By Amanda Gerut June 4, 2015


Five years of annual say-on-pay votes has laid the foundation for increased engagement among companies and shareholders in order to hash out differences in executive compensation, board composition and leadership.

At McKesson Corp., which is ranked 15th in the Fortune 500 and has revenues of $137.6 billion, the company has dramatically revamped its approach to shareholder engagement during the past few years, mainly on the back of say-on-pay vote results.

After weak support for its pay plans in the first two years of voting, the company was one of 73 organizations that failed on say on pay in 2013, receiving only 22% support. Yet, that year the company’s total shareholder return performance exceeded both the sector median and the S&P 500 index. After failing to get majority support, the board set about increasing its dialogue with investors and modifying its compensation plan.

“In terms of our overall philosophy, it is engagement, engagement, engagement,” saysLoretta Cecil, senior vice president in governance relations at McKesson. “It started in 2012 and 2013 and then really exploded in 2014 for us, is the way I would describe it.”

McKesson’s journey is a symbol of what consultants all agree is the most positive result of say on pay: boards talking directly to investors.

“One of the best parts of say on pay is shareholder engagement,” says Aubrey Bout, a partner with Pay Governance. “That is a positive thing any which way you look at it.”

The SEC began requiring that companies hold say-on-pay votes at annual meetings in January 2011. Data from ISS shows that average shareholder support for the votes has been high since they commenced five years ago. In the first year of say on pay, investor support averaged 91.6% among the Russell 3000. Average support has hovered at the same level ever since; year-to-date support has climbed to 92.1%.

For companies, obtaining say-on-pay approval is a credibility risk, consultants say. Directors, particularly those who oversee large-cap companies, don’t want to be known for serving on boards that can’t get investors to support their executive compensation plans.

Thus, yearly say-on-pay votes have largely flushed out pay practices investors viewed as unsavory and have helped pave the way for stronger independent leadership on boards and new director recruits.

“We’ve seen a fundamental shift in how compensation is delivered to executives as a result of say on pay,” says Russ Miller, founder and CEO of ClearBridge Compensation Group.

At McKesson, concerns about executive pay practices arose even before the company held its first say-on-pay vote, which ISS noted in its 2013 report on the company. The compensation committee, chaired by Alton Irby, had received “lukewarm support” in director elections at the company’s 2010 annual meeting. The lingering issue that made headlines was CEO John Hammergren’s supplemental pension benefit.

Hammergren’s pension, which is a contractual arrangement, had grown to $159 million by 2013, ISS noted, an increase that was partly due to an unusual interest rate environment. Investors had other issues with pay at the company beyond the pension benefit, however.

Michael Pryce-Jones, a senior corporate governance analyst in the investment group atChange to Win Federation,says there were a lot underlying, systemic problems with pay and governance at the company. McKesson was relying too heavily on earnings per share (EPS) in both the short and long term, he says.

Plus, the board needed new directors, adds Pryce-Jones, who has been involved in engagements with the company in recent years and helped lead a “Vote No” campaign against its directors. He and other investors were concerned that the board had become too deferential to Hammergren, and had allowed a “founder mentality” to creep into its interactions with the CEO.

“How does the board sleepwalk to a $159 million pension liability?” Pryce-Jones says.

The McKesson board was aware of investors’ concerns and had taken steps to address them.

The 2012 proxy states that the compensation committee had added new metrics to strengthen the link between pay and performance, including adjusted EPS, adjusted Ebitda, adjusted return on invested capital (ROIC) and long-term earnings growth and adjusted operating cash flow (OCF). The board also eliminated an “individual modifier” — which allowed it to consider individuals’ contributions to performance — from its restricted stock unit program so that awards were based strictly on financial performance, and reduced long-term incentive cash opportunities by 5%.

The board had also transitioned from having a presiding director that rotated out of the role every July to a bona fide lead independent director.

It wasn’t enough. With support dwindling, the board decided it was time to chart a new course.

Cecil says the crescendo in shareholder engagement following the 2013 vote was helped by centralizing efforts across the company. Cecil’s position was created in January 2014, and she was charged with driving the engagement initiative.

From January through July 2014, lead independent director Edward Mueller and longtime director and chair of the governance committee Jane Shaw began meetings with key investors that focused on executive compensation, says Cecil. Shaw brought the feedback to the compensation and governance committees and directors began the process of reworking the compensation plan alongside a new consultant, Semler Brossy.

That spring, Mueller held another series of meetings with investors, says Cecil, before another round of changes in May and June. The company filed its proxy in June, and held its annual meeting in July. All told, the company conferred with 26 of its largest institutional investors, as well as ISS and Glass Lewis, in 31 meetings held at shareholders’ offices and 15 phone calls.

The 2014 proxy, which includes new graphics covering board composition details and executive pay, along with a tightly written accompanying narrative, carefully lays out the new changes ushered in after the meetings with investors, which Cecil notes isn’t by accident.

“Our board was instrumental in creating an intentionally different look and feel for the proxy statement and CD&A in 2014,” she says.

First up was Hammergren’s pension benefit. The board reduced it by $45 million, fixing it at $114 million, a change Hammergren voluntarily agreed to. His total direct compensation dropped from $27.5 million in 2013 to $25 million in 2014, even while TSR was 65%.

The board adopted new metrics in its compensation plan, replacing OCF with adjusted ROIC in its cash plan, and replacing its performance restricted stock unit long-term equity incentive program with a total shareholder return unit (TSRU) plan. The company now relies on relative TSR, with the S&P 500 Health Care Index as its performance metric in the TSRU program. Long-term incentive plans now have performance or vesting periods of at least three years, the proxy states.

In the area of governance, the board expanded the lead director’s responsibilities further and appointed new committee leaders. Shaw was named chair of the compensation committee and Wayne Buddtook over as chair of the governance committee.

The board also appointed a new director, Anthony Coles, and has since appointed Donald Knauss, executive chairman of Clorox, and Susan Salka, CEO and president of AMN Healthcare Services. Shaw retired at the 2014 annual meeting.

On June 1, the board announced it had approved a proxy-access bylaw amendment, which will take effect immediately if shareholders approve it at the 2015 annual meeting.

For its efforts, McKesson received investor support of 95% in 2014. McKesson has also been named as a finalist in the NYSE’s 2015 Governance, Risk and Compliance Leadership awards for its shareholder engagement efforts.

Cecil says the company continues to invest in engagement. “There’s no pulling back,” Cecil says. “In fact, we’re building on the program from 2014.”

Pryce-Jones says continued efforts are warranted. ISS also noted in its 2014 report that “distinctively high executive compensation levels remain” and “close monitoring of the new pay program is advised.”

Indeed, Pryce-Jones says the board should work to further link the company’s no-action process with its shareholder engagement so that lawyers don’t attempt to obtain no-action relief while the board is engaging with investors. He’s also still concerned about succession planning in the absence of an independent chair, and the pension benefit — even with the reduction — because it represents a board that “took its eye off the ball.”

“McKesson has traveled a great distance,” he says, “but they still have more road to travel here in reforming their governance. The vote in 2013 was a wake-up call, and we’re still seeing where this is taking this board.”