With executive compensation issues firmly in the public spotlight, the SEC is once again considering expanded CD&A disclosure requirements. The SEC’s most recent proposals include improved disclosure on the connection between compensation and risk, greater detail on overall compensation philosophy and design, and further insight into potential conflicts of interests between compensation consultants and the companies they advise.
With these developments in mind, Equilar recently used its “Compensation Consultant League Table” database to complete an analysis of executive compensation consultant market share at Fortune 1000 companies. In 2008, boards at 90.7% of Fortune 1000 companies retained the services of at least one compensation consulting firm.
The following table lists the Top 10 consulting firms, by executive compensation consulting market share during ’08, at Fortune 1000 companies:
1. Towers Perrin – 19.3%
2. Frederic W. Cook & Co. – 17.5%
3. Hewitt Associates – 14.5%
4. Mercer Human Resources Consulting – 11.4%
5. Watson Wyatt Worldwide – 7.5%
6. Pearl Meyer & Partners – 5.4%
7. Semler Brossy Consulting Group – 3.8%
8. Hay Group – 2.3%
T-9. Exequity – 1.6%
T-9. Deloitte Consulting – 1.6%
Note: FY 2008 market share percentages are based on a total of 867 engagements with boards of directors at 824 of 908 Fortune 1000 companies studied. See methodology statement below for more information. Also note that Towers Perrin and Watson Wyatt announced plans to merge into a new firm called Towers Watson on June 29, 2009. The combined firm would have a market share of 26.8 percent.
Additional Key Findings:
– Top 10 Firms Lose Overall Market Share as Smaller Firms Proliferate – In 2008, Fortune 1000 companies listed a total of 53 executive compensation consulting firms as advisors to their boards of directors. Among these firms, the Top 10 consulting firms held a combined market share of 84.9 percent. In contrast, Fortune 1000 companies listed only 42 executive compensation consulting firms as advisors in 2006, when the Top 10 consulting firms held a combined market share of 93.8 percent.
– Independent Firms Gain Market Share – In 2008, independent executive compensation consultants held 39.3 percent of engagements with boards of directors at Fortune 1000 firms, up from 37.4 percent of engagements in 2007. Market share for independent firms had increased from 35.0 percent to 37.4 percent between 2006 and 2007. Independent firms are defined by Equilar as companies that focus primarily on executive compensation consulting.
– Full-Service Firms Maintain Market Share Above 60% – Full-service firms, which are defined by Equilar as companies that offer accounting, broad-based HR, retirement and/or benefits consulting in addition to executive compensation services (though not necessarily to the same client), held 60.7 percent of engagements with boards of directors at Fortune 1000 firms in 2008.
Readers of this analysis should take the following methodology notes into consideration:
– To study trends on the use of executive compensation consulting firms at public companies, Equilar reviewed disclosures at 908 firms listed in the Fortune 1000 index. Each firm covered by the study has an updated CD&A statement for fiscal year 2008.
– Among the companies included in this analysis, 824 firms (or 90.7 percent) retained an executive compensation consultant to advise their board of directors on executive pay. The remaining firms either have no consultant or a consultant retained by management. For the purposes of tracking market share at Fortune 1000 companies, Equilar only considers direct engagements between a board of directors and a consulting firm.
– In some cases, a board of directors may engage multiple executive compensation consulting firms during the course of a single year. Equilar counts these cases as a full engagement for all consulting firms involved. As such, the 824 companies with an executive compensation consultant for their board of directors produced a total of 867 engagements in fiscal year 2008.
Here is an extended version of Equilar’s compensation consultant market share analysis, including data on year-over-year changes in market share. Equilar is an information services firm specializing in executive compensation research.
An Alabama state judge recently temporarily froze executive payments at Regions Financial Corporation at the request of a Louisiana pension fund. While company officials say the order has been lifted and the lawsuit moved to federal court, the case is another example of how shareholders are using litigation to try to constrain executive pay.
In a derivative lawsuit filed in May, the Louisiana Municipal Police Employees Retirement System claimed that Regions executives were awarded excessive bonuses while the company was receiving $3.5 billion in assistance from the federal government’s Troubled Asset Relief Program. The lawsuit also alleged that management misled investors about its $10 billion acquisition of AmSouth Bancorp in 2006. The pension fund claimed that executives and directors breached their fiduciary duties, wasted corporate assets, and engaged in gross mismanagement, according to news reports. The defendants include CEO Dowd Ritter, two dozen current and former executives and directors, auditor Ernst & Young, and Merrill Lynch. The Louisiana pension fund, which is seeking to place $155 million in compensation into a trust, also urges Regions to adopt governance reforms and fully comply with TARP pay restrictions.
