Year in and year out, Say-on-Pay is one of the most contentious items on the proxy voting agenda. It’s also one of the most difficult for companies to communicate, and for investors to assess. What datapoints should determine whether or not to support the proposal? How should each datapoint be calculated, and then combined to form a comprehensive analysis?

A supplementary filing released April 19th by Valero Energy puts these questions in the spotlight. Valero has raised concerns about an independent analysis of its upcoming Say-on-Pay vote, with particular focus on award valuation and peer group selection. The filing highlights the complexities of executive compensation and the importance of a balanced, case-by-case approach – and having plenty of time to consider your vote decision.

So, what concerns has Valero raised?

Award Valuation

There’s no one right way to arrive at a meaningful value for outstanding equity awards. Should the goal be to reflect the amount that the company expects the executive to receive, years down the line? The target amount, or the maximum? Should you apply your own assumptions about share price movements during the vesting period, and the likelihood of performance targets being achieved? Or simply calculate the most recent, up-to-date value of the award based on total number of shares by … current share price? A recent average? How long of a recent average?

In this case, Valero determined the number of shares its CEO would receive in 2021 based on a target value of $11.3 million, divided by a 15 trading-day average. Notably, this was the same target value it used for 2020 awards, and the same methodology for determining the number of shares. In its supplementary filing, Valero raised concerns about an independent analysis that valued the award based solely on the date of grant share price (that is, number of shares x share price on date of grant), yielding a figure 35% above the date of grant share price for the CEO’s 2020 award – despite Valero using the same target value and methodology for determining the number of shares, and making the grants in the same calendar week of the year.

Using date of grant share price is as good a method for valuing awards as any other. If your goal is to strip out messy assumptions and provide a simple comparable value, it might be the best approach. But it only tells you so much – indeed, however you value awards, context is key. Relying on a single number, calculation or methodology without looking at the bigger picture runs the risk of perverse outcomes.

Glass Lewis Approach to Award Valuation

Glass Lewis’ approach is to review say-on-pay proposals on a qualitative and a quantitative basis, with consideration for both the company’s intentions, as communicated in its publicly available filings, and the ultimate outcomes for executives and shareholders. That includes the grant date value of new awards – as well as a wealth of additional data, put into context.

On the quantitative side, Glass Lewis has partnered with Diligent to deliver market-leading analysis of CEO pay and company performance over five years. The charts displayed for the U.S. and Canadian markets analyze total realized pay each year for the past five years compared to performance. Realized deferred and long-term incentives are recorded as disclosed by the company to ensure a complete analysis of the actual performance outcomes relevant to the rewards. Diligent Compensation & Governance Intel’s platform provides access to more data for outstanding and grant date value awards, giving clients the tools they need to perform their own assessment.

The charts included on Glass Lewis’ Compensation Analysis page provide an additional point of reference for understanding the alignment between realized company pay and corporate performance over several years relative to peers. The analysis does not produce a score and does not determine Glass Lewis’ voting recommendations, although it is an additional input into our analysis of pay for performance.

Peer Group Construction

Peer groups are a central component of how executive pay is determined and assessed. They are used to set the ballpark for the size of an executive’s pay opportunity, and provide a point of comparison for assessing how much of that opportunity should pay out based on how well the company (and by extension the executive) has performed.

But peer groups are notoriously difficult both to construct and evaluate. Set the criteria too strictly, and you’ll end up with a tiny group of companies. Cast too wide a net, and the resulting sample may be too inclusive to provide meaningful comparisons. And what is the correct criteria — should you look at companies of a similar size? In the same industry? Growth stage? Geographical region?

In this case, Valero has expressed concerns about an independent analysis’ inclusion of both smaller and larger peers – smaller companies in the same industry with significantly lower revenues, and a vastly larger company in a completely different industry. Like with award valuation, the issue isn’t so much whether any one peer is “right” or “wrong”, but that the overall picture, and the methodology used to get there, matters.

Glass Lewis Approach to Peer Groups

Based on thousands of engagements with public companies and their shareholders, we have found that investors tend to favor industry-based peers, followed by country-based peers. By contrast, public companies tend to prefer their self-disclosed peers, stemming from the unique position they feel they hold in the marketplace.

Glass Lewis’ methodology is intended to break the feedback loops that result from a disproportionate focus on companies’ self-selected peer groups without losing the benefits of that methodology. Although we believe the company’s self-disclosed peers and peer-of-peers are important inputs when evaluating pay, we believe a truly independent and robust comparison should also consider investor views of factors such as industry, country, and company size. By incorporating the investor view, we can avoid the “echo-chamber” effect and market-wide ratcheting on executive compensation levels encouraged by peer-of-peers methodologies that rely exclusively on how companies reference one another in their disclosures.

Our peer methodology addresses these issues in a measured way. Beginning with a company’s self-disclosed peers, Glass Lewis then includes investor views on both industry-based and country-based peers, in addition to the company’s peers-of-peers. The methodology then scrutinizes this larger pool of potential peers by introducing additional screens based on corporate revenue, market capitalization, and assets; weightings also consider the source and frequency of confirmation, and peer rankings are based on a strength-of-connection approach that considers all potential peers, not just those resulting from the network effects of corporate disclosures.

This hybrid approach reflects both the reality of how companies choose their peers, and investor preferences for industry and country-based comparisons, providing a higher level of confidence in the integrity and independence of our peer assessment and pay analysis.

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You can read more about Glass Lewis’ peer group methodology, or contact us to learn about our approach to executive compensation and proxy voting:

GROW@glasslewis.com (Institutional Investors) | ENGAGE@glasslewis.com (Public Companies)