Sullivan & Cromwell is out with Part 2 of its 2024 Proxy Season Review covering compensation-related matters, and it contains a helpful deep dive into ISS’s qualitative say-on-pay analyses in 2024. The report lists the following issues regularly cited by ISS in its qualitative assessments this year:
Insufficient disclosure of performance goals. Similar to prior years, the inclusion of limited, opaque, or undisclosed performance goals was a significant qualitative factor in say-on-pay recommendations for S&P 500 companies in 2024. ISS specifically cited this concern for 19 of the 34 companies that received negative recommendations (vs. 24 of 42 in H1 2023). The continued significance of this qualitative factor is consistent with ISS’s focus on pay-for-performance alignment in the quantitative assessments.
Discretion in bonus plans. In addition, ISS was more focused on the use of subjective criteria for determining bonuses, or the use of discretion to increase an executive’s compensation, than it had been in prior years. ISS identified this as a qualitative factor for 17 of the 34 S&P 500 companies that received a negative recommendation in H1 2024 (vs. 16 of 42 in H1 2023). In some cases, companies used discretion to limit the impact of poor performance on outstanding equity awards, which ISS considers to be problematic.
Sizeable compensation. ISS cited the broad provision of outsized compensation, including through large base salaries and one-time, special cash or equity awards, for 17 of the 34 S&P 500 companies (vs. 18 of 42 in H1 2023). Certain companies were also criticized for granting multiple incentive awards that utilized identical performance metrics, resulting in high compensation for the same performance.
Large perquisites. Thirteen of the 34 S&P 500 companies were criticized by ISS for providing excessive perquisites (vs. 19 of 42 in H1 2023). ISS specifically mentioned security services and aircraft use in seven and six of these cases, respectively. Other frequently mentioned perquisites include car services and tax gross-ups.
The use of time-based incentive awards rather than performance-based incentive awards. ISS identified this concern at 12 of the 34 S&P 500 companies (vs. 13 of 42 companies in H1 2023). The failure by ISS to consider time-based vesting awards to be a robust measure of performance has been the subject of criticism because time-based equity awards can give holders a stake in the performance of the company and align the interests of executives with those of shareholders. However, awards granted subject to performance-based conditions are considered to be a matter of good governance by many stakeholders.
The use of above-median peer group benchmarking practices. ISS criticized eight of the 34 S&P 500 companies for using above-median peer group benchmarking practices (vs. 19 of 42 in H1 2023). Specifically, ISS criticized the provision of compensation above the median level of the company’s identified peer group and the selection of a peer group with a greater average revenue than the company. In 2024, ISS also criticized three companies for granting long-term incentive awards to their CEO with a value exceeding the total pay for CEOs at the median company in ISS’s and/or the company’s selected peer group.
Interestingly, ISS’s reports referenced “above target payouts” more than any other “pay practice” in its qualitative assessments for companies receiving negative say-on-pay recommendations, but the reports weren’t always critical of payout levels. They only went one step further to say performance conditions were not sufficiently rigorous in about half of those reports. S&C suggests that other factors, including the above, may have a larger impact on the decision to recommend against say-on-pay.
The qualitative evaluation in ISS’s pay-for-performance screen often gets less attention than the quantitative piece but shouldn’t be overlooked! The following is from ISS’s December 2023 updated Pay-for-Performance Mechanics document that provides technical info & guidance on its say-on-pay methodology:
ISS conducts an in-depth qualitative evaluation for all companies that exhibit a quantitative pay-for-performance misalignment, and for some companies that do not, depending on the circumstances. … It is the outcome of the qualitative evaluation that determines the vote recommendation for the say-on-pay proposal (or, in some cases, for the election of directors when there is no say-on-pay proposal on the ballot). The qualitative evaluation … identifies whether the pay-and-performance misalignment is mitigated or otherwise reinforced.
Last year, ISS reported on the widening transatlantic gap in CEO pay. Comparing CEO pay at large cap companies in the US and UK, an ISS study found that CEO pay levels at S&P 500 companies “markedly outpaced” CEO pay at FTSE 100 companies between 2019 and 2023. This recent HLS Blog from Glass Lewis says that’s concerning to UK asset managers and the UK Investment Association is reviewing its Principles of Remuneration “to ensure that they are supporting a competitive market.” The Investor Relations Society reports, “particularly for the largest UK companies and those with significant US presence or revenues, there are challenges in attracting US executives and competing in the US market.”
The UK may start to follow a US approach:
– There is a need for more flexibility to offer higher LTIP awards to create a competitive remuneration structure.
– Global companies wish to operate hybrid schemes (with both performance and restricted shares), which are used in the US and other jurisdictions, again for competitiveness reasons.
