– Jim Reda and David Schmidt, James F. Reda & Associates
There have been substantial changes reported by companies in their 2009 proxy statements following an unprecedented drop in stock prices. In our recent study of 200 of the largest companies (by market capitalization) that comprise the S&P 500 Stock Index we reviewed “forward looking” statements with regard to changes in 2009.
Surprisingly, 70 percent of companies reported changes to their 2009 executive compensation programs. These range from “minor changes” relating to salaries to “major changes” relating to short and long-term incentive programs. We also reviewed changes to severance, retirement and perquisites programs. In our study, we reviewed each proxy statement for a description of prospective changes for 2009 in response to the economic downturn and increased shareholder scrutiny.
Executive compensation program changes reported for 2009 appear to be primarily related to the stock price drop from December 31, 2007 to February 28, 2009. The greater the drop in stock price, the more likely it is that a company reported a change to their program. This relationship also applies to each element of compensation.
To assist in our study, we categorized changes as “minor” or “major”. Minor changes are related to adverse salary changes. Major changes primarily relate to short- and long-term incentive plans, but we have also included changes to severance, retirement and perquisite programs in this category as well.
In general, incentive plans have changed as follows:
– A shift away from long-term incentives to include more focus on short-term incentive plans;
– Short-term incentive (“STI”) plan performance measures shifted to profit and cash flow from capital efficiency and non-financial performance goals;
– Long-term incentive plan performance measures shifted to capital efficiency, cash flow and total shareholder return; and
– Companies are increasing their emphasis on time-vested restricted stock (“RS”) and restricted stock units (“RSUs”).
Specifically, a substantial majority (70 percent) of companies that filed proxy statements disclosed changes to their executive compensation programs effective in 2009 that will impact pay levels reported in next year’s proxy. Highlights of the changes are as follows:
– Base Salary: Eliminated merit increases for 2009 (43 percent) and froze or reduced base salaries for 2009 (13 percent);
– Short Term Incentives: Adjusted short-term incentive program (e.g., move to discretionary plans, changes to Pay for Performance Curve- the relationship between threshold, target or maximum performance levels and the corresponding threshold, target or maximum payout levels).
– Long Term Incentives: Adjusted long-term incentive grants (e.g., awarding the same number of shares regardless of value, decreasing the value of awards, changing the mix of award types, and changes to Pay for Performance Curve) (39 percent); and
– Other Elements of Compensation: Changed various other elements of compensation (e.g., modifying change-in-control (“CIC”) benefits, eliminating tax gross-ups on perquisites, reducing retirement benefits) (15 percent). Modified CEO’s change-in-control benefits (e.g., reducing the severance multiple) (4 percent).
In summary, our findings show:
(i) Greater focus on short-term cash flow results which is counter to the direction suggested by the U.S. Treasury, academics and other expert advisers regarding ways to mitigate risk, which is to encourage a long-term perspective by subjecting more compensation to stock price risk; and
(ii) More reliance on restricted stock and restricted stock units which is not performance-based as it vests simply with the passage of time.
We suggest that companies consider:
(a) Rebalancing their short- and long-term incentive target opportunity levels which may result in (x) a reduction of STI levels, or (y) a combination of reduction of STI levels and a slight increase in LTI levels;
(b) Change the LTI mix away from restricted stock (or units) to a more performance-based award program; and
(c) Revise the pay for performance curves for both short- and long-term incentive plans by reducing maximum payout levels.
These changes collectively will better align corporate risk, corporate performance and executive pay.
Yesterday, in a sternly-worded 12-page order, US District Court Judge Jed Rakoff’s refused to approve a $33 million settlement between the SEC and Bank of America over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed. As this Bloomberg article notes, even though a February 1st trial is scheduled, the SEC has limited options now because it argued before Rakoff that that there was insufficient evidence to charge individuals. The SEC’s best bet may be to dismiss the case and file an administrative claim that wouldn’t be heard in federal court.
The following excerpt from this NY Times article gives you a sense of how Judge Rakoff felt about the settlement:
He accused the S.E.C. of failing in its role as Wall Street’s top cop by going too easy on one of the biggest banks it regulates. And he accused executives of the Bank of America of failing to take responsibility for actions that blindsided its shareholders and the taxpayers who bailed out the bank at the height of the crisis.
