CalPERS gets tougher on companies over compensation

When it comes to executive compensation issues at the corporations in CalPERS' portfolio, pension fund officials have made corporate board member actions personal.

In 2020, the $410 billion California Public Employees' Retirement System, Sacramento, for the first time voted against compensation committee members when voting against executive compensation plans, said Simiso Nzima, investment director and head of corporate governance, in an interview.

In the 2020 proxy season, CalPERS voted against 2,716 board members on the annual meeting ballot due to their roles as compensation committee members in failing to properly align executive pay and performance.

If CalPERS officials are unhappy with a company's compensation plan, they are now holding corporate directors accountable for failing to institute a plan in which executive pay and performance are aligned, Mr. Nzima said.

Out of 2,256 say-on-pay votes cast as of June 30, CalPERS voted against the executive compensation plan 52% of the time, down slightly from 53% during the 2019 proxy season. CalPERS voted against compensation committee members at every company it voted against executive pay. It did not vote against members who had been on the compensation committee for a year or less, he added.

"I don't think others of our size are voting against members of compensation committees," he said.

Since say-on-pay votes are advisory, voting against compensation committee members is a way to hold company executives accountable for their actions.

"We don't want to say that we don't like what you are doing, but will vote for you anyway," he said.

Typically, say-on-pay shareholder proposals are supported by an overwhelming majority of shareholders. Executive compensation proposals received 90% average support in the 2020 proxy season, about the same as last year, according to analysis from Willis Towers Watson PLC released in September. The majority of shareholders voted against 3% of say-on-pay proposals in 2020, also flat with the year-earlier proxy season.

The Willis Towers Watson analysis was based on information from 2,003 Russell 3000 companies from Jan. 1 to July 17.

Proxy advisory firm Institutional Shareholder Services Inc., Rockville, Md., recommended negative votes on say-on-pay proposals 11% of the time in 2020, down from 13%. ISS recommended shareholders vote against compensation committee members at only 14% of the companies at which the most shareholders voted against say-on-pay proposals, Willis Towers Watson analysis revealed.

This is the second year CalPERS has used a new five-year quantitative pay-for-performance model as part of the framework it uses to review executive compensation proposals, Mr. Nzima said. CalPERS officials compare the pay of the company's CEO with the pay of his or her peers. For example, if a CEO's compensation is in the 50th percentile but the company's performance is in the 25th percentile, then the CEO is being overpaid relative to peers, he explained.

CalPERS officials also consider the CEO's compensation compared to rank-and-file workers, Mr. Nzima said. The problem is that how companies pay contract workers is not standardized. Every company uses a different business model for employee pay relative to its peers, he said.

Also new this year, CalPERS not only voted against committee members when it voted against say-on-pay plans, pension plan officials followed up with requests to discuss their votes with company executives.

The response rate was low, 30% as of the end of August, most likely due to the pandemic, Mr. Nzima said. He added that the rate is likely to rise as some companies wait to respond to meeting requests in September, October and November.

Executive compensation issues are not the only ones leading to a CalPERS vote against board or committee members. On the issue of making corporate board's more diverse, CalPERS voted against 164 directors at companies where meetings or other contact with executives about the lack of diversity on its board failed to produce constructive outcomes. By comparison, CalPERS voted against 314 directors in 2019 and 468 directors in 2018.

The decline is a sign of progress, Mr. Nzima said. Some 67% of the 733 companies CalPERS officials met, spoke or otherwise engaged with since July 2017 have added a diverse director to their boards.

In the past, CalPERS tended to vote against board directors on an ad hoc basis such as when company executives exhibited poor oversight resulting in a controversy, he said.

Now CalPERS is voting against board members on thematic issues such as climate change.

"This is relatively new for us," Mr. Nzima said.

CalPERS is leading engagements at 22 companies, including six Japanese firms on the issue of climate change. However, CalPERS votes against corporate directors on climate change issues only on an ad hoc basis, Mr. Nzima said.

"We may vote against directors on other thematic issues as well," he added. In March, the team will report to the board on its new ideas for 2021.

CalPERS officials have been holding 15 to 20 meetings with company executives on corporate governance issues each week since the middle of June.

CalPERS' willingness to vote against board members has gotten the attention of company executives. Almost half of those engagement meetings that CalPERS held through mid-September on executive compensation included at least one board member in attendance, Mr. Nzima said. This is a huge difference. In general, a board member will attend a proxy meeting, regardless of the issue, only 5% of the time, he said.

"This is true for most investors," that board members attend shareholder engagement meetings only on rare occasions, Mr. Nzima said.

Institutional investors generally end up meeting mostly with corporate counsel or investor relations executives, he said.

"When you talk to a board member ... you have a conversation where you are actually solving the problem," Mr. Nzima said. "At the end of the day, for us, this is about investment returns."

As large as it is, CalPERS on its own does not own that much of a single company, he explained. CalPERS' largest public holdings are Microsoft Corp. and Apple Inc, which each accounted for 1% of the pension fund's total assets as of June 30.

"If more investors really hold people accountable, we will see change," Mr. Nzima said. "We need directors, we need boards working for us. We are using our capital the right way so we can have the investment returns."