Could the fate of Oracle CEO Larry Ellison's 2013 compensation plan be a wake-up call for boards of directors and specifically compensation committees?

Oracle's board is under fire for approving a wildly generous pay package of $78.4 million for Ellison for the 2013 fiscal year. The board's recommended compensation plan got less than half of shareholder support.  If you back out the 1.1 billion shares that Ellison owns and presumably voted to approve his own paycheck, the shareholder support level drops to 20 percent. And Ellison's pay for FY 2013 was down from the $96 million he received previous year.  In comparison, Cisco's CEO John Chambers received $11.7 million for 2013.

While the shareholder vote is non-binding under the “say-on-pay” provision of the Dodd-Frank Act that the Securities and Exchange Commission adopted in 2011, should the Oracle board choose to ignore the will of the majority of shareholders, it would likely set up certain directors, particularly those on the compensation committee, for a “no-vote” when they come up for election next year. Even then, there's no guarantee that they will lose their board seats. The two major proxy advisory firms, Institutional Shareholder Services and Glass Lewis, targeted several individual directors for a “no vote” this past proxy season, but most of them survived. On average directors were elected with 95 percent of the shares voted in favor. Only 2 percent failed to receive a majority vote.

In a recap of the 2013 proxy season, Proxy Pulse, a Broadridge and PwC report covering 4,037 shareholder meetings from Jan. 1 to June 29, 2013, showed that average, 2013 pay plans were approved with 89 percent of shares voted in favor, a slight increase over 2012.

Companies are also making changes to executive compensation plans based on say-on-pay results, even if the plans win approval from shareholders. According to the Proxy Pulse report, 47 percent of companies modified their proxy statement compensation disclosures as a result of their 2012 votes, whereby 36 percent made compensation more performance based and 27 percent increased their proxy communications with proxy advisory firms. Most of those who revised their proxy disclosure were motivated because they received less than 70 percent favorable vote for their 2012 pay plans.

The issue of executive compensation is not going away, given the SEC's effort to require companies to disclose the pay ratio between the CEO and average employees. This ratio will focus shareholder attention on what many will see as a major disparity, and cause them to keep a closer eye on what the board recommends in executive pay plans.

David Katz of Wachtell, Lipton Rosen & Katz reported in The Harvard Law School Forum on Corporate Governance and Financial Regulation that is was clear from the recent proxy seasons that executive compensation issues continued to be a significant issue for shareholders. And proxy advisory firms continue to wield some power, although shareholders generally make up their own minds. Of the S&P 500 companies that received a negative recommendation from proxy advisory firms on executive compensation in 2012, 21 percent experienced failed votes. Katz noted that a negative ISS recommendation results in an average of 65 percent favorable vote versus 95 percent for those with a positive recommendation.

“One of the most important components of the pay-for-performance test for a company is the alignment of the CEO pay and total shareholder return, and in particular how that alignment compares with that of the company's peer group as selected by ISS, primarily based on S&P's Global Industry Classification Standard grouping largely based on market capitalization and revenue range.”

Maximize Shareholder Outreach

Katz says there are certain steps that companies can take to maximize the effect of their shareholder communication efforts. They are:

Communicate frequently with shareholders throughout the year and listen to their concerns and comments that will help companies understand their priorities and voting patterns as well as the degree of influence that proxy advisory services may exert.

Communication serves the company best if it is done before the rush of the proxy season. Yet, remember that investors may change their vote any time until the shareholder meeting, so a positive vote indicated early in the communication process could turn negative.

Companies should keep in mind that institutional investment decision makers may not be aware that their corporate governance department is issuing a negative vote on a say-on-pay proposal; therefore, companies may want to consider meeting directly with the investment professionals to determine whether a negative vote is based on significant dissatisfaction with the CEO's performance relative to the company's performance and whether the investment decision makers are aware that the pay proposal is a concern.

Companies should consider which avenues of communication are best. Some companies, when faced with a negative vote recommendation may file supplemental proxy materials in support of their compensation proposal. Supplemental filings may be necessary under Regulation Fair Disclosure when communicating with certain shareholders, and they can be helpful in reaching shareholders who are otherwise not reachable. Keep in mind that supplemental filings containing no new material information can draw unwanted negative attention.

Companies should carefully consider which of its directors and executives or employees may be the best representatives to speak with shareholders and investment decision makers.

I have found that companies are reluctant to have directors speak with shareholders one-on-one unless they are thoroughly trained in Reg FD compliance. I recommend that a company assemble a proxy compliance team consisting of a representative from the corporate counsel's office who is most familiar with the proxy, the corporate secretary, the head of investor relations, and possibility a human resources representative. That team should meet with shareholders, preferably in advance of the proxy season.

Katz also cited Exxon Mobil for breaking new ground in last year's proxy season by holding a conference call with investors in May in advance of their annual shareholders' meeting to address negative vote recommendations from both ISS and Glass Lewis. The tactic paid off, according to Katz, when Exxon received a 78 percent favorable vote for its executive compensation package at the annual meeting.

Michael Pryce-Jones, an analyst at the CtW Investment Group who led a campaign against Ellison's pay, said looking back at Oracle's 2013 say-on-pay vote raises questions about the suitability of the board. “It's a defeat for the board however you spin it. I don't think the board has the courage to stand up and represent shareholders.” All of Oracles directors were re-elected but Oracle did not immediately disclose how much support each director received.

There will be increasing pressure on directors to exercise their good judgment in keeping executive compensation, particularly that of the CEO, in line with company performance and relatively close to peer company CEOs. The issue of executive compensation is not going away, given the SEC's effort to require companies to disclose the pay ratio between the CEO and average employees. This ratio will focus shareholder attention on what many will see as a major disparity, and cause them to keep a closer eye on what the board recommends in executive pay plans.