The Regions lawsuit is the latest example of what appears to be a resurgence in shareholder litigation over executive pay decisions this year. In other high-profile cases, investors filed suit in April over American International Group’s $165 million in retention bonuses and sued Bank of America over the $3.6 billion bonuses paid to Merrill Lynch employees shortly before the investment firm was acquired.
However, investor lawsuits over executive pay are not new. Shareholders filed more than 150 derivative lawsuits over misdated stock options at technology and health care companies in 2006 and 2007. While some of the backdating derivative cases were accompanied by securities class-action lawsuits, most of them were not.
Derivative lawsuits can be difficult to pursue because the laws of Delaware and other states generally require investors to file a demand that the company management bring the case before proceeding on their own, or show that such a demand would be futile. Lawsuits over compensation can be especially difficult, because Delaware courts generally have applied the “business judgment” rule to analyze pay decisions by independent directors. In perhaps the best-known Delaware case over pay, a Chancery Court judge ruled in 2005 that Walt Disney directors did not breach their fiduciary duties when they approved a multi-million dollar severance package for former executive Michael Ovitz.
However, there have been recent Delaware rulings for investors in lawsuits over misdated options at Maxim Integrated and Tyson Foods that have made it more difficult for companies to get derivative lawsuits dismissed and have increased the negotiating leverage for investor lawyers. In addition, there was the February decision in Delaware over the $68 million exit package received by former Citigroup CEO Charles Prince. While the court dismissed claims that executives and directors failed to properly monitor subprime mortgage risks, the court held that investors could proceed with their claims over Prince’s exit package.
In his ruling, Chancery Court Judge William Chandler noted that “the discretion of directors in setting executive compensation is not unlimited….Indeed, the Delaware Supreme Court was clear when it stated that ‘there is an outer limit’ to the board’s discretion to set executive compensation, ‘at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste.’”
While derivative lawsuits often result in governance changes, they usually don’t lead to large settlements or judgments. One recent exception is the $2.88 billion verdict issued on June 18 by a judge in Alabama against former HealthSouth CEO Richard Scrushy. In that case, the company’s new management participated in the derivative lawsuit, which re-litigated many of the same fraud allegations that were the subject of an earlier criminal trial where Scrushy was acquitted. While it’s unclear how much Scrushy still has, investor lawyers say they hope to recover $100 million.
Other notable settlements include UnitedHealth, where investors, who also filed a securities lawsuit, obtained an $895 million settlement over misdated options. At American International Group, investors obtained a $115 million settlement over commissions paid by AIG to C.V. Starr, a privately held affiliate controlled by former Chairman Hank Greenberg and other AIG directors.
Meanwhile, investors continue to negotiate settlements in securities class-action actions over alleged options backdating. Recent examples include a $72 million agreement obtained by Marvell Technology Group investors in early June and a $13.5 million accord negotiated by Sunrise Senior Living shareholders in February, according to RiskMetrics Group data.
While we were tickled to see our March-April issue of The Corporate Counsel cited in footnote 44 of the release, we were even more excited that the SEC is soliciting comments on a number of important areas of the executive compensation rules, such as whether boards consider internal pay equity when they set the amounts of executive compensation. Here is a discussion of this fix – and others – that we urge you to consider when drafting your comment letters for the SEC on the executive compensation proposals.
Our “4th Annual Proxy Disclosure Conference“: Now that the SEC’s proposals are out – and broker nonvotes are gone – you need to register now to attend our popular conferences and get prepared for a wild proxy season:
“4th Annual Proxy Disclosure Conference” & “6th Annual Executive Compensation Conference.” You automatically get to attend both Conferences for the price of one; they will be held November 9-10th in San Francisco and via Live Nationwide Video Webcast. Here is the agenda for the Proxy Disclosure Conference. Register now.
Since the Treasury adopted its interim final rule on June 15th, the first of the requisite “luxury expenditure policies” have been posted online as required. Recall that the board for each TARP company is required to adopt such a policy (as well as file it with Treasury and post it online) before the later of ninety days after the closing date of the agreement between the Treasury and the TARP recipient or September 13th. We have started posting samples of these policies in our “Management Perks” Practice Area.
Here is something I recently posted on our blog: Judge, law and economics pioneer, prolific conservative commentator, and all-around polymath Richard Posner weighs in on the controversy over executive compensation on his blog. While he acknowledges that excessive compensation is a problem, he says:
It is not a momentous concern and costly measures to ally it would not be justifiable. Modest measures, such as making it easier for shareholders to replace directors than under the existing, Soviet-style system in which shareholders vote for or against the slate proposed by management, and requiring full disclosure and monetization of all forms of compensation paid CEOs and other top executives, may be sensible; but nothing more should be attempted.
The solving of the overcompensation problem would have little if any effect on risk taking by bankers and other financiers, so probably any efforts to solve it should be postponed until the economy recovers from its present sickness.
