You probably saw last week’s NYT DealBook article or Wall Street Journal article that Tesla has filed its preliminary proxy statement and it includes a proposal requesting that shareholders ratify Musk’s 2018 pay package that the Delaware Chancery Court ordered be rescinded. There’s a lot here, and it’ll be fascinating to watch the vote and how the litigation proceeds (both the appeal in Tornetta and any other legal challenges). In the meantime, here are some interesting tidbits from the Times and the Journal, plus Tulane Law Prof Ann Lipton’s post and Bloomberg’s Matt Levine’s column on the topic:
– After the January 2024 opinion in Tornetta, Tesla created a special committee to assess redomestication of the company to Texas (proposal 3 in the proxy statement). Its authority was subsequently expanded to consider whether Musk’s 2018 award should be ratified at the same time. The committee was comprised of one member who was not on the board at the time of the 2018 grant — the second member stepped down after the committee’s authority was expanded. Note that the proxy makes clear that the special committee’s focus was on whether the award in its previously agreed form should be ratified based on current facts; it did not engage a compensation consultant, substantively evaluate the award or negotiate with Musk.
– Tesla touts unsolicited support it received from institutional shareholders after Tornetta and includes excerpts of a letter of support from T. Rowe Price in the special committee’s report.
– Tesla’s market capitalization has gone down since the milestones included in the performance-based options were achieved. The largest milestone reflected a market cap of $650 billion; Tesla’s market cap was around $500 billion when the preliminary proxy was filed.
– The legal impact of this ratification is unclear — and the proxy says as much:
The Company is asking its stockholders to ratify the 2018 CEO Performance Award under Delaware common and statutory law. Delaware common law ratification permits a Delaware corporation to validate a corporate act where the actors that purported to effect it lacked requisite corporate authority to do so. Common law ratification can also extinguish claims for breach of fiduciary duty by authorizing an act that otherwise would constitute a breach. When properly implemented, common law ratification “reaches back” to validate the challenged act as of its initial enactment. The Company believes that, under the Tornetta Opinion, the 2018 CEO Performance Award is such an act that may be ratified under Delaware common law. The Company also seeks ratification under any other legal theory or appropriate statutory provision, including but not limited to Section 204 of the DGCL. […]
While the Company believes that the Ratification should be upheld by a Delaware court, the Special Committee noted that even a favorable vote by our stockholders to ratify the 2018 CEO Performance Award may not fully resolve the matter. The Special Committee and its advisors noted that they could not predict with certainty how a stockholder vote to ratify the 2018 CEO Performance Award would be treated under Delaware law in these novel circumstances.
Ann’s blog has much more on this topic — particularly on the topic of corporate waste.
This Alliance Advisors memo gives an interesting data point for anyone who is sweating out an equity plan replenishment proposal for the second (or third or fourth) year in a row:
If going back for shares two years in a row caused companies to lose support on their equity plan proposals, then surely a company that asked shareholders to approve a new share increase six consecutive years would face a significant increase in ‘against’ votes over time.
Alliance Advisors found twelve members of the Russell 3000 had proposed new or amended equity incentive plans each year from 2018 to 2023. Alliance Advisors analyzed each of those proposals and determined there is no evidence of a change in shareholder support as a result of repeated equity plan replenishments.
Phew! The memo also offers this practice point if your equity plan proposal involves replacing your old plan with a new one:
– Commitments needed to secure ISS support when replacing an existing equity plan. When companies seek approval of a new equity plan and intend to terminate and cancel the remaining shares available in an existing equity plan, proxy disclosures need to be clear on this intention. Otherwise, ISS may include the remaining shares available under the old plan in its calculation of plan costs (termed shareholder value transfer, or SVT, by ISS). This would render the plan more costly and negatively impact scoring under the Equity Plan Scorecard (EPSC) – ISS’ tool for analyzing employee stock incentive programs.
A few years ago, ISS revised its policy to require an explicit commitment that: (a) no further shares will be granted under the existing plan unless the successor plan is not approved, or (b) the number of shares available under the successor plan will be reduced by shares granted under the existing plan prior to the successor plan’s approval.
If you have this type of proposal on the ballot and didn’t include the “magic language,” there may still be time to do so in a supplemental filing before ISS issues its report. Obviously, whether and when you need to act on this depends on your meeting date. And, as Alliance points out, there are cases where a negative ISS recommendation won’t sink your ship. The memo notes that while investors may use proxy advisor recommendations as a factor in their decision, they often have their own formulas (which may be more stringent). You always need to know your shareholder base.
Check out the full memo for more tips for getting this year’s equity plan proposals across the finish line.
