Facing pressure by Congress and others who are impatient to see action (e.g. recent introduction of the “Authorizing the Regulation of Swaps Act” in the Senate), the Treasury Department outlined plans yesterday to regulate derivatives. Under these plans, the Commodity Futures Modernization Act of 2000 would be rolled back. The plans are detailed in this letter by Treasury Secretary Geithner to Congress and in this Treasury Department statement.
This action followed remarks by President Obama that he intends to rein in pay practices at all financial institutions, not just those receiving TARP money. It’s unclear yet what form these restrictions would take, although a few alternatives are posited in this WSJ article.
In this WSJ video, Joann Lublin does a great job explaining the futile consequences of past efforts by the government to rein in pay. Takes the words right out of my mouth…
– Ira Kay and Steve Seelig, Watson Wyatt Worldwide
We read with interest Broc’s post about the “debate” on whether CEO pay went up or down during 2008, and the have a very short answer to that debate: Our research finds that CEO pay levels have declined no matter how you measure it.
Oh, were there not apples and oranges. We’ve blogged here before on how we think equity values should be measured. Not based on the grant date value for accounting purposes used by the Associated Press in their reporting (and soon to be required by the SEC per Mary Schapiro’s most recent comments) and most certainly not based on the number the SEC currently requires to be shown on the Summary Compensation Table (the value recorded for the year on the financial statement). Either of these measures is just the opportunity being granted to the executive for the year. We think the real equity value earned for the year is what the executive gained or lost based on how the stock price changed for the year on outstanding grants and those vested for the year, something we call “realizable pay.” We’ve written about this concept in a recent Watson Wyatt Insider article and intend to ask the SEC to consider using this approach on the Summary Compensation Table as it revisits the disclosure rules.
Any study that measures CEO pay levels based on grant date values from the start of the year, but then measures whether they match the value delivered to shareholders as of year-end must be viewed with some skepticism. Stock values need to be measured on an apples to apples basis. This is not to say there’s no room for criticism if there are higher pay opportunities granted for the 2009 fiscal year or when 2008 year-end discretionary bonuses are paid when the company performed poorly.
So what does the data say about 2008 realizable pay and 2009 pay opportunities?
1. 2008 Realizable Pay: In a soon to be released study, we looked at pay levels of 80 CEOs and found the typical CEO saw a decline of $39 million or 53 percent in value for pay realizable in 2008, with a drop in annual bonuses alone of 24 percent. These declines in pay opportunity and realizable pay are proportionate to the companies’ stock price declines. The analysis also found that despite a moderate stock market rebound in recent months, the typical CEO lost an additional 21 percent in equity value for existing holdings in the first three months of 2009.
2. 2009 Pay Opportunity: Based on a review of Form 4 filings during the first quarter of 2009, we found the long-term incentives granted to CEOs for 2009 declined 17 percent in dollar value from values granted in 2008, even though there was an 25 percent increase in the number of shares granted to account for stock price declines. This reflects that companies did not stick with a pure economic value approach to equity grants and recognized a need to cut back on grants to recognize poor performance during 2008 and to mitigate potential gains should the market rebound.
In a separate survey of corporate directors just released, more than a third (34 percent) of directors said their companies had already reduced salary, target bonus and/or long-term incentive award levels. Six percent plan to make those changes in the next six months and another 48 percent are considering making them.
Our research reflects that the so-called “ratchet effect” for CEO pay, whereby pay levels only increase as companies chase the illusive ever-rising median, does not exist in our current down market. If and when the stock market recovers over the next few years, we think we will see an uptick in pay opportunity and realizable pay.
As the proxy season progresses, we are starting to see the results from efforts by activist investors to move Say on Pay forward through the shareholder proposal process. Not surprisingly, proposals asking companies to implement an advisory vote on executive compensation have been garnering significant levels of support this season, as the outrage over pay levels continues largely unabated.
