The recent rejection of executive pay packages at Jacobs Engineering Group Inc. by shareholders has made the company the first in the country to be on the losing end of a new federally required “say on pay” vote.
The Jan. 28 vote was not binding on management. However, it looks to be the beginning of headaches for the Pasadena engineering company, which is facing a shareholder lawsuit spurred by the outcome – and the prospect of others.
“It shows that ‘say on pay’ is going to be an important fact of life for public companies,” said Gregory Schick, a partner in the San Francisco office of Sheppard Mullin Richter & Hampton, who specializes in executive compensation.
On Jan. 25, the Securities and Exchange Commission adopted regulations requiring companies with more than $75 million worth of outstanding shares in public markets to hold shareholder votes on executive compensation. The rules, which had previously only applied to companies taking federal bailout money, implement a provision of last year’s Dodd-Frank financial regulatory reform law.
Three days later, Jacobs shareholders voted at the annual meeting against the company’s executive pay packages, a first for a company not taking Troubled Asset Relief Program money. Atlanta-based homebuilder Beazer Homes USA became the second after losing a similar shareholder vote Feb. 2. Thousands more votes are expected this year.
Last year, Jacobs raised overall compensation of the top five executives by an average of 23 percent, mostly in the form of one-time stock awards. Chief Executive Craig Martin received the biggest raise, from $4.6 million in 2009 to $6.4 million.
In a public filing before the vote, the company told shareholders that it needed to pay the extra money to retain officers, and that executive compensation at Jacobs was below the median compared with its peers.
But 54 percent of shareholders rejected that explanation, and also voted to hold the say-on-pay votes every year, instead of every three years as the company had recommended.
Paul Hodgson, a senior research associate at Governance-Metrics International, a corporate governance consulting firm in Portland, Maine, said shareholders voted no because of the poor explanations for the stock awards, not necessarily because they thought executives were overpaid.
“It’s just not convincing that they absolutely had to give them additional stock grants in order to retain them,” Hodgson said. “I wasn’t too impressed with the justification and clearly nobody else was either.”
The “pay on say” votes are nonbinding, and it’s unclear how Jacobs will respond.
Chief Financial Officer John W. Prosser Jr., who received a 24 percent bump in compensation last year to $2.4 million, declined to discuss the company’s response.
“It’s certainly something we’re taking into consideration,” he said. “The board and the comp committee are evaluating how to look at it and go forward.”
Asked if that meant the company’s executives were considering taking pay cuts, Prosser declined to comment further.
The “say on pay” votes apparently prompted litigation.
The Jacobs vote was followed by a shareholder derivative action filed Feb. 4 in Los Angeles Superior Court against the company’s management. It alleged “excessive and unwarranted 2010 executive compensation” in the face of “abysmal” dropping revenues and net income. The complaint prominently cited the results of the “say on pay” vote.
The lawsuit accuses executives of breach of fiduciary duty, corporate waste and unjust enrichment. It seeks unspecified damages and an order implementing internal controls at Jacobs to prevent excessive executive compensation.
Other law firms have announced they’re investigating whether to file shareholder actions against Jacobs.
Similarly, shareholders of Occidental Petroleum Corp. filed shareholder lawsuits after a voluntary “say on pay” vote last year that went against management. The litigation is ongoing even as highly paid Chief Executive Ray Irani is set to step down in May and his successor has agreed to take a smaller paycheck.
“That’s another potential concern if you get a ‘no’ vote,” Schick said. “Even if you had a ‘yes’ vote, but it was a close call, indicating there was some high level of dissatisfaction with executive compensation arrangements, I suppose that could motivate a group of shareholders to initiate something.”
Analysts say Jacobs’ financial performance and its management team don’t warrant the wrath of shareholders, though revenue and net income slipped last year.
Net income fell to $246 million from $400 million on a 14 percent reduction in revenue to $9.9 billion. But the share price has gone up nearly 50 percent since the end of August, closing at $51.85 on Feb. 10. Of 24 analysts who cover the company according to Bloomberg News, 12 rate the stock a “buy,” 11 have a “hold” rating and only one rates it a “sell.”
Jeff Windau, an analyst at St. Louis-based Edward Jones & Co., said the company’s financials over the past year were weaker than 2009, because it’s a late-cycle industry that is taking longer to rebound from the downturn.
“Due to the long-term construction projects, it takes time to work through the system,” said Windau, who recommends buying the stock. “We think it’s a good time now to be into the stock because it should start to recover.”
Rob Norfleet, an analyst at Richmond, Va.-based BB&T Capital Markets, who is neutral on the stock, said the recent vote was more about larger trends in shareholder dissatisfaction than the performance of Jacobs executives, whom he called a “reputable and talented management team.”
“I don’t think the vote is specific to Jacobs at all,” he said. “I think this is a vote that shareholders across a wide swath of companies are doing to basically empower their rights.”
There’s already some evidence that companies are fighting back. A recent Wall Street Journal story reported that the Center on Executive Compensation, a lobbying group that represents companies including IBM Corp. and McDonald’s Corp., has begun going after two large proxy advisers that sometimes recommend shareholders vote against pay packages.
The lobbying group sent a letter to 100 institutional investors last month asking them to more closely monitor possible conflicts of interest of the two proxy advisers.