You probably saw yesterday’s Wall Street Journal article on the Delaware Chancery’s latest decision related to Elon Musk’s 2018 Tesla pay package. There are very few takeaways for executive compensation professionals in the decision, but it seems worthy of addressing here — even if only for its novelty. So, keeping with the theme of my April post on Tesla’s proxy filing — including the proposal requesting that stockholders ratify said pay package after the Chancery Court ordered it rescinded — here are five things to know about the latest decision:
– This opinion was still at the Chancery Court level — penned by Chancellor McCormick, who was also responsible for the initial post-trial decision ordering rescission of the award. The order addressed the defendants’ motion to “revise” the post-trial opinion based on the stockholder vote and plaintiff attorneys’ petition for fees and expenses.
– Chancellor McCormick used this opportunity to clarify/emphasize a few points from the initial post-trial opinion. Specifically, that the decision did not hold that the Tesla board should have paid Musk nothing. She says, “there were undoubtedly a range of healthy amounts that the Board could have decided to pay Musk. Instead, the Board capitulated to Musk’s terms and then failed to prove that those terms were entirely fair.” She also clarified that none of the legal theories applied in the opinion were novel — if anything was novel in the opinion, it was simply that those legal principles had not previously been applied by the court to Musk vis-a-vis Tesla.
– The opinion considered events post-dating the initial post-trial decision, including the actions of the single-member special committee that was formed to assess the redomestication of Tesla to Texas and whether Musk’s 2018 award should be submitted to a second stockholder vote and the 2024 stockholder vote intended to “ratify” the award.
– Chancellor McCormick found that the “ratification” argument had four fatal defects — three expected, one surprising.
First, there are no procedural grounds for flipping the outcome of a post-trial decision based on evidence created after trial. Procedural rules allow the court to reopen the trial record for newly discovered evidence (“in existence at the time of trial”) but not newly created evidence. From a policy perspective, if this was allowed, “lawsuits would become interminable” and it would “eviscerate the deterrent effect of derivative suits.”
Second, as an affirmative defense, common-law ratification is waived if not timely raised. And, “wherever the outer boundary of non-prejudicial delay lies,” raising the defense “six years after this action was filed, one and a half years after trial, and five months after the Post-Trial Opinion” was too late.
Third, in a conflicted-controller transaction, the “maximum effect” of stockholder ratification is to shift the burden of proving entire fairness; it doesn’t shift the standard of review, which would require MFW’s additional protection of an independent committee and conditioning the transaction on the dual protections before negotiations. Defendants tried to argue that MFW was invoked after the post-trial opinion, to which the opinion says, “One does not ‘MFW‘ a vote, which is part of the MFW protections; one ‘MFW‘s a transaction.”
Finally, the proxy statement contained material misstatements. Tesla went to great lengths to avoid any argument that this second vote was not fully informed — having annexed 10 documents to the proxy, including the opinion and the special committee’s report to the board. But the legal impact of the stockholder ratification was unclear — and, trying to be transparent, the proxy said as much. That was a problem. “To be fully informed for ratification purposes, ‘the stockholders must be told specifically . . . what the binding effect of a favorable vote will be.’” Plus, the proxy used phrases like “extinguish claims,” “any wrongs … should be cured” and the disclosure deficiencies “corrected,” which were “materially false and misleading.”
– Using “sound” methodology, the plaintiff’s attorneys asked for $5.6 billion in freely tradeable Tesla shares as attorney fees. To this, the opinion says, “in a case about excessive compensation, that was a bold ask.” To avoid a windfall and reach a reasonable number, the opinion adopts the defendants’ approach of using the $2.3 billion grant date fair value to value the benefit achieved and applies 15% to that amount, resulting in a (still massive) fee award of $345 million.
This article from Meridian Compensation Partners addresses managing a company’s run rate — the number of shares granted from the incentive pool during the year divided by the average common shares outstanding used for basic EPS. The article notes that, last year, the ten top shareholder return performers in the S&P 500 increased their run rate by an average of approximately 5% year over year, while the bottom ten increased by about 40% on average. While the article discusses three approaches to comparing run rate relative to peers — gross shares granted at target, gross shares earned and net number of shares granted (excluding forfeitures and cancellations) — Meridian recommends using target number of shares granted for the best comparative assessment.
Going into 2025, for companies experiencing depressed stock prices, significant volatility or an otherwise high relative run rate, the post has this reminder of various options to reining in dilution:
– Apply a long-term stock price average to derive the number of shares: Use a 6- or 12-month stock price average that may smooth out temporary dips.