I am pretty sure that the economy cannot recover from “its present sickness” until it gets some medicine – and fixing executive compensation can be a powerful antibiotic to address the poor credibility and perverse incentives of flawed pay plans. And I am certain that if and when the economy recovers, no one will be interested in further reforms.
By definition, a problem needs a solution. I agree with Posner that the answer has to come from the board and appreciate his support for more legitimate and robust elections and hope he will recognize that this “effort to solve it” cannot be postponed.
The “newest old thing” these days is designing compensation plans that do not encourage excessive risk taking. “Experts” have identified risk as the hottest emerging issue for compensation committees, stating that “we” do not yet know how to create the proper relationship between pay and risk.
I fully agree that the word “risk” has never been used more in compensation committee meetings than in the last six months, but that doesn’t mean the concept is new. In fact, responsible directors have considered the risks and potential impact, good and bad, of every pay decision for decades.
While not explicitly termed “risk assessment” each time a salary increase is considered, or a short- or long-term incentive plan is adopted or modified, management and boards consider the risks associated with their actions, or lack of action. But in the old days, the considered risk was how decisions would impact the company, its operating results and stockholders. Now boards are confronted with the added risk of how regulators, legislators and the public will view their decisions, today and tomorrow, with the added benefit of 20-20 hindsight.
Debate continues as to whether Wall Street and its regulators had the proper controls to manage risk. However, it was aggressive business plans, approved by directors, which led to the highly-leveraged positions fatal to some firms. Compensation programs implemented to support such business plans were not the drivers of risk, but rather were designed to incent plan achievement.
Ironically, Wall Street has been down this road before. About twenty years ago, Wall Street recognized the high risk to shareholders if executives were paid solely in cash for short-term results achieved in a manner detrimental to the long-term success of the firm. Sound familiar? In response, Wall Street firms began to pay part of annual bonuses in shares subject to future price fluctuations. Therefore, if an individual earned an annual bonus through actions that were not in the best interests of customers, those customers would leave and, as the business suffered, so would the stock price on shares held by executives.
Additionally, such deferred payouts served as a retention tool, as well as creating significant ownership and shareholder alignment. It is clear from the losses realized by executives at Bear Stearns and Lehman Brothers that there was significant “skin in the game,” a fact that should have counterbalanced any desire to take risky positions only to generate short-term payments. Sometimes businesses make bad decisions, and pay has nothing to do with it. Given the investment these employees had in their firms, it is difficult to believe how compensation plans alone created a high risk culture.
Let’s be clear – risk assessment should be an important part of every pay-related decision made by compensation committees. Specifically, assessment should focus on:
– Whether performance goals are fair and reasonable in light of past performance, market conditions and the competition. Are they based on a thorough review process by the full board that defines the pay for performance range from minimally acceptable to exceptional?
– Consideration of unintended consequences. Could the pay program create an incentive for behavior that rewards executives, while detrimental to the company and its shareholders? Has the probability of a black swan been considered?
– Will the compensation program address the often unmentioned risk that the firm may not be able to attract, retain and motivate executives essential to the firm’s success?
– Are currently accepted “best practices” considered in the design? If not, why not? Unfortunately, to complicate the issue, there are examples of “old” best practices that are now viewed negatively.
– Is the program sufficiently flexible to permit the compensation committee to recognize and adjust for special situations that, left ignored, could either create undeserved windfalls or penalize executives unfairly?
The events of the last two years have been tragic from a business and stockholder viewpoint. The fact that many employees of impacted companies were recipients of very large pay packages prior to the market collapse certainly provides blame-seekers with a terrific target. Unfortunately, with the benefit of hindsight, the cause of the downfall is not compensation-related, but rather, poor business decisions driven by risky business strategies. Decisions to take on increasing levels of risk were pushed by investors and analysts focused on short-term growth, earnings and stock gains with little concern for the risk profile necessary to achieve the desired performance.
But, one must consider the fates of management and boards who resisted the push. Their lack of relative performance would certainly have doomed their tenure given market demands for ever higher earnings and stock price. Lest we forget, although it is true that the last several years saw high investor gains mirrored by huge pay packages, we also saw dramatically shorter tenures, particularly at the most senior levels as boards quickly replaced “non-performers.”
There are undoubtedly many reforms to be considered as boards work to rebuild shareholder confidence, and assuring that pay programs continue to support business strategy is certainly one of them. But it is foolish to believe that a new, elaborate exercise that considers pay and related risk is a new approach that will magically avoid past mistakes. This process has been firmly entrenched in the work of compensation committees for many years. The real need is for recognition that engaged board oversight of rigorous business planning, including risk assessment, will serve to avoid the mistakes of the past far better than a more complex compensation process.
