Corporate Governance

Shearman & Sterling LLP Introduction | 3 Nonetheless, say-on-pay proposals passed at a significant majority of companies that received a negative recommendation from ISS. Why? Companies were better prepared. With experience from 2011, many companies proactively crafted their proxy disclosures to provide a clear and concise description of the compensation program, tailoring disclosures to anticipate and address issues on which ISS and other shareholder advisors were likely to focus. Once a company received a negative recommendation from ISS or another advisor, it was equipped to react effectively by contacting significant shareholders and filing supplemental proxy materials that rebut the criticisms and reiterate why the compensation program is successful. The most common reason for a negative recommendation from ISS is a CEO pay-for-performance disconnect. For 2012, ISS implemented a two-step pay-for-performance analysis focused on both relative and absolute measures of CEO compensation. The first is a quantitative test comparing: § "relative alignment" of CEO pay and the company's total shareholder return percentile ranking (over one and three years); § the multiple of the CEO's total pay relative to the median CEO pay for the company's peer group; and § the five-year trend in the company's total shareholder return and CEO annual pay. If a company fails the quantitative test, ISS analyzes mitigating factors such as the rigor of performance goals, the ratio of performance- to time-vested equity and performance-based compensation to total compensation, actual financial performance, benchmarking practices and completeness of proxy disclosures. The ISS analysis has been widely criticized and was the focus of a substantial majority of the supplemental filings made in 2012. The most common complaint was that ISS's peer group created groupings of unrelated peers from different industry segments with significantly varying revenues. Beginning in July 2012, Glass, Lewis & Co. instituted a new voting policy that addresses many of these complaints. Glass Lewis uses a more directed peer group based on the company's self-designated peer group and the peer companies designated by such peers. Moreover, while ISS has been criticized for looking only to total shareholder return, Glass Lewis measures the three-year weighted average of various metrics, including total shareholder return, change in operating cash flows, earnings per share, return on earnings and return on assets. An issue to watch in 2013 is how companies fare under the Glass Lewis policy and whether ISS will modify its 2013 voting policies similarly. tHe exeCutive summary evolves. The executive summary has become a regular component of the Compensation Disclosure and Analysis ("CD&A"), with 87 of the Top 100 Companies providing an executive summary in 2012—a nearly 15% increase from 2011. In prior years, the executive summary was used to highlight overall company performance, compensation-related corporate governance features and significant compensation decisions. In 2012, the executive summary emerged as the foundation of a company's pay-for-performance analysis. Executive summaries relied on narratives, graphs and charts and often focused on "realizable" or "realized" pay, rather than "pay opportunity" as calculated in the summary compensation table (and relied upon by proxy advisors). This allows shareholders to compare amounts actually paid to the named executive officers ("NEOs") over a multi-year period with the company's financial performance for the same period. disClosure of 2011 say-on-pay results. The Securities and Exchange Commission ("SEC") rules require a company to disclose in its CD&A whether, and if so, how, the prior year's say-on-pay vote was considered in making compensation decisions. Eighty-six of the 87 Top 100 Companies that held a say-on-pay vote in 2011 provided the required CD&A disclosure and the remaining company disclosed its 2011 approval rate. The disclosures were made in either the executive summary or in a separate section of the CD&A and by the end of the proxy season fairly standard disclosures emerged. Not surprisingly, there was a direct correlation between a company's 2011 say-on-pay results and the level of disclosure provided in the 2012 proxy. Companies that received high levels of shareholder support on their say-on-pay proposals (including 67% of the Top 100 Companies) generally followed a standard disclosure format noting that the company reviewed the results of the shareholder vote, considered the high level of support indicative of shareholder confidence in the executive compensation

• Cover