The sharply worded ruling, which invoked justice and morality, seemed to speak not only to the controversial deal, but also to the anger across the nation over the excesses that led to the financial crisis, and the lax regulation in Washington that permitted those excesses to flourish.
Implicit in the judge’s remarks were broader questions on the anniversary of one of the most tumultuous weeks in Wall Street’s history: What do the giants of finance owe their shareholders and the investing public? And who will adequately oversee these behemoths?
As the drama of this case continues to unfold, Bank of America awaits the findings of NY Attorney General Andrew Cuomo as some expect him to file a complaint charging individuals at Bank of America in connection with the disclosure of Merrill Lynch bonuses in the near future.
Obama Speaks on Lehman’s Collapse Anniversary: Latest Timetable for Congressional Reform
Yesterday, President Obama was also stern as he delivered a speech near Wall Street in which he talked about the need for financial reform. As noted in this NY Times article, the window for true reform is quickly closing as the stock market climbs every day. Below is an excerpt from that article about the possible timeline for Congress taking legislative action:
Senior Congressional Democrats had originally planned to have the House complete its work on the financial overhaul before turning to the more recalcitrant Senate. But the tighter time schedule has forced lawmakers to rethink that approach.
Later this week, Barney Frank, Democrat of Massachusetts and the chairman of the House Financial Services Committee, is expected to announce a series of hearings for the coming days before his committee marks up legislation in October. Aides say he is hoping to get legislation to the floor by the end of next month or beginning of November.
There is less certainty in the Senate, where Christopher J. Dodd, Democrat of Connecticut and the chairman of the Senate Banking Committee, has been working to put together a package that could withstand the threat of a filibuster.
In the furious activity over the past few days, it’s easy to understand why many in Congress have demanded new measures for restraints on executive pay. The measures would give regulators the authority to prohibit “inappropriate” or “risky” compensation practices for banks or other regulated financial institutions. From a perception standpoint, this opens the door for overall government regulation of executive compensation.
Representative Spencer Bachus III (R – Alabama) stated that “doing something about executive compensation would be very popular with the American people”. No surprise here – in the eyes of the American public, many of the same executives whose compensation is to be “restrained”, are those currently leading the effort to get the diversified financial industry sector back on its feet, and, in their eyes, are the very same “masters of the universe” whose greed and myopia brought the sector, and, subsequently our country, to its knees in the first place.
Nonetheless, the decision of Congress last week to impose some form of still unspecified executive pay limits, is a mistake.
At this very moment, it’s a valiant struggle for many of you to keep a straight face when reading the words “talent”, “banking”, “auto industry”, and “Wall Street” in the same sentence. And yet, precisely because Wall Street, banking, automobile manufacturing, and many other industry sectors are currently a trainwreck, Corporate America will desperately need scores of simply brilliant, hard working executives and key employees, if it is to return to a state of financial health that benefits the rest of the economy.
The sort of sums that would satisfy Congress as “executive pay caps” may be far above the income levels of average Americans, but if artificial caps are put into place, there will be no surer way of driving American industry sectors offshore, or into other forms of private ownership where they will be beyond the gaze of regulators. Besides, if ever there was a time when executive pay in financial services, maufacturing, and in general industry overall is likely to be depressed by the market, it is now. The past financial bubble didn’t only inflate asset and stock prices, but, as a result of often flawed executive pay plan design that was largely equity-based, it also inflated pay. Now that bubble has burst in an unprecedented and ugly way, and millions of people want work.
As in the past, U.S. politicians have a lamentable record of intervening in setting executive pay. Too soon we forget that in the early years of the Clinton administration, Congress imposed IRS 162(m), a salary cap of $1 million, beyond which companies faced a tax penalty for any pay above the cap that wasn’t “performance-based”.
Executive pay rose as CEOs beneath the cap, realized that they might be “underpaid”, and another set of executives gained from an outpouring of creativity, as companies, with a great deal of help from (mea culpa) executive pay consultants invented myriad types of short- and long-term incentive plans get around the limit. This not only complicated an already confusing situation, it also made it harder for shareholders to know who was getting what, when, and most importantly, why.