Glass Lewis says that there’s at least some reception to this shift across the pond:
– Among FTSE 350 companies that held a policy vote this year, one in ten have proposed a U.S. style ‘hybrid’ incentive plan where a portion of the awards vest solely on time served, and three in ten have proposed to increase the total opportunity under one or both incentive plans.
– A wide range in voting support on these proposals (ranging from 56.8% to 99.9%), indicates that shareholders are open to considering higher bonus opportunity or retention-focused awards, but will oppose proposals absent a compelling rationale.
The shift is intended to allow pay packages at UK companies to be competitive with those executives could make at a US-based company, but of course it could impact the market and pay for CEOs in the US as well.
WTW’s latest review of key compensation-related vote results and trends from the 2024 proxy season is out now with some added color on say-on-pay results — beyond the general takeaway that average support is similar to historical norms and the failure rate is down. Here are some of the other helpful lessons from the report:
– Seventeen companies failed the SoP vote for the first time in 2024, representing 63% of total failed votes. Top two reasons for first-time failures were: (1) poor disclosures and (2) special awards.
– The proportion of SoP failures from midcap and smallcap companies have been cut more than half in previous years.
S&P 500 failures: 5 (2024), 13 (2023), and 22 (2022)
Midcap failures: 6 (2024), 3 (2023), and 10 (2021)
Smallcap failures: 2 (2024), 10 (2023), and 22 (2022)
All other failures: 14 (2024), 27 (2023), and 32 (2022)
– There was an uptick in say-on-parachute failures this year, with many coming from deals voted on at the beginning of 2024. One-in-five (20%) say-on-parachute proposals failed in 2024, up from 16% in 2023. Single-trigger equity vesting remains the primary driver of say-on-parachute opposition, followed by provisions that allow performance awards to vest at maximum levels of performance during a merger.
As Dave shared on TheCorporateCounsel.net, ISS recently ran its Annual Benchmark Policy Survey (closed on September 5). As this Winston & Strawn blog notes, ISS selects the questions it asks of survey respondents to gauge investor and other stakeholder interests and market sentiment. For that reason, the survey can shed light on ISS’s potential areas of policy focus for the upcoming proxy season. Here are two highlights from the executive compensation-related questions:
Time-vesting Equity Awards. Under ISS’s current approach to its pay-for-performance analysis, when reviewing a quantitative pay-for-performance misalignment, ISS generally views a predominance of performance-conditioned equity awards as a positive mitigating factor, while a predominance of time-vesting equity awards is generally considered a negative exacerbating factor.
ISS is contemplating revising the weight given to performance-vesting over time-vesting equity awards to view both performance-vesting and long-term time-vesting equity awards as positive mitigating factors. To that end, ISS is soliciting feedback with respect to the threshold vesting period for such time-vesting equity awards and whether a meaningful post-vesting holding period should be required for ISS to view such awards as a positive mitigating factor.
Discretionary Performance Assessments. ISS generally views incentive programs with quantified, pre-set goals and disclosed targets favorably and views incentive programs that are heavily reliant on discretionary determinations negatively. However, some companies maintain incentive programs that are entirely based on discretionary performance assessments on the basis of company-, peer-, and/or industry-specific considerations.
ISS is soliciting feedback with respect to whether discretionary incentive programs should be viewed negatively in all circumstances, even where such discretionary incentive programs are consistently used across a particular industry or group of peer companies.
I blogged this past spring about “director say-on-pay” – a proposal that was structured as a binding bylaw amendment. Seven or eight companies received no-action relief on this proposal, and the five that went to a vote didn’t get much love:
Notable this year was a new type of proposal to amend company bylaws to require shareholder approval of director compensation. 11 such proposals were filed this year. Five went to a vote, receiving 2% average support.
That’s from Georgeson’s proxy season recap (available for download), which also points out that support was down overall for executive and director severance and compensation proposals – and has significantly dropped since 2022. Georgeson says the decline correlates with fewer “For” recommendations from proxy advisors.
I thought that last tidbit was interesting because in his final update on director say-on-pay, Michael Levin at The Activist Investor (who was the proponent for director say-on-pay) gave a peek behind the curtain at his experience working with the proxy advisors on the proponent side of things.
We did talk with ISS and Glass Lewis, and explained our proposal and rationale. We diligently kept them updated as we submitted proposals and worked through SEC no-action requests.
We requested a copy of their recommendation. ISS sent us one company’s out of five, with a friendly note that they don’t typically provide these to proponents. Glass Lewis provided nothing. Aside from the one ISS report, we don’t know the recommendations, although we assume they advised clients to oppose the proposals at each company. Both ISS and Glass Lewis offered to sell us copies of the reports, though.