In a memo published last week, Compensation Advisory Partners analyzed how the CEO pay of 50 “early filers” compared to the companies’ financial results. The companies in CAP’s sample – which had fiscal years ending between August and October 2023 – spanned several sectors and reported revenues ranging from $1.4 billion to $383 billion (median revenues of $11.9 billion), and median fiscal-year-end market capitalization of $16.4 billion.
Overall, CAP found that year-over-year financial performance was flat, but median total CEO pay was up. However, that increase was primarily due to the grant date fair value of LTI awards that were made early in fiscal 2023, at a time when the overall market was high and companies were coming off strong 2022 performance. This was offset by a decline in median bonus payouts. Here’s more detail:
Approximately 50% of companies in our sample had an annual incentive payout that was at or above target in 2023 (median payout of 129% of target). These higher performing companies saw modest growth at median for revenue, EBIT and EPS growth, and had strong TSR performance. For companies with below target performance (median payout of 61% of target), median revenue growth was down slightly (-2.6%) while EBIT and EPS performance was down double digits (-15.6% and -11.4%, respectively). Median TSR increased for both groups. TSR was up significantly (+17.8%) for at or above target performers and up slightly (+2.3%) for below target performers.
In 2023, annual incentive payouts had a normal distribution with companies nearly evenly split in receiving payout either above or below target. This is a change from the prior two years when a majority of companies paid out at or above target. The distribution of payouts coupled with the median incentive payout around target suggests the difficulty in setting goals amid unpredictable macroeconomic factors.
The report goes on to discuss how some companies are incorporating metrics relating to a CEO’s individual performance, which I found especially interesting after reading about Boeing’s recent decision to reduce an element of executive pay in the name of “individual accountability” (although in Boeing’s case, the focus was on LTIs). Here’s what CAP found:
Approximately one-third of Early Filers incorporate individual performance in the annual incentive payout for the CEO. This means that the CEO’s payout as a percentage of target may be higher or lower than that of the corporate funding factor (i.e., the percentage at which the annual incentive funds based on company performance). 70% of companies in our sample provided a payout to the CEO that was +/-5 percentage points from the corporate funding factor in 2023.
Nearly 15% of companies reduced the CEO’s payout from the corporate funding factor in 2023, which is up from 2022 (4% of companies) and 2021 (7% of companies). However, the average reduction in payout was lower in 2023 than in prior years. On average, companies that lowered the CEO payout in 2023 reduced it by 30 percentage points compared to 39 points in 2022 and 102 points in 2021. The number of companies that increased the CEO’s payout by more than 5 points above the corporate funding factor was up slightly from last year (17% in 2023 vs. 11% in 2022) but down from 2021 (when it was 33%). However, the increase in payout was more modest, with companies raising the CEO’s payout by, on average, 15 points in 2023 compared to 20 points in 2022 and 34 points in 2021.
Every night before I go to sleep, I say a little prayer that none of my clients will discover the need for any financial statement corrections that would border anywhere close to what would be considered a “restatement.” Not only does a restatement (especially a “Big R” restatement) trigger a string of difficult decisions & disclosures, but there is now the added consequence of having to sort through the Dodd-Frank clawback policy and potentially recover compensation from Section 16 officers. I am sleeping just a little better knowing that tomorrow at 2 p.m. Eastern, there will be an expert discussion of the steps involved with this analysis – so don’t miss our webcast, “Clawbacks: Navigating the Process After a Restatement.” It always helps to have a playbook!
We’ll be hearing from WTW’s Richard Luss and Steve Seelig, Gibson Dunn’s Ron Mueller, and Latham’s Maj Vaseghi. They’ll be covering these topics:
– Coordinating with the Audit Committee
– Engaging the Right External Advisors & Internal Resources
– What is an Event Study? How Does it Work?
– Sources of Clawed Back Compensation & High-Level Tax Implications
– Managing Litigation Risk
– Communications with Impacted Executives
– Support & Documentation
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Last month, the WSJ and several other outlets reported that Boeing would overhaul its employee & executive compensation program in order to incentivize a commitment to safety. The change comes after years of speculation about whether the company’s emphasis on financial returns would affect its products. I was very interested to see how these changes would be described in Boeing’s proxy statement, which is now on file for the company’s May 17th AGM (the company shifted its meeting back by about a month compared to last year’s meeting date).
In the CD&A, after describing the 2023 program and payouts, the company includes a section on “Early 2024 Compensation Decisions” – which first describes changes to the annual incentive program:
Changes to our 2024 Annual Incentive Plan
In January 2024, following the Alaska Airlines Flight 1282 accident and our assessment of performance against our operational product safety metrics of stability and quality during 2023, we initiated a comprehensive review of our annual incentive plan design to determine if changes were warranted. In this effort, we were informed by feedback from shareholders. Following this review, we made the following changes to our annual incentive plan for 2024:
• Weightings of financial and operational performance for Commercial Airplanes. In 2023, the Company Performance Scores for all three business units were weighted 75% towards financial performance and 25% towards operational performance. In 2024, the score for our commercial airplanes business will be weighted 60% towards operational performance, and 40% towards financial performance.