If the “deja vu all over again” foolishness of Congress trying to set and regulate executive pay levels is an old lesson, the financial crisis is teaching some new lessons to shareholders. Forget the conventional wisdom that paying executives large grants of stock options or restricted stock in their own companies ensures “skin in the game”, thus driving sensible risk-taking and maximum shareholder value decision-making. In the collapses of Lehman Brothers and Bear Stearns, senior management didn’t just take reckless gambles with other people’s money. Dick Fuld and Jimmy Cayne took reckless gambles with their own, still failed to do the right things, consequently ended up losing everyone’s money, as well as most of their own fortunes. Public company shareholders, institutional investors, and watchdogs should remember that loading up top executives with shares can certainly be an aid to corporate governance, but not a substitute for it.
For executives and employees alike, the tales of Lehman Brothers, Washington Mutual, Merrill-Lynch, AIG, Countrywide, and other catastrophic corporate failures, especially after meltdowns of the past like Enron, Tyco, Global Crossing, the whole “.com bust”, etc., is a reminder of the danger of having too much capital tied up in the company where you work. Additionally, it clearly magnifies the need for a “balanced portfolio” of well designed executive pay vehicles that are both operationally and market driven. Many more truly talented executives and key employees will now demand their short- and long-term incentives in cash, and, perhaps ask for even more shares. That surely will have an effect on the way that companies recruit key employees and on equity-based executive pay in general. And, hopefully, the concept that forcing significant equity-based stakes on executives in their own companies as a means to stop bad decision making has finally been put to rest.
A strong message to Congress – the design and payout structure of executive pay programs is far more important than the amount — especially in troubled industry sectors. For Wall Street and banking, and financial services industry executives, foolish short-term risk-taking could be discouraged by matching the timing and payout of executive compensation to the achievement of performance metrics for the companies and portfolios they are responsible for. And, if we’re going to collect “bailout capital” from the taxpayers, we ought to insure that there is adequate return on invested capital to them, as well as any of our stakeholders, and link those successes directly to executive pay – without guarantees of wealth in spite of failure at the detriment of both employees and shareholders.
Congress can certainly ask that financial institutions, or any other business that has accepted bailout funding, to put up more capital if their executive pay structures appear to be dangerously risky. They have to be able to fund bonuses like any other business. That makes far more sense than “capping” executive pay.
In the end, companies, their Boards of Directors, and their shareholders are far better at setting executive pay than government bureaucrats will ever be. There will never be adequate fixes to executive pay in any industry sector – public or private – as long as there are guaranteed “Golden Parachutes”, or any other risk-free contractual provisions that allow executives to bail out of a failing company while both employees and shareholders go down with the ship.
Candidly, what has created the highest degree of recent outrage in executive pay has been the captains of those sinking ships paddling away in their own comfortable lifeboats and thumbing their noses as their employees and shareholders went under.
Recently, Ed Durkin of the United Brotherhood of Carpenters reported that it has withdrawn its proposals for an alternative “triennial” say-on-pay process (the concept is explained in this blog), with the following explanation:
We made a decision that the best course of action to take was to withdraw the triennial pay vote proposal from the companies to which it was submitted. On balance, we felt that it would not be constructive to call the vote on the issue at this subset of companies in light of the status of the legislative process. We had good discussions about the pay vote issue and executive compensation generally with most of the companies, and a number of them offered to lend their voice to the effort to legislatively establish a triennial vote as outlined in the proposal. The Union is continuing to advocate for a triennial vote in Congress, with the recent TARP company say-on-pay votes providing solid evidence of the shortcomings of the say-on-pay vote formulation in HR 3269 (annual vote, vote on overall plan only, applied to all publicly-traded companies).
Following a trend commenced last year by Schering-Plough, industry rivals Lockheed Martin and Northrop Grumman recently posted shareholder surveys regarding executive pay on their websites. The principal idea behind these surveys is to provide a better avenue than say-on-pay for shareholders to weigh in on compensation (egs. shareholders can provide specific comments and the questions are more narrowly focused).
You may recall that I recently conducted a podcast with Susan Wolf of Schering-Plough regarding how the experience worked out for them this past proxy season. Schering-Plough intends to announce the results of its survey sometime during the next few months. Amgen also canvassed shareholders this past proxy season. We have compiled all these surveys in our “Say-on-Pay” Practice Area.
A Comparison of the Surveys
1. Posting Surveys Online – The two newest surveys are posted online – but Schering-Plough mailed their survey as part of their proxy materials (as noted in this press release). Amgen also posted its survey online. It will be interesting to see whether posting surveys increases – or decreases – shareholder participation. My guess is “increase” – but you never know (for example, note how e-proxy has resulted in a decrease in retail votes).