– Below the executive level, grant a portion of the intended equity value in restricted cash: Maintains employee satisfaction and retention without diluting shareholders (at the expense of reducing alignment with shareholders).
– Reduce equity eligibility: Reserve equity for positions that are difficult/impossible to recruit and retain without equity awards.
– Reduce vesting period in connection with a lower grant date value: Annualized value delivered will feel similar to the employee despite a smaller number of total shares granted.
– RSUs in lieu of stock options: RSUs provide greater retention, cannot be underwater and use fewer shares for a given targeted dollar amount.
– Reduce dollar value of equity awarded: When a company’s share price decrease is precipitous (e.g., energy companies in 2020), companies may decrease the dollar value of equity awarded to manage both the run rate and upside leverage on share price rebound.
Last week, Glass Lewis released this special report (available for download) on its approach to analyzing equity plan proposals. The report reviews the proxy advisor’s Equity Compensation Model — the tool used by its analysts to assess share request proposals put forth by U.S. companies — in detail and discusses equity plan proposal trends from the 2024 proxy season.
The model includes eleven quantitative and qualitative tests that gauge:
– The potential dilution and overall costs of the proposed plan,
– If the company already has enough shares for near-term granting,
– If the proposed share pool is excessively large, decreasing the frequency in which shareholders will have a say on the company’s equity compensation program, and
– If the company’s actual share usage aligns with shareholders’ values.
Glass Lewis’ four cost-based tests evaluate actual and projected costs to shareholders relative to industry peers. Potential dilution as measured by overhang is evaluated on both absolute and relative bases. The results of the remaining quantitative tests are compared to fixed benchmarks, adjusted to incorporate sector-specific considerations or changes to the size of the employee base at the company. Additional tests measure how well the qualitative features of the proposed plan follow best practices in pay governance.
For the 2024 proxy season, the “dilution exceeds peers” test was most commonly failed — though the report notes that a mere 6% of proposals that failed this test actually received an against recommendation after the full, holistic assessment. The next most failed test was the “pace of historical grants” test, which finds the ratio of the company’s net recent grants to its total shares outstanding and compares that to an industry benchmark. In terms of the test most correlated to against recommendations, the “expensed cost as a percentage of operating metrics” and “projected cost as a percentage of operating metrics” were most correlated. A majority of proposals that failed either test ultimately received an against recommendation.
Glass Lewis has recently been emphasizing how its approach to executive compensation is both “holistic” and “case-by-case,” and this is again reiterated in this report.
In some tests, the model uses historical practices to forecast future granting behavior. However, it may be the case that such historical data no longer apply to companies that have experienced significant transformations such as large mergers. As a result, each company that presents a proposal to Glass Lewis’ clients for vote is evaluated on a case-by-case basis to ensure that all tests used in the model are applicable. When a transformative event or a contravening factor is identified, Glass Lewis refrains from using the full model, though unimpacted tests remain part of our assessments.
With ISS’s FAQ update last month, there is now one more reason to review your company’s approach to clawback policies and provisions. A recent Debevoise memo summarizes key voting policies on this topic:
– ISS recently clarified in its FAQs on executive compensation policies that, for purposes of ISS’s say-on-pay vote recommendation, clawback policies must explicitly cover all time-vesting equity awards in order to receive credit for a “robust” clawback policy. This is consistent with the view ISS had already taken for purposes of analyzing equity-based incentive program proposals under its Equity Plan Scorecard (“EPSC”) policy. Under ISS’s FAQs on Equity Compensation Plans, in order to receive EPSC points for the clawback policy factor, an issuer’s clawback policy should authorize recovery upon a financial restatement and cover all or most equity-based compensation for all NEOs, including both time- and performance-vesting equity awards.
– Glass Lewis’s view on clawback policies under its 2025 U.S. Benchmark Policy Guidelines is that effective clawback policies should provide companies with the authority to recoup incentive compensation (whether time-based or performancebased) in the event of a restatement of financial results or similar revision of performance indicators upon which the awards were based. In addition, recovery should be available when there is evidence of problematic decisions or actions, such as material misconduct or a material reputational failure, material risk management failure or material operational failure, the consequences of which have not already been reflected in incentive payments and where recovery is warranted. Glass Lewis expects that this authority to recoup should be provided regardless of whether the employment of the executive officer was terminated with or without cause.