• Operational performance metrics. In recognition of the progress towards safety and quality that must be made across our enterprise, our operational performance metrics will be focused entirely on quality and safety goals. For Commercial Airplanes, these metrics will include reduction in rework and traveled work, completion of 787 join verification rework, delivery of 737 MAX inventory built prior to 2023 and reduction in employee injury rates.
• Financial performance metrics. In 2023, the financial performance component of our design was weighted 67% towards total Company performance and 33% towards business unit performance. In 2024, total Company and business unit performance will be equally weighted, in order to drive greater accountability for financial outcomes at the business unit level. Free cash flow will be the sole metric measured at the total Company level. At the business unit level, performance in revenue and operating earnings will contribute to incentive payouts, except for our defense business, where operating earnings will be the sole financial metric.
The company then discusses how safety metrics are incorporated into the long-term incentive program:
Changes to our 2024-2026 Long-Term Incentive Program
In early 2024, the Compensation Committee approved a long-term incentive award structure similar to that first implemented in 2023, comprised 45% of time-vested RSUs and 55% of PRSUs that will pay out between 0% and 200% of the target number of units granted based on the achievement of free cash flow goals over the 2024-2026 performance period. New for 2024, our PRSUs incorporate a product safety downward modifier, under which the NEOs’ calculated payout following the end of the three-year performance period may be reduced by 25% or down to 0% if two product safety operational goals are not timely completed. These two goals require (1) the design and deployment of an employee culture survey aimed at assessing how deeply and effectively our Safety Management System is inculcated in our workforce, and (2) the development and implementation of operational control limits for several programs (including the 737 program) that include measures for determining when a safety risk assessment is required before a product can move past a specified point in our production system. Unless these goals are both completed by or before year-end 2024, the 2024-2026 PRSU payout will be subject to either 25% reduction (if goals are completed in 2025) or reduction to 0% (if goals are completed after 2025). Progress towards completion of these two goals will be overseen by the Aerospace Safety Committee and subject to final certification by the Compensation Committee.
In accordance with its normal process, the Compensation Committee also set long-term incentive targets for each executive officer. However, after approving the long-term incentive targets for our senior executives, the Board and the Compensation Committee made the decision to reduce each executive’s long-term incentive award by the percentage decline in the Company’s stock price between January 5, 2024 (the day of the Alaska Airlines Flight 1282 accident) and the grant date. This decision was implemented to hold our leadership team accountable for the decline in our stock price following the accident, and resulted in an approximately 22% reduction in long-term incentive grant values as compared to target values for our senior leadership team. The impact of this decision process on our CEO’s 2024 long-term incentive award, and a comparison against his 2023 award, is shown below.
The graphic shows that in 2023, the CEO’s award was $21.25 million. The 2024 award target had been set at $17 million, which was reduced by 22%, down to $13.25 million – a 38% reduction compared to the 2023 award.
There will no doubt be a lot of attention on the company’s say-on-pay outcome and other AGM results. If say-on-pay garners high support, these program changes and the related disclosure could be a good playbook for other companies dealing with product & PR challenges.
In the current uncertain economic landscape, stock option repricing and exchange programs have once again resurfaced as commonly explored alternatives to alleviate the competitive compensation and retention headwinds faced by companies with a significant number of underwater options. However, the inherent complexities and potential limitations of these programs often create roadblocks or require commercial compromises that impair the program’s effectiveness in achieving the desired incentive and retention goals.
Specifically, the memo goes on to address tender offer considerations for traditional stock option repricings and exchanges:
An option exchange program typically requires option holder consent and constitutes a tender offer under applicable US securities rules because option holders are required to make an investment decision when electing whether to participate in the exchange. An option repricing can also trigger the tender offer requirements where option holder consent is required, such as if the repricing is tied to the imposition of additional or extended vesting conditions on the repriced options.
The memo notes that companies “grappling with these issues may want to consider a novel approach to addressing underwater options,” and describes the “premium” approach, which “delays the availability of the repricing unless and until certain new exercise conditions are satisfied (e.g., continued employment through a later date).”
[A]n alternate approach to option repricing is available through which repriced options remain subject to a higher exercise price (or a “premium” exercise price) applicable to exercises occurring prior to the expiration of a specified vesting or retention period (the “premium period”), which may be longer than the original vesting period and/or contain other new vesting conditions.