ISS and Glass Lewis have an elaborate process for responding to companies. They have procedures for companies to submit data and rebut proposals, and share copies of a company’s report with them in advance of a vote. They have updated recommendations based on company input. Proponents have no such access.
I’ll note that these company accommodations (to the extent they do exist) have come by way of a lot of hard work and negotiations over many years. Here are Michael’s parting thoughts:
We thought shareholders would welcome the opportunity to express views about a BoD beyond empty complaints to a nominating committee or a feckless “vote no” campaign. We thought proxy advisors and the SEC would embrace or at least not object to a corp gov innovation that could prevent other companies from trying the same stunts as the TSLA BoD. Boy, we got that wrong.
Look, shareholders don’t owe us anything, much less an explanation why they voted against the proposal. Yet, we thought we put together something that should matter to investors interested in improving corp gov materially. We thought we interacted with them in an appropriately discrete and civil manner.
We’d like to understand why they “really hate” the concept. We still don’t know whether they have too many proposals to vote on, are happy with the current ways to object to directors, or don’t want to provoke companies by supporting something as forceful as a vote on director pay.
We note that in 2023 your executive officers received bonuses based on the achievement of key performance indicators as determined by your board of directors. We also note the statement that you performed a recovery analysis and determined there was no incentive-based compensation tied to financial performance for any of our executive officers during the relevant recovery period. Please briefly explain to us why the application of the recovery policy resulted in this conclusion. See Item 402(w)(2) of Regulation S-K.
Although comment letters are always situation-specific, this suggests that the Staff is taking a close look at what companies say about application of their policies. To get practical guidance on this complex situation, make sure to join us next month at the “Proxy Disclosure & 21st Annual Executive Compensation Conferences.” Compensia’s Mark Borges, Ropes & Gray’s Renata Ferrari, Davis Polk’s Kyoko Takahashi Lin, and Gibson Dunn’s Ron Mueller will discuss “lessons learned” from clawback disclosures and comment letters to-date (and more). Here’s the full agenda for all of the topics we’ll cover over the course of 2 days.
Time is running out to register! You can do so online or by calling 800-737-1271. You can join us in person in San Francisco or attend virtually, and with either format, you’ll have access to on-demand replays for a fully year after the event. That’s incredibly valuable, because it means you can go back to listen to critical guidance as situations arise.
I blogged earlier this year about Apple’s win in case that alleged a problematic approach to equity award valuations. Even though the company won on that particular claim, this guest post from Orrick’s J.T. Ho says that plaintiffs are continuing to scrutinize disclosures about equity award valuations & assumptions. Fortunately, there may be an easy fix to stay out of their crosshairs. From J.T.:
This proxy season, several companies have faced shareholder complaints requesting disclosure of the assumptions used to determine the grant date fair values of stock-based compensation, calculated using a Monte Carlo simulation in accordance with FASB ASC Topic 718.
The basis of this complaint is Instruction 1 to Item 402(c)(2)(v) and (vi) of the Summary Compensation Tables rules, which requires companies to “include a footnote disclosing all assumptions made in the valuation by reference to a discussion of those assumptions in the registrant’s financial statements, footnotes to the financial statements, or discussion in the Management’s Discussion and Analysis.” The requested information includes assumptions such as the expected volatility, risk-free interest rate, dividend yield, and expected life of the performance-based stock awards.
Many companies do not include all this information in their footnotes to the Summary Compensation Table or footnotes to the financial statements in the Annual Report on Form 10-K, which are referenced in the Summary Compensation Table footnotes. However, since the requested information should be readily available and is generally not sensitive, companies are advised to consider whether to modify their footnotes to the Summary Compensation Table to mitigate against such claims.
For a couple of examples of how companies are supplementing their disclosures, check out the additional materials filed by NetScout Systems and LiveRamp Holdings.
This “Governance Intelligence” (formerly “Corporate Secretary”) article walks through practical steps compensation committees need to take to implement a clawback policy. The article highlights the benefits of advanced planning to determine the process to be followed in the event the policy is triggered.
In preparing to implement a clawback, the compensation committee should establish a written process and related timeline for required actions, as well as the identification of potential members of a clawback implementation group. This group should comprise people from the company and any outside experts necessary to implement the process.
Working through some of this in advance seems helpful because the many complexities may be more difficult to navigate when “under the gun.” For example:
If it is determined by the audit committee or the full board that a restatement is required, the compensation committee should meet to implement the clawback review process, set timeframes for required actions and establish the clawback implementation group members responsible for the collection of relevant information and the determination of the impact of the restatement on incentive compensation. The compensation committee should also consider the potential for conflicts of interest when management is involved in determining clawback amounts and making judgment calls with respect to calculations, sources of funds and taxation matters.