– BlackRock’s view, expressed in its 2024 Proxy Voting Guidelines for U.S. Securities, is that it favors prompt recovery from any senior executive whose compensation was based on faulty financial reporting or deceptive business practices. This includes DoddFrank-compliant policies and broader policies requiring recovery from (or the foregoing of) the grant of any awards by any senior executive whose behavior caused material financial harm to shareholders, material reputational risk to the company or resulted in a criminal investigation, even if such actions did not ultimately result in a material restatement of past results. BlackRock generally supports shareholder proposals on these matters unless the company already has a robust clawback policy in its view.
The memo notes that even for the largest U.S. companies – most of whom already have policies or provisions that go beyond Dodd-Frank requirements (e.g., additional triggers, a broader group of covered employees, etc.) – it’s a good time to take a fresh look at policies. And companies that don’t go beyond what’s mandated may want to discuss whether to change that. In addition to proxy advisor and investor positions, compensation committees should consider the DOJ’s pilot program and company-specific factors. The Debevoise team recommends taking these steps:
1. Where companies have existing discretionary policies, companies should review these policies to confirm whether any standalone clawback policy or related terms set forth in an incentive plan are sufficiently rigorous under proxy advisor or shareholder guidelines. Consider whether any changes are appropriate for the organization.
2. For companies without existing discretionary policies, consider whether the board should have the authority to recoup compensation in other circumstances to comply with proxy advisor guidelines or to otherwise strengthen the company’s corporate governance program. While industry and peer benchmarking can be instructive, companies should design discretionary policies that reflect their own unique risks and organizational and compensation structures.
3. Engage with legal counsel to ensure that all clawback policies are enforceable under state laws and are integrated into agreements where appropriate.
Programming Note: Happy Thanksgiving, everyone! We’ll see you back here next week.
It’s hard to believe we are rolling into Year 3 of pay versus performance disclosures. Glass Lewis already incorporates this data as a supplemental quantitative factor in its executive compensation analysis (pg. 53), but ISS and many investors are still in “wait & see” mode. This Semler Brossy memo predicts that the “Compensation Actually Paid” metric will become a more valuable data point over time. Here’s why we aren’t there yet:
One way to think about full-tenure CAP is that it is the best possible running estimate of what compensation has been and could be delivered. The annual fluctuations in unvested equity values net themselves out over time and end up showing the tallied value of compensation the moment someone could have taken their pay off the table. Even the method for calculating stock options gives credit to the long lifespan of this vehicle. By using a Black Scholes calculation at the time of vest, CAP gives credit to the long life of a stock option, even if it is “underwater” when it vests (but still has economic value). It shows a credible estimate of what could be delivered to the executive the moment it was theirs to take.
The problem is that each individual year of disclosure is meaningless in isolation. Most years are overly influenced by the change in value of outstanding equity, not the full tallied value. When there is a big negative CAP value, it’s hard to make sense of it unless you know how much the outstanding equity was initially worth. There isn’t a clear story to tell unless you can compare the full tallied value of SCT and CAP numbers.
But:
Once full-tenure CAP is available, CAP/SCT ratios become powerful because they are apples-to-apples comparisons of everything that was awarded and what it turned into (i.e., the actual compensation outcomes that were delivered) in a manner that allows for comparison across organizations. In the first two years of PVP reporting, only 84 companies in the Russell 3000 had new CEOs join in the window that would provide enough information to look at full-tenure CAP.
By 2025, organizations will be required to report five full years of data. As CEO transitions occur over time, the data set of full-tenure CAP/SCT ratios will get richer and allow for benchmarking. There will also be the opportunity to assess and develop clearer market standards for a reasonable relationship between full-tenure CAP and SCT.
Taking a closer look at the 84 companies that report “full-tenure CAP,” the memo shows how the data can raise questions (or tell a story):
– Agricultural retail company. The CEO’s full-tenure CAP/SCT was higher than relative performance due to a strong leverage profile in its long-term incentive (LTI) structure (25% options and 50% performance stock units [PSUs]) and a 200% payout on PSUs in recent years. This outcome begs the question: Has performance justified the payouts?
– Pharmaceutical company. The organization had low full-tenure CAP/SCT and flat performance due to a 100% stock option design. The CAP values decreased as options neared vesting without price improvement, and the Black Scholes calculations remained low. This scenario raises the question: Is the design working, or are there any retention risks to address?
I’m willing to bet that there are diligent compensation committee members (and advisors) who would intuitively know that something is amiss in these types of scenarios. At some point, full-tenure CAP could give them another data point to help articulate concerns. . . hopefully before an investor brings it to their attention.