2. Evaluation of CD&A Transparency – To some degree, all of the surveys piggyback on TIAA-CREF’s list of ten questions for evaluating CD&As that was released back in August ’07 (in fact, Amgen’s survey is identical to TIAA-CREF’s survey). All of the surveys ask whether shareholders found their CD&As clear and useful and allow for five types of answers.
3. Tying Pay to Performance – The surveys ask whether shareholders think pay is tied to performance in slightly different ways. Lockheed Martin’s survey asks whether its executive pay as disclosed ties pay to performance and is aligned with shareholder value. Northrop Grumman’s survey asks whether its compensation play is aligned with the long-term creation of shareholder value. Schering-Plough asks whether its executive pay program is tied to performance and then also drills down with questions about specific performance metrics.
4. Does Pay Matter? – Northrop Grumman asks two interesting questions that the others do not: whether the shareholder analyzed the company’s pay policies and practices before becoming a shareholder and whether the company’s compensation plan was a material consideration in becoming a shareholder.
5. Retention and Mix of Equity – Schering-Plough was the only company to ask whether shareholders thought that the company’s pay plan allows it to attract and retain well-qualified executives, as well as ask questions about the mix of equity in both its executive’s and director’s pay.
6. Whether Shareholders Support Pay – Both of the newest surveys – Lockheed Martin and Northrop Grumman – cut to the chase and ask the $64,000 question: whether shareholders support the company’s compensation plan as described in the CD&A.
7. Additional Comments – All of the surveys allow for shareholders to submit their own comments, a smart move since the use of multiple choice answers can be limiting. Amgen’s survey doesn’t even provide an opportunity to select from a multiple choice menu – each question has a text box below it. I think providing multiple choice selections will increase the likelihood of obtaining more responses – as some potential respondents may be daunted by the burden of spending too much time on a survey.
Note that Northrop Grumman decided to also use its survey to solicit feedback on two non-compensation related matters: allowing shareholders to call a special meeting on any issue and if so, what minimum percentage of shares should be the threshold to do so.
– Dave Lynn, CompensationStandards.com and Morrison & Foerster
A recent article in the WSJ discussed two new academic studies that have focused on benchmarking practices at public companies. While the article tends to sensationalize the issue a bit, it does note how the studies highlight one of the principal failings of benchmarking, which is the way in which peer groups are selected. In particular, the studies appear to demonstrate a bias toward selection of peer companies with better paid CEOs, compounded by a trend noted in one of the studies that approximately 40% of the companies reviewed indicated that they paid their CEOs more than the median level of comparable pay.
In the article, the typical competitiveness arguments are noted in support of benchmarking. The article observes that these studies were made possible by the 2006 amendments to the executive compensation disclosure rules, which require disclosure of the list of peer companies when benchmarking is used.
Obviously this is not any breaking news; rather, what is noteworthy is that there is now some empirical support (which, of course, should always be taken for what it is worth and in consideration of its limitations) for some of the claims about benchmarking. It certainly helps to confirm what then-Corp Fin Director Alan Beller so eloquently said at our conference back in 2004:
“Too many boards have apparently operated on the principle that compensation must be in the top half or even the top quartile of some benchmark group (the basis of selection of which is often not disclosed) for the company to be competitive in attracting executive talent. (This principle apparently operates without regard to whether performance is commensurate to compensation). This approach produces what I have called the Lake Wobegon effect, where everyone is above average. Boards of directors ought to be able to do better than this.”
What can be done now, in light of this new evidence of the obvious? I think that one place to start is the useful guidance provided in the Obama Administration’s broad compensation principles announced in June, which call for developing an improved pay for performance paradigm that is less focused on external competitive positioning and more focused on relative performance of the company, achieved through a diversified set of performance criteria having an emphasis on long-term value creation.
On August 28th, Treasury issued these FAQs on the Interim Final Rule on TARP that it released back on June 15th. This memo sets forth our analysis of the effect of the FAQs, informed by informal conversations with Treasury, on a TARP recipient that repays its obligation prior to the deadline for forming a compensation committee.
By the way, check out our new “Say-on-Pay Resource Center,” which is intended as a convenient one-stop location for our client alerts, as well as legislative, regulatory and other materials on the topic. Thanks to the executive compensation team at Cleary Gottlieb – Brick Susko, Janet Fisher, Mary Alcock and Katie Sykes – for helping to man this fort!