Yesterday, the SEC voted 3-2 to approve the NYSE’s proposal to amend Rule 452 (and Listed Company Manual Section 402.08) to eliminate broker discretionary voting for director elections. The amendment to Rule 452 will be applicable to meetings held after January 1, 2010 (but won’t apply to a meeting that was originally scheduled to be held in 2009 if adjourned to a date after January 1st).
As I’ve mentioned before, in my opinion, this change is the biggest of the reforms that companies face – bigger than proxy access, say-on-pay, etc. Here is the SEC’s press release addressing all of its actions yesterday – and here is Chair Schapiro’s opening remarks (and Commissioners Walter’s statement and Aguilar’s statement).
Commissioners Casey and Paredes opposed the proposal, both stating that the broker nonvote issue should be considered in the broader context of rejiggering the proxy process (read “proxy access”) as well as examining more completely the impact of this change on companies. In his opening remarks, Commissioner Paredes noted they weren’t alone – 93 comment letters (out of a total of 136) also urged a comprehensive review of the proxy system. They also expressed concerns that the change would disenfranchise retail holders at the expense of more control by institutional investors.
Since all the other Commissioners agreed with the importance of studying the proxy system’s “plumbing,” near the end of the meeting, Chair Schapiro stated that the SEC would conduct this type of review later this year. I see roundtables in our future. If interested in reviewing “live tweets” that occurred during the meeting, see @footnoted and @simonbillenness.
Oh, boy! Check out today’s front-page article from the Washington Post about how the SEC was warned in ’04 by a SEC Staffer about Madoff – but yet the SEC didn’t follow up. And that Staffer’s boss ended up marrying Madoff’s niece. The article is quite in-depth and is likely to result in more headaches for the SEC. I’ll cover this more extensively next week.
The Surprise: SEC Proposes Expedited Disclosure of Voting Results
Although most of the SEC’s big open Commission meeting went as telegraphed by earlier statements by the SEC Chair, there was one big surprise. The SEC proposed a new Form 8-K requirement for companies to disclose the results of a shareholder vote within four business days after the end of the meeting at which the vote was held (in contested elections, the final results would be permitted to be delayed under certain circumstances).
As I’ve complained before, the current disclosure standard doesn’t elicit voting results for weeks – or sometimes months – after the vote, which doesn’t really work in today’s more competitive annual meeting environment.
Not a Surprise: SEC Proposes Say-on-Pay for TARP Recipients
Not surprisingly, the SEC also proposed rules – by a 5-0 vote – that would help implement Section 111(e) of EESA to permit an annual advisory non-binding shareholder vote on executive compensation. The SEC’s proposal clarifies how these requirements apply to TARP recipients in the form of new Rule 14A-20. The SEC has already posted the proposing release for this one; could be record time for that. Here is Corp Fin’s opening statement.
During the open Meeting, it was pointed out that – outside of the EESA mandate – the SEC Staff has allowed the inclusion of say-on-pay proposals. Commissioner Casey note that she only supported this proposal because it was required under EESA.
SEC Proposes Changes to Executive Compensation Disclosure Rules
No surprises here either. As expected, the SEC proposed amending Item 402 of Regulation S-K as follows (here is Corp Fin’s opening statement):
– Broader CD&AS to cover risk – provide information about how a company’s overall compensation policies create incentives that can affect the company’s risk – and the management of that risk, including policies for employees generally, including non-executive officers. Such disclosure would only be required if the risks arising from those compensation policies may have a material effect on the company. The SEC did not propose any requirement that would not require the disclosure of specific salaries of any individuals beyond those already required.
– Improved reporting of stock and option awards – revise way in which stock and option awards are reported in the Summary Compensation Table and Director Compensation Table so that it’s based on the award’s fair value on the grant date. This would reverse the December ’06 “surprise.”
– More disclosure about compensation consultants – in an effort to allow shareholders to evaluate potential conflicts, require disclosure about compensation consultant fees and services (and their affiliates) when they play any role in determining the amount or form of compensation for executives and directors, but only if those consultants (or their affiliates) also provide other services to the company.
In his “Proxy Disclosure Blog,” Mark Borges provided in-depth analysis of the proposals yesterday.
SEC Proposes More Corporate Governance Disclosures
Finally, the SEC proposed a few governance disclosure enhancements, including revising Item 401 of Regulation S-K to require more disclosure about each director’s particular experience, attributes and skills that are appropriate for the person to serve as a director and as a member of any committee to which the person is appointed; extend the disclosure of the director’s board memberships to the past 5 years; and expand disclosure of legal proceedings to the prior 10 years.
In addition, the SEC proposed requiring disclosure of why the board selected a particular management/leadership structure, particularly why the board chose to combine or separate the board chair and CEO positions. Although not proposed, the SEC’s proposing release will solicit comments about whether the SEC should require disclosure about director diversity, including whether diversity is a factor considered when nominating director candidates.