We’ve patted everyone on the back a few times about this year’s record-low failure rate for say-on-pay. We also saw much lower rates of ISS opposition. This Pay Governance memo takes a close look at factors that may have contributed to this result, including:
1. Significantly better performance on the ISS Multiple of Median (MOM) test. The MOM test evaluates the ratio of 1-year CEO pay to the median CEO pay of the ISS-selected peer group and has historically been (and continues to be) a meaningful predictor of adverse ISS SOP recommendations. The average MOM outcome was 1.7x in 2024, compared to 2.2x in 2023 and 2.4x in 2022, demonstrating a migration of CEO pay toward peer median levels and fewer outlying pay packages.
2. Improvement in Compensation Committee responsiveness to proxy advisor and shareholder concerns over executive pay. We observed fewer Compensation Committees being criticized by ISS for poor responsiveness to shareholder concerns and fewer cases of significant one-time awards that led to an against SOP recommendation. In addition, the number of companies that received ISS opposition to SOP in two consecutive years declined, demonstrating that companies are getting better at addressing investor feedback.
These findings are worth considering if your say-on-pay resolution has gotten lower support than you’d like in recent years, and the memo goes into much greater detail on both. The notion of “conformity” also appears to align with another study that I blogged about last month.
Calendar year-end companies are gearing up to provide new disclosures under Item 402(x) of Regulation S-K in 2025 proxy statements. The new subsection of Item 402 requires:
– Disclosure of policies and practices related to the timing of awards of options, SARs and/or similar option-like instruments in relation to the disclosure of MNPI, and
– New tabular disclosure to the extent that, during the fiscal year, any stock options, SARs or similar instruments were granted to NEOs during the period beginning four business days before and ending one business day after the filing of a 10-Q, 10-K, or 8-K that discloses MNPI.
Over on the Q&A Forum (Topic # 12418) on TheCorporateCounsel.net, a member recently asked, “Have you seen any examples of disclosures containing insider trading and/or equity award disclosures that will be required for the first time in 2025 for calendar year filers?” I suspect many folks are — or will soon be — on the lookout for sample or precedent disclosures under Item 402(x), so here is my response:
Also take a look at this DLA Piper alert that gives an illustrative example of the tabular disclosure. And keep in mind that, like other sections of Item 402 that require tabular disclosure, Item 402(x)(2)(i) includes a blank table.
Late last week, shortly after releasing the results from its second annual global policy survey, Glass Lewis announced the publication of its 2025 Voting Policy Guidelines (U.S.) and the Shareholder Proposals & ESG-Related Issues Guidelines (global) that apply to shareholder meetings held after January 1. Two updates relate to executive compensation matters. Here is the description from the Summary of Changes for 2025:
Change-In-Control Provisions. We have updated our discussion of change-in-control provisions in the section “The Link Between Compensation and Performance” to define our benchmark policy view that companies that allow for committee discretion over the treatment of unvested awards should commit to providing clear rationale for how such awards are treated in the event a change in control occurs.
Approach to Executive Pay Program. We have provided some clarifying statements to the discussion in the section titled “The Link Between Compensation and Performance” to emphasize Glass Lewis’ holistic approach to analyzing executive compensation programs. There are few program features that, on their own, lead to an unfavorable recommendation from Glass Lewis for a say-on-pay proposal. Our analysis reviews pay programs on a case-by-case basis. We do not utilize a pre-determined scorecard approach when considering individual features such as the allocation of the long-term incentive between performance-based awards and time-based awards. Unfavorable factors in a pay program are reviewed in the context of rationale, overall structure, overall disclosure quality, the program’s ability to align executive pay with performance and the shareholder experience and the trajectory of the pay program resulting from changes introduced by the compensation committee.
Yesterday on TheCorporateCounsel.net, I blogged about the other (non-compensation-related) proposed changes. For more commentary and insight, we’ll be posting memos in our “Proxy Advisors” Practice Area, and Glass Lewis is planning a webinar on December 11 to share additional context.
Yesterday, ISS announced the launch of its open comment period on proposed changes to its benchmark voting policies. During this open comment period, ISS gathers views from stakeholders on its proposed voting policy changes for 2025 (and beyond). The comment period closes at 5:00 p.m. Eastern time on December 2.
It looks like 2025 will be another light year for benchmark policy changes. The main substantive policy updates address poison pills and SPAC extension requests. However, ISS also provided a summary of ongoing considerations related to U.S. executive compensation policy on the use of performance- vs. time-based equity awards, including a planned change in policy application for 2025 (under the current policy). Here’s more:
The current pay-for-performance assessment for executive compensation under ISS U.S. benchmark policy considers a predominance of time-vesting (as opposed to performance-vesting) equity awards to be a significant concern at a company that exhibits a quantitative pay-for-performance misalignment. However, a growing number of investors have expressed changing viewpoints regarding U.S. equity award practices. Some investors highlight concerns with performance equity programs that may be poorly designed and/or disclosed, including concerns about highly complex programs and non-rigorous performance measures, and some consider that well-designed timevesting awards are preferable to performance-vesting awards.