Last week, AFSCME issued a press release noting “[w]ith 29 Say on Pay proposals voted on since the start of the 2009 shareholder season, ten have received a majority of the votes cast (out of FOR and AGAINST votes). These 29 proposals have averaged more than 46 percent support, and this level of support is expected to increase as companies release their final voting numbers. Approximately 80 Say on Pay shareholder proposals are expected to be voted on this year.” Generally, the level of support this year has been higher than the support received for similar proposals in the very short history of the Say on Pay shareholder proposal.
Ted Allen of RiskMetrics Group recently provided some additional insights in the RMG Risk & Governance blog, noting “[t]he best showing so far this season was 62 percent support for a shareholder proposal at Hain Celestial; the lowest were 30 percent votes at Eli Lilly and Burlington Northern Santa Fe, according to RiskMetrics data. The two votes appear to reflect the firms’ ownership mix. At Lilly, a family endowment holds an 11.9 percent stake; at Burlington Northern, Berkshire Hathaway owns a 22.6 percent stake. In the coming weeks, ‘say on pay’ proposals are scheduled for a vote at Chevron, ConocoPhillips, Exxon Mobil, Home Depot, McDonald’s, Qwest Communications, Raytheon, Target, UnitedHealth, and Yum! Brands.”
For at least one company that has already implemented Say on Pay, apparently not all shareholders are on the warpath – as noted in this Washington Post article, last week shareholders overwhemingly supported executive pay at Verizon Communications with a 90% vote in favor!
CalSTRS Calls for Pay Reforms at 300 Companies
Say on Pay features prominently in a new initiative announced by CalSTRS last week. CalSTRS is calling on 300 of its portfolio companies to develop executive compensation policies and to allow shareholders advisory votes on those policies.
As part of the initiative, CalSTRS has published model executive compensation policy guidelines, as well as some broad executive compensation principles for the targeted companies to follow. CalSTRs plans to step up its engagement with the 300 targeted companies on executive pay issues, and in the event that the companies are unresponsive, the pension fund will ultimately vote against or withhold votes in directors’ re-election.
Below is the second in a series of blogs exploring the different approaches to say-on-pay that companies can take (here is the first blog on this topic):
Broad Retrospective Model – The Aflac Model
Aflac’s 2008 proxy statement states that Aflac adopted a say-on-pay policy voluntarily following interest expressed by a shareholder in November 2006. The company originally intended to put executive compensation to a shareholder vote in 2009 after three years of comparable compensation data was available. Aflac concluded, however, that the two years of data available in 2008 was sufficient. Accordingly, Aflac put the following resolution to a shareholder vote in that year:
“Resolved, that the shareholders approve the overall executive pay-for-performance compensation policies and procedures employed by the Company, as described in the Compensation Discussion and Analysis and the tabular disclosure regarding named executive officer compensation (together with the accompanying narrative disclosure) in the Proxy Statement.”
This resolution seeks approval of Aflac’s “overall executive pay-for-performance compensation policies and procedures.” Shareholders are referred to two sections of the proxy statement for a description of these policies: first, the Compensation Discussion and Analysis section, and second, the compensation tables, which generally appear after the CD&A.
Aflac’s approach to say-on-pay is broader than the “Narrow Retrospective Model” since it contemplates shareholders voting on both the amount of compensation and the policies underlying it.
As a result, shareholders could vote against the prior year’s executive compensation because they disagree with the policy underlying it rather than the amount (or even if they approve of the amount). This could occur, for example, if shareholders consider the amount of compensation attributable to long-term incentives to be insufficient and believe the company’s compensation policies are overly-focused on short-term returns.
Furthermore, the vote is not limited to the SCT, but covers additional tables included in the proxy statement. This would include the table showing “Grants of Plan-Based Awards” during the prior fiscal year. It might also include those tables that merely summarize “Outstanding Equity Awards at Year End”, “Option Exercises and Vested Stock”, “Pension Benefits” and “Non-Qualified Deferred Compensation.”
There is also a potential pitfall for companies adopting the “Broad Retrospective Model.” CD&A is intended to provide an explanation of a company’s overall compensation policies and practices in order to provide a context for compensation “awarded to, earned by, or paid to” named executive officers.
