023 proxy season. It will be important for companies to monitor what shareholders and proxy advisory firms are signaling and emphasize engagement given the greater likelihood that ESG-related proposals will make it to a vote.
PAY VERSUS PERFORMANCE
On August 25, 2022, the SEC announced its adoption of the long-awaited "pay versus performance" rules under the Dodd-Frank Act. Codified in Item 402(v) of Regulation S-K of the Exchange Act, the new rules require covered listed companies to disclose the relationship between compensation paid to named executive officers and the company's financial performance pursuant to specific disclosure obligations that are first applicable this proxy season.
For large domestic filers with fiscal years ending on or after December 16, 2022, pay versus performance disclosure will be required in proxy statements filed in 2023.
The pay versus performance rules require three key elements of disclosure: (1) a new pay versus performance table providing comparative data eventually over a five-year period (three years in the first year of disclosure and four in the second year); (2) graphic or narrative descriptions of the relationship between "compensation actually paid" (CAP) and each of the performance measures disclosed in the table; and (3) a tabular list of three of the most important financial performance measures used to link CAP to company performance for the most recent year shown in the table and up to four additional performance measures (which can be non-financial) used to link CAP to company performance for the same year. This list need not be ranked, nor are results on these measures required to be disclosed.
The new table requires for each covered year (2022, 2021 and 2020 for this proxy season) disclosure of: CAP and total compensation as reported in the company's summary compensation table for the company's principal executive officer; average CAP and average total compensation for the company's other named executive officers; cumulative total shareholder returns (TSR); peer group cumulative TSR; net income; and a "company selected measure" (CSM) (which is the most important financial performance measure in the company's view used to link CAP to company performance). A key decision point for companies in preparing the table is selecting the CSM.
Calculating CAP requires adjusting total compensation as reported in the company's summary compensation table by modifying the pension and equity award values. This is a formulaic adjustment, but it may take substantial time to prepare and may also require the services of outside valuation consultants. Peer group cumulative TSR may be based on either the same peer group used by the company for purposes of the stock performance graph of Item 201(e) of Regulation S-K or a peer group disclosed in the company's Compensation Discussion & Analysis as used for setting compensation. Companies obligated to comply with new pay versus performance rules should plan accordingly by selecting the performance measures to be included in this new disclosure, putting in place a system for calculating CAP, briefing boards and management about the disclosure requirements and monitoring for additional SEC guidance.
UNIVERSAL PROXY
On August 31, 2022, the SEC rules mandating the use of a universal proxy card in contested director elections became effective. The new rule permits activists in contested director elections to include their nominees on the company's proxy card, rather than preparing and mailing their own proxy card. This allows stockholders voting in contested director elections to pick and choose among company and activist director nominees, rather than selecting one slate of directors or the other.
The new rules require parties seeking to take advantage of a universal proxy card to meet a number of related requirements, such as notice periods and minimum solicitation thresholds, which generally are aligned with existing practices or alternately would not be challenging to satisfy. ISS and Glass Lewis have hailed the universal proxy card for the greater flexibility it affords shareholders in picking nominees from both sides, but have stated that their overall approach to assessing proxy contests will stay the same. Thus, activists will still have to make strong arguments for change to win support.
We do not expect the existence of a universal proxy card to encourage experienced and well-funded activists to launch more campaigns, but it is possible that the significant reduction in cost to get dissident candidates on a ballot will shift the focus of proxy campaigns from competing slates of directors to competing candidates.
This can provide opportunities for new activists, like ESG-focused investors and groups, to consider putting a nominee on the board, or using the threat of it, as part of their engagement toolkit.
The new rules may also spur more contested elections, and the ability of stockholders to pick one or two dissident nominees while otherwise voting for incumbents arguably raises the likelihood of activists winning minority slates on boards. This change in focus may heighten attention on the qualifications of individual directors, as activist campaigns may seek to unseat incumbents they view as vulnerable.
To prepare, public companies should review their bylaws to ensure their advance notice bylaw requires comply with the requirements of the new rule. For example, companies should consider amendments to bylaws to reflect the notice and solicitation threshold requirements associated with use of the universal proxy card and require more information about the parties the shareholder is actually collaborating with in connection with the solicitation. It is important to implement these changes before an activist has taken the first steps toward a possible campaign. Finally, some companies, as part of a response to universal proxy, have implemented bylaw changes that impose significant requirements on any party seeking to nominate a candidate for election to the board. We have seen and we expect to continue to see negative stakeholder reactions to these types of bylaw changes.
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