Depending on the dollar amounts involved, the compensation committee may decide to hire independent compensation or accounting experts and counsel to work with the internal clawback implementation group. Considerations of attorney-client privilege may dictate that counsel hire outside experts in order to maintain the privilege.
The panelists in our spring webcast “Clawbacks: Navigating the Process After a Restatement” had a similar message. I’ve even heard of companies working through a “dry run” with their counsel to work out (some) kinks in a hypothetical situation.
Join us at our 2024 Proxy Disclosure & Executive Compensation Conferences on October 14-15 in San Francisco to hear the latest on tricky clawback issues and market practice during our “Living with Clawbacks: What Are We Learning?” panel. There are now a number of examples of disclosures regarding mandatory clawbacks, disclosures that no clawbacks were required and SEC comments, and I’m looking forward to hearing our panelists’ perspectives. You can peruse our agenda to see what else our expert practitioners will cover and register here for in-person or virtual attendance.
We were just wondering over here what was happening in the other Tesla compensation litigation — the one where the Police and Fire Retirement System of Detroit sued Tesla’s board alleging excessive director compensation. Thankfully, the folks at The Activist Investor have been following it closely — attending hearings and submitting letters — and came out with this timely update!
You may recall that the parties announced a proposed settlement in July 2023. It was a particularly notable settlement by dollar value alone but also had some interesting governance terms. As the TAI post explains, the settlement has yet to be approved, partially because Tornetta threw a wrench in the works, but that’s starting to become a problem for the settlement terms because…stock options.
In Tornetta, the plaintiff attorneys requested TSLA shares that are currently valued at $5-6 billion. They argued for these at a hearing In July 2024. The letter indicates Chancellor McCormick expects the legal arguments over the Tornetta legal fees will affect those in Detroit. She has yet to rule on the Tornetta legal fees, although it should be sometime soon. Thus, Detroit waits for the final Tornetta opinion.
Last week the plaintiff and defendants sent a letter to Chancellor McCormick, the first substantive communication in the case since January.
The Detroit settlement includes a mix of cash, shares, and unexercised options that sum to the $750 million clawback. Options of course have an exercise period. If the option holder fails to exercise them by the end of that period, they expire worthless.
That could start to happen to some of the options that the plaintiff and defendants want to include in the settlement. A tranche of options belonging to BoD Chair Robyn Denholm expired August 18 (two days ago). The parties intended to include those options in the clawback. They planned to return those (now-expired) options once Chancellor McCormick approved the settlement, which she obviously has not done.
Instead of those expired (and presumably exercised, no one with any sense whatsoever lets TSLA options issued in 2017-2020 expire unexercised) options, the parties said they will include other unexercised-but-in-the-money Denholm options in the total clawback. The letter notes replacing the expiring options with other options having a later expiration increased the value of the settlement by $209. Presumably Denholm “paid” the extra $209, since it had to come from somewhere.
The parties want to avoid having to again swap out expiring options for unexpired ones. The next tranche of options they plan to return expires in June 2025. They worry that future exchanges will cost one or another director much more than $209. Thus, the parties urge Chancellor McCormick to approve the settlement promptly, before the next tranche of options expires. They even ask her to sever the consideration of the attorney fee request from that approval. She would decide later on the $250 million in legal fees, presumably after she rules on the $5-6 billion in legal fees in Tornetta.
TAI takes issue with the letter’s assertion that there are no open issues at issue in the settlement — pointing to TAI’s prior objection regarding “lack of allocation of the aggregate clawback among directors, and unenforceability of the shareholder vote on director pay.”
A client has a grant policy that allows for grants a few times a year at set times. They have asked if they can and should make an exception to this policy and grant on a different date to a new executive they are hiring instead of making the exec wait. I don’t like the precedent this would set or the possible future disclosure if this person becomes an NEO or the potential for investors to say that they are gaming the system. Am I being too conservative?
Here was John’s response:
Many equity compensation award policies address grants to new hires, and those policies often accommodate off-cycle grants of that type. I think the practice described in a Mercer publication summarizes the approach taken by most companies:
“For off-cycle grants (e.g., new hire, promotion, and retention awards), the policy will typically specify monthly or quarterly dates for approval, particularly for grants to non-executives. Companies sometimes make exceptions to this cadence to recruit or retain key executives or other employees.”
These grant procedures are all the more important given the “new” requirements under Item 402(x) to discuss policies and practices on the timing of awards of options in relation to the disclosure of material nonpublic information and provide tabular disclosure regarding option awards granted to NEOs contemporaneous with the release of material nonpublic information.