As a result, the CD&A largely provides the rationale for the prior year’s compensation. However, by its nature, a discussion of overall compensation policies and practices has general application and will often also apply to future compensation decisions. In addition, the SEC has provided comments to the CD&A sections of companies’ proxy statements seeking disclosure of prospective targets for bonuses.
Companies have generally resisted these requests by undertaking to provide prospective targets only to the extent they are relevant to the discussion of historical targets. However, the breadth of the Aflac resolution gives shareholders a vote both on historical amounts and policies, and on prospective policies and targets if they are included in the CD&A.
In what I believe is a reflection of the sheer complexity of executive pay packages, a number of well-respected compensation consultants differ on whether executive pay levels went up or down last year. If the experts can’t even agree on something as basic as whether pay is up or down, I am dubious that boards can fully understand how all the various complex components that make up most pay packages work together. Over the past few decades, the area of executive compensation has become rocket science!
Recently, Bill Gerek of the Hay Group blogged about pay appearing to be going down, according to their joint survey with the WSJ. Jim McRitchie recently posted notes from a panel that dissected this survey.
In comparison, Bud Crystal recently wrote this article about how executive pay levels are going up. Similarly, a preliminary analysis by The Corporate Library suggests that generous incentive compensation will drive an increase in total CEO compensation in 2008 (it’s the April 7th report).
In addition, a recent Financial Executives International survey on CFO compensation – which interviews the executives themselves – revealed that 31% of financial executives didn’t receive a salary increase in 2008 – and an estimated average base salary increase of all respondents of 3.7% (which was down a percentage point compared to the previous year – but still amazing that salaries went up and not down! – while 94% of survey respondents reported receiving a 2008 bonus. Here is FEI’s press release regarding the survey. Note how they emphazize “no salary increase for one-third” – the real headline should be “two-thirds still got salary bump despite crap economy”…
As a “thank you” to members – and due to the importance of the analysis included in it – we have decided to share a complimentary copy of the March-April issue of The Corporate Executive with you. This issue includes pieces on:
– Grant Guidelines and Declining Stock Prices
– Excessive Windfalls in Compensation Once Stock Prices Recover
– Two Fundamental—and Very Relevant—Considerations for High Level Executives
– Executives Surrendering Underwater “Mega” Grants
– Important, Timely Guidance on the Accounting Treatment of Acceleration of Vesting—Including Ramifications for Underwater Options
– Important, Timely Suggestions from a Respected CEO
In addition, you should read this supplement as it contains our recommended key fixes to the SEC’s executive compensation rules.
Act Now: To continue receiving the practical guidance imparted in The Corporate Executive, try a no-risk trial now.
Congrats to Jesse Brill for appearing on “The Today Show” this morning during a piece on executive pay. Here is a video archive of the segment.
SEC May Reverse “December Surprise”: Equity Compensation Disclosure Methodology for the Summary Compensation Table
In her AP article, Rachel Beck notes how the SEC may be considering reversing the rules from the December ’06 “surprise” – this relates to equity compensation disclosure methodology for the Summary Compensation Table.
Here is some commentary from Cleary Gottlieb on this development:
Many of you will recall that when the SEC comprehensively revised the executive compensation disclosure rules in August 2006, equity awards were to be presented in the Summary Compensation Table based on the full grant date fair value of each year’s awards, computed in accordance with FAS 123R. This was the methodology set forth in the proposed rules in February 2006, and there was full consideration of the approach as part of the comment process before the final rule was adopted.
In an unexpected release on December 22, 2006, the SEC changed the rules to require that the grant date fair value of an equity award be reflected in the Summary Compensation Table based on the recognition of accounting expense in the reporting company’s financial statements as required by FAS 123R in respect of the award, typically over an amortization schedule that corresponds to the award’s vesting period. That revision was adopted without a public meeting, without notice and comment and without any adequate explanation as to why the change was being made. Beyond the procedural concerns, many considered that the revision undercut the purpose of the Summary Compensation Table by obfuscating the value of equity-based grants, which are of course a principal element of executive compensation, and led to unnecessary last-minute changes to the composition of the named executive officers, primarily because amortization under the accounting rules was typically not permitted for “retirement eligible” executives.