On TheCorporateCounsel.net, we recently wrapped up our Quick Survey on “Corporate Airplane Use by Outside Directors.” Below are our results:
1. At our company, when it comes to allowing non-employee directors to use the company’s plane to travel to – and from – board meetings:
– Yes, we allow – but we disclose the aggregate incremental costs associated with such use as director perks in the Director Compensation Table – 1.0%
– Yes, we allow – but we believe such travel is for a business purpose and thus do not disclose it in the proxy statement – 60.8%
– Yes, we allow – but we believe such travel is for a business purpose and therefore only disclose that such travel is permitted in the narrative portion of the proxy statement – 12.4%
– Yes, we allow – but only a percentage of the amounts associated with such use is considered for a business purpose – so some of the cost is disclosed in the Director Compensation Table – 0.0%
– No, we don’t allow non-employee directors to fly on the company plane to our board meetings – 7.2%
– No, as a result of a recent change in our travel policy, we no longer allow non-employee directors to fly on the company plane to board meetings – 1.0%
– We don’t have a company plane – 17.5%
We just sent out the July-August 2009 issue of The Corporate Executive, along with a Special Supplement. This issue is devoted to in-depth analysis and practical guidance on the SEC’s proposed changes to the executive compensation disclosure rules, including:
– The SEC’s Proposed Changes – And their Effects
– The Relationship of Compensation and Risk
– A Broader Scope to the CD&A (But Only When Material)
– Revisiting Equity Award Disclosure – Some Welcome Relief
– A Troublesome Result – And a Fix
– Compensation Consultant Disclosure: An Interim Step?
– Other Important Areas Where Comment is Solicited – And Our Comments
– Walk-Away Disclosure and Analysis – A Heads Up
– Are You Recognizing Too Much Expense for Your ESPP?
– Limits Reduce Employee Returns
– Accounting Considerations
– Proxy Disclosure Updates – Full Walkaway Model CD&A
– Treasury’s Mark Iwry to Speak at 6th Annual Executive Compensation Conference
Subscribing to The Corporate Executive is now more important than ever, particularly given all of the changes contemplated with executive compensation and SEC disclosure requirements. In recognition of the need we are serving this year (and in view of the tight economic times), we are extending a special offer for new subscribers which will enable anyone to receive The Corporate Executive at no risk. If you sign-up now for 2010, you can get the July-August 2009 issue on a complimentary basis and the rest of 2009 for free.
– Dave Lynn, CompensationStandards.com and Morrison & Foerster
At the risk of saying anything about health care reform (lest I be attacked by an angry Town Hall-roving mob), I had not really considered the connection that may exist between the debate over health care and the debate over executive compensation until I saw these letters sent out last week by Representative Henry Waxman (D-CA) and Representative Bart Stupak (D-MI). Representative Waxman is, of course, the Chairman of the House Committee on Energy and Commerce, and Representative Stupak is the Chairman of that Committee’s Subcommittee on Oversight and Investigations.
The letters request that 52 health insurers provide five years of essentially Summary Compensation Table data for each employee or officer who was compensated more than $500,000 in any one of those years, as well as five years of compensation data for the board of directors. The letters also seek, among other things, information about company-paid outside conferences, retreats or events, company financial performance, documents used by the compensation committee in developing or applying compensation plans, and details about the companies’ health care insurance products. Some of the information must be provided by September 4 and some by September 14.
A number of the insurers are public, while others are not (including, e.g., a number of Blue Cross/Blue Shield systems), but in any event developing the compensation data and the other requested information will likely be quite a chore. The letters from Waxman and Stupak follow a letter from Representative John Dingell (D-MI) and Representative Sander Levin (D-MI) to Blue Cross Blue Shield of Michigan asking about executive compensation and a series of rate hikes.
It is not yet clear how the compensation and other information will be used by the Committee in the course of its deliberations on health care policy, or whether this is just a political move designed to demonize the insurance industry through the perennial hot button issue, compensation. I think that I will keep my thoughts on that topic to myself.
New Treasury and SEC Regulations and the ARRA: Executive Compensation Restrictions
We have posted the transcript from our recent webcast: “New Treasury and SEC Regulations and the ARRA: Executive Compensation Restrictions.”