As with a traditional option repricing, under this approach the exercise price of an underwater option is reduced to the fair market value of the company’s stock on the effective date of the repricing (thus locking in the availability of the repricing-date fair market value). However, if the option holder exercises the repriced option or terminates service, in either case, prior to the expiration of the premium period, the option holder does not benefit from the repricing and must instead pay the premium exercise price per share (i.e., an amount up to the original exercise price) upon exercise.
This approach effectively imposes a new vesting schedule on the repriced option, but typically can be implemented by the plan administrator unilaterally since it conveys only a benefit (i.e., the reduced exercise price after the satisfaction of the premium period) and has no material adverse impact on the option as it currently exists.
If you’re still looking for resources to do one last compliance check on your proxy statement, check out Goodwin’s 2024 Year-End Took Kit, updated in March to include proxy form check resources. These tools are all the more important as pay-versus-performance and clawbacks have only complicated the compensation-related disclosure requirements for proxy statements. The actual form check table has helpful callouts noted in red for any newly added rows and reminds companies to confirm that the CD&A narrative is consistent with PvP and clawback disclosures.
When the new clawback listing standards came out, there was a lot of discussion about how companies would go about the necessary calculations for stock price or TSR-based awards. While event studies were identified as the likely standard, advisors were recommending that the clawback policy not identify the calculation methodology in advance and instead allow the compensation committee to select a methodology based on the facts and circumstances.
This recent WTW memo, 4 Steps for Executing Clawbacks After Your Restatement, agrees — noting “not all stock plans or total shareholder return-based plans will require an event study for every restatement.” If you’re wondering how a compensation committee would go about making the decision of whether to commission an event study, a helpful table addresses several factors that will influence whether one is needed. The listed factors include inflection points in the comp plan, the quantum of stock price movement, market volatility, percentage of pay impacted and the magnitude & cause of the restatement.
For more on the complexities of implementing a clawback, tune in for our upcoming webcast “Clawbacks: Navigating the Process After a Restatement” on Wednesday, April 17, at 2 pm Eastern to hear from two of the authors of the memo, Steve Seelig & Rich Luss, who will be joined by Gibson Dunn’s Ron Mueller and Latham’s Maj Vaseghi. They’ll discuss how to run a thoughtful, thorough and organized process if you find yourself in mandatory clawback territory.
The 2024 update to Skadden’s Compensation Committee Handbook is now available — now in its 10th edition, it reflects key developments since last spring, including updates for the clawback rules and developments in pay-versus-performance disclosures. In the discussion of clawbacks, it briefly touches on the interplay with other legal requirements, including SOX and state laws:
Committees should keep in mind that certain states, such as California, have laws that generally prohibit the recovery of wages that have already been paid. While the Dodd-Frank clawback rules are currently expected to preempt conflicting state law, litigation activity may be on the horizon to definitively confirm this.
CEOs and chief financial officers (CFOs) remain subject to the clawback provisions of the Sarbanes-Oxley Act of 2002 (SOX), which provide that if a company is required to prepare an accounting restatement because of “misconduct,” the CEO and CFO are required to reimburse the company for any incentive or equity-based compensation and profits from selling company securities received during the year following issuance of the inaccurate financial statements. To the extent that a Dodd-Frank Clawback Policy and SOX cover the same recoverable compensation, the CEO or CFO would not be subject to duplicative reimbursement. Recovery under the Dodd-Frank Clawback Policy will not preclude recovery under SOX to the extent any applicable amounts have not been reimbursed to the issuer.
PLI’s “SEC Speaks” program continued yesterday, with an emphasis on enforcement. As I noted yesterday, all Staff remarks were made subject to the standard disclaimer that they are made in the person’s official capacity and don’t represent the views of the Commission, the Commissioners or other Staff members.
In yesterday’s program, Stacy Bogert, Associate Director of the Division of Enforcement, noted that Sarbanes-Oxley Section 304 clawbacks are a continued issue of focus for the Enforcement Division. The Division has issued several warnings about this – and the DOJ is also interested. If the Staff is talking about it at a conference, we should pay attention.
Stacy noted that the enforcement approach is guided by the policy underlying the statute: to incentivize CEOs and CFOs to implement robust internal controls designed to detect and prevent misconduct in financial reporting and encourage an appropriate tone at the top. So, you can expect the Commission to seek recovery in these cases beyond the “fraud delta” (the amount of executive enrichment that resulted from the misconduct at issue). It’s likely that they’ll pursue reimbursement to the company of the full amount of all forms of compensation – including profits that the executives received upon the sale of equity. Stacy also gave a reminder of the view that the clawback can apply regardless of whether the CEO or CFO personally engaged in the misconduct that caused the restatement.
These remarks send a “deterrence” signal that may cause many companies to take (yet another) look at their controls & trainings….