Fast forward two-plus years, and we learn that the SEC is considering a reversal back to the original August 2006 rule. Press reports on Friday stated, based on an interview with SEC Chairman Mary Schapiro, that the SEC “is considering changing a formula that critics say often allows public companies to low-ball in regulatory filings just how much top executives are paid.” If the reversal happens, it in fact should be a welcome development for critics and reporting companies alike. The inclusion in the Summary Compensation Table of the grant date fair value of equity awards granted in each year to named executive officers presents a clearer picture of compensation decisions in a given year, and makes the determination of the named executive officers more predictable and sensible.
If the press reports are correct, interesting questions arise as to the transition from the current rule to the new rule. Will unamortized awards from prior years be entirely excluded from the Summary Compensation Table? Will companies be required or permitted to recompute the amounts disclosed for prior years, as if the changed rule had been in effect in the past? Could the basis of disclosure for 2009 (if that is the first fiscal year for which the change is effective) equity awards be different than the basis for the amounts set forth in the Table for earlier years? We would expect the SEC to address these and other transition issues as part of any rule change or in accompanying guidance. Stay tuned.
In its proxy statement filed recently, Coca-Cola discloses that it went back and forth with the Corp Fin Staff over whether to disclose performance targets under its Performance Incentive Plan based on a competitive harm argument. It seems that the Staff didn’t buy the argument and required Coke to disclose the targets for its business units.
In response, Coke changed direction and instead gave up their performance-based plan and switched to discretionary awards. I hope fear of disclosure doesn’t become a trend that drives companies to design pay arrangements with boundless borders – but I understand companies other than Coke had already taken this approach before Coke. So I’m not singling out Coke as there are a number of companies in this category.
Below is the relevant disclosure from pages 38-39 of the Coke proxy statement:
“Typically, the annual incentive to all employees is paid under the Performance Incentive Plan using a formula, as described in the Company’s 2008 Proxy Statement, based on objectively determinable business results. The Company has never disclosed the exact business targets or their interrelationships used under the formula to determine the annual incentive because doing so would result in competitive harm to the Company. In addition, the Company does not believe that such disclosure would be material to shareowners’ understanding of the plan. In May 2008, the Company received a comment letter from the SEC requesting that we disclose the exact performance targets used for the Performance Incentive Plan. The Company did not believe such disclosure was required. After extensive discussions with the SEC over a number of months, the SEC then requested that we disclose the range of business performance targets and the personal performance factors for each Named Executive Officer. The Company believed that disclosing the ranges would allow a competitor to recreate the matrix of business performance targets and use this information to determine our business strategy.
Therefore, the Compensation Committee decided to approve discretionary bonuses for the Named Executive Officers for 2008 rather than base incentives on those confidential business performance targets. This means that the incentives paid to Messrs. Isdell, Kent, Finan and Cummings (the U.S. based Named Executive Officers other than the Chief Financial Officer) will not be deductible for tax purposes for 2008 pursuant to Section 162(m) of the Tax Code. The Compensation Committee weighed the additional tax cost versus the competitive harm in disclosing the plan targets and determined that the potential competitive harm significantly outweighed the additional tax cost, which was not material.”
We just sent the March-April issue of The Corporate Executive to the printer. This issue includes pieces on:
– Grant Guidelines and Declining Stock Prices
– Excessive Windfalls in Compensation Once Stock Prices Recover
– Two Fundamental—and Very Relevant—Considerations for High Level Executives
– Executives Surrendering Underwater “Mega” Grants
– Important, Timely Guidance on the Accounting Treatment of Acceleration of Vesting—Including Ramifications for Underwater Options
– Important, Timely Suggestions from a Respected CEO
To have this issue rushed to you, try a no-risk trial to The Corporate Executive today.