Talking Points III - What to Do About Reviewing Outstanding CEO Pay Packages and Agreements

1. Why should Compensation Committees and Boards undertake this effort?
   • Obligations to Re-Examine and/or Modify Existing Arrangements.
     • For the good of the shareholders and the protection of the Board, the Compensation Committee, the CEO, and the Company's public image, the Compensation Committee should re-examine the terms, cost and likely outcomes of all existing arrangements. 
     • Directors may have personal liability for not acting.
     • Case law examples.
   • If the board/comp committee has approved the agreement, why should it review the agreement again?
     • To ensure that the process was appropriate under the applicable corporate governance standards and properly documented, and that resulting arrangements still make sense.
     • To understand the multiplier affect that an increase in one element of compensation can have on other elements, and the reality that each new decision could be viewed as a ratification of the past arrangements. 
     • Where appropriate, to adjust for the consequences of timing/carryforward effects: Some severance agreements and other provisions may have been warranted at the time the executive was hired, due to uncertainties over the company's future and reputation risk for the executive, but may  no longer be necessary due to changed circumstances, compensation already paid, etc.
     • To understand the effect (cost and value by item) of open-ended “continuation” provisions (i.e., provisions that say the executive will continue to receive whatever benefits he was receiving as an executive).
     • To avoid employee morale and other costs of bad publicity, and adverse determinations by institutional shareholders and their advisors.?
     • Better late than never.
2. How to Avoid Traps for the Unwary Director When Negotiating Employment Contracts and Other Compensation Arrangements
   • Lack of Independence Among the Consultants, Counsel and Other Players
   • Lack of truly independent advisors on consulting and legal matters
   • Aggressive term of employment and/or evergreen renewal of same
     • What is projected impact/cost of non-renewal?
   • Too much severance (too large or paid under too many circumstances) before and after Change in Control,
   • Magnitude and rationale for guaranteed bonuses and upfront signing bonuses; lack of claw back for early departure [or adjustment for poor performance]
   • Insufficient analysis of surveys and peer group information (compensation and performance data), and internal factors.
   • Failure to price out value to executive, and cost to Company, of long-term incentives, severance, SERP benefits, etc. under likely and possible scenarios (including termination due to poor performance)
   • Ignoring the potential effects of provisions that base severance or retirement payouts on other compensation (e.g., ripple impact of above-target bonuses).
   • Inattention to items often poorly disclosed in proxy statements under current rules (cumulative deferred compensation, defined contribution SERPs, some DB SERPs, perks) 
   • Defining "Cause” too narrowly; Good Reason" defined too loosely
   • Golden Parachute Agreement Issues: Single trigger parachutes, size of multiples, scope of compensation included in multiples, cost of gross-ups, triggering of protection even if deal collapses.
3. What should Compensation Committees and Boards be doing?
   • Fixing and Adding "Cause" Provisions, "Good Reason" provisions, Clawbacks and Terms to Protect the Company
     • How address material misconduct that may or may not be criminal
     • How address internal investigation scenarios (failure to cooperate, impact of suspension)
   • Agreements should provide for little or no payments to executive in the event of a termination for "Cause."  (See, Ovitz, Cendant, Warnaco, Gemstar/TV Guide, Computer Associates, Aramony.)
   • Agreements should provide for claw back of certain compensation in the event of "cause" discovered after termination, or for violation of non-compete or other restrictive covenants.
   • Need to address how handle restatements of earnings, etc. previously certified by CEO and CFO in terms of impact of same on previously awarded annual bonuses and other incentives paid to CEO, CFO and other senior executives directly involved.
   • Often, an agreement will not need to be entirely renegotiated, but the operation of certain provisions may need to be revised.
   • Alternatives to some of the more offensive comp designs or elements
4. Implement Meaningful Net Share Holding Periods for Equity-Based Compensation as a Matter of Better Governance and, Where Appropriate, to Adjust for Past Largess
   • Some executives should be required to hold the after-tax portion of these shares until retirement so that the executive truly has a long-term incentive.  Depending on the facts and circumstances.
     • Post-exercise net share holding periods for new and outstanding stock options and SARs,
     • Post-vesting net share holding periods for new and outstanding restricted stock,
     • Similar retention requirements for other equity-based compensation
   • CEOs should be required to hold meaningful percentage (at least 50% to 75%) of (i) after-tax portion of spread value realized on option/SAR exercises, and (ii) after-tax portion of full value realized on vesting of restricted stock (RS), in the form of shares after option exercise or RS vesting, subject to appropriate exceptions (e.g., death and disability)
     • For options, avoids/reduces risk/appearance of front-running
     • Factors to be considered include structure/length of vesting schedule and extent of any performance tie-ins
   • Examples: Merrill Lynch. (See TheCorporateCounsel.net links to dozens of these sample guidelines.)
5. How should Compensation Committees and Boards go about this?
   • Ways to Address Current Executive Compensation and How to Have the Difficult Conversation about Rolling Back Compensation
     • The CEO, too, has fiduciary obligation to review his/her compensation. See In re Walt Disney, Integrated Health Systems.
     • Emphasize to the CEO that the result will be that he has greater assurance that he will actually receive what he expects.
     • An opportunity for the compensation committee to change and renegotiate a past practice occurs each time any aspect or component of a CEO's compensation is considered or each time the contract comes up for renewal.  Compensation committee could withhold future awards to the CEO unless he or she agrees to modifications of could agree to fixes to past and outstanding awards.
     • Bargaining chips or trade-offs to offer the CEO to make cutbacks or revisions more acceptable or palatable.
       • Company could pay an extraordinary bonus for outstanding performance, but provide that the bonus will not count toward severance pay or SERP.
       • Severance or change in control payments could be halted only if the executive accepts another position.
     • Prepare, prepare, prepare. Examples showing that it can be done.