These changing viewpoints were demonstrated by the results of a question in the 2024 Global Benchmark Policy Survey. … Considering the various feedback and arguments put forward, a potential policy update remains under consideration for 2026 (or later) regarding the evaluation of the equity pay mix for regular-cycle equity awards whereby a preponderance of time-vesting equity awards generally would not in itself raise significant concerns in the qualitative review of pay programs.
For 2025 and in advance of any potential wider policy changes for 2026, we intend to implement certain pay-for-performance policy application changes that do not require formal policy changes at this time but are adaptations within the current U.S benchmark policy framework. …
Effective for 2025 (for meetings on or after Feb. 1, 2025), we will introduce adaptations to the qualitative review of performance-vesting equity awards carried out under the current U.S. benchmark policy. Specifically, any design or disclosure concerns regarding performance equity will carry greater weight in the qualitative analysis, and significant concerns in these areas will be more likely to drive an adverse say-on-pay recommendation for a company that exhibits a quantitative pay-for-performance misalignment. Further details on the changes will be provided in an update to ISS’ U.S. Executive Compensation Policies FAQ, expected to be published in mid-December 2024.
They invite additional feedback on the following questions:
– If, in the future, U.S benchmark policy were to no longer view a predominance of time-vesting equity awards as concerning in itself, what criteria would you consider most important for analyzing time-vesting equity awards? (for example, vesting periods, award magnitude, holding period requirements, or any other significant factors)
– If U.S. benchmark policy were to no longer view a predominance of regular-cycle time-vesting equity awards as concerning, do you believe the same standard should be applied to any off-cycle/one-time equity awards?
Over on TheCorporateCounsel.net in late August, I blogged about some things companies need to do — or consider — if they want to be ready to capitalize on any potential IPO window that may open in 2025. This Morgan Lewis blog is focused on the same topic — but specifically with executive compensation considerations in mind. Here are a few tips from the blog:
Cheap Stock: During the period prior to an IPO, private companies often seek to incentivize employees through the grant of stock and stock-based equity awards. While this practice is frequently a successful means of incentivizing key employees and service providers, without sufficient preparation and consideration, the practice can raise the issue of whether pre-IPO awards represent “cheap stock.” …
With equity being a popular form of compensation for many pre-IPO companies, the following are key considerations companies should take prior to the IPO:
– Work with outside advisors well in advance of the IPO process (especially in the 12-month period prior to the IPO) to understand the potential accounting, tax, and disclosure implications of cheap stock grants.
– Obtain frequent independent valuations with respect to the value of shares underlying all equity awards made during the pre-IPO period (with the valuations made contemporaneous to, or close in time to, the grant date of the equity awards).
– Ensure that there is a good corporate record of all grants of equity awards, including formal approvals by the company’s board and its consideration of outside independent valuation.
Triggering Events in Existing Arrangements: In the lead-up to an IPO, a company should consider the impacts that the IPO will have on existing executive arrangements generally and equity compensation considerations specifically. For example, it is common for an IPO not to be treated as a “change in control,” “change of control,” or “liquidity event” under its equity plan and the individual award agreements that govern private company equity awards. Many companies do not have other bonuses or arrangements with key executives that will become automatically payable in connection with an IPO.
It is advisable to review all outstanding equity awards and other executive compensation arrangements to ensure that executives have sufficient incentives to get to the IPO. If no arrangements will be automatically triggered, consider structuring bonuses or other arrangements to reward the executive team for getting the company through a successful IPO. It is not uncommon for members of the executive team to retain their own legal advisors to negotiate these arrangements and advise on market practices from the executives’ perspective. This review tends to be coupled with the proposals and considerations below to ensure that key employees and service providers will be incentivized for post-IPO success.
“Cheap stock” and other IPO-readiness issues will be addressed during an upcoming webcast on TheCorporateCounsel.net. Tune in at 2 pm ET on Thursday, December 12, 2024 to hear White & Case’s Maia Gez, Mayer Brown’s Anna Pinedo, Cooley’s Richard Segal and Gunderson Dettmer’s Andy Thorpe discuss “Capital Markets: The Latest Developments.”
Members of TheCorporateCounsel.net are able to attend this critical webcast at no charge. If you’re not yet a member, subscribe now. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.