– Broc Romanek, CompensationStandards.com

As discussed in Sullivan & Cromwell’s latest memo on the topic, the banker bonus tax imposed in the United Kingdom continues to be a hot topic. This Business Week article analyzes how the banker bonus topic is a key issue in the upcoming election in the UK…

– Broc Romanek, CompensationStandards.com

With Congress moving quickly on financial regulatory reform, huge changes are afoot for executive compensation practices and the related disclosures – that will impact every public company. We are doing our part to help you address all these changes – and avoid costly pitfalls – by offering a special early bird discount rate to help you attend our popular conferences – “Tackling Your 2011 Compensation Disclosures: The 5th Annual Proxy Disclosure Conference” & “7th Annual Executive Compensation Conference” – to be held September 20-21st in Chicago and via Live Nationwide Video Webcast (both of the Conferences are bundled together with a single price). Here is the agenda for the Proxy Disclosure Conference.

Special Early Bird Rates – Act by Tomorrow April 15th: Register by April 15th to take advantage of this discount.

– Broc Romanek, CompensationStandards.com

Below is an excerpt from this Akin Gump memo, based on their survey on recent risk oversight disclosures:

To assess the types of disclosures that companies are providing about the board’s role in overseeing risk management, we reviewed preliminary or final proxy statements filed by 50 randomly selected S&P 500 companies since the February 28, 2010 effective date of the new disclosure rules. The results of our survey, categorized by the various types of disclosures, are set forth below.

Separate Section Devoted to Risk Oversight

Ninety-two percent of surveyed companies had a designated section in their proxy statements for risk oversight. This section typically stood alone, but sometimes was combined with the section addressing board leadership structure. Typically, the section was located in the portion of the proxy statement discussing corporate governance matters and was often titled “The Board’s Role in Risk Oversight” (or words of similar effect).

Statements about Management’s Primary Risk Management Responsibility

Twenty-four percent of surveyed companies included a statement to the effect that management is primarily responsible for risk management, while the board’s role is one of oversight.

Sample disclosures are set forth below:

Sunoco, Inc.: “Management of risk is the direct responsibility of the Company’s CEO and the senior leadership team. The Board has oversight responsibility, focusing on the adequacy of the Company’s enterprise risk management and risk mitigation processes.”

Peabody Energy Corporation: “Management is responsible for the day-to-day management of the risks we face, while the Board, as a whole and through its committees, has responsibility for the oversight of risk management.”

AT&T Inc.: “Assessing and managing risk is the responsibility of the management of AT&T. The Board of Directors oversees and reviews certain aspects of the Company’s risk management efforts.”

Strategic Direction

Forty-two percent of surveyed companies explained that oversight of risk management was an important or integral part of the board’s role in the strategic planning process.

Several illustrative examples are set forth below:

Valero Energy Corporation: “The Board also believes that risk management is an integral part of Valero’s annual strategic planning process, which addresses, among other things, the risks and opportunities facing Valero.”

Stryker Corporation: “A fundamental part of setting the Company’s business strategy is the assessment of the risks the Company faces and how they are managed.”

Bristol-Myers Squibb Company: “Our Board meets regularly to discuss the strategic direction and the issues and opportunities facing our company in light of trends and developments in the biopharmaceutical industry and general business environment. Our Board has been instrumental in determining our strategy to combine the best of biotechnology with pharmaceuticals to become a best-in-class next generation biopharmaceutical company. Throughout the year, our Board provides guidance to management regarding our strategy and helps to refine our operating plans to implement our strategy. Each year, typically during the second quarter, the Board holds an extensive meeting with senior management dedicated to discussing and reviewing our long-term operating plans and overall corporate strategy. A discussion of key risks to the plans and strategy as well as risk mitigation plans and activities is led by the Chairman and Chief Executive Officer as part of the meeting. The involvement of the Board in setting our business strategy is critical to the determination of the types and appropriate levels of risk undertaken by the company.”

Enterprise Risk Management

Fifty-four percent of surveyed companies expressly used the term “enterprise risk management.”

Sample disclosures are set forth below:

American Express Company: “The Company relies on its comprehensive enterprise risk management process (ERM) to aggregate, monitor, measure and manage risks. The ERM approach is designed to enable the Board of Directors to establish a mutual understanding with management of the effectiveness of the Company’s risk management practices and capabilities, to review the Company’s risk exposure and to elevate certain key risks for discussion at the Board level. The Company’s ERM program is overseen by its Chief Risk Officer who is an executive officer of the Company and a member of the Company’s most senior management.”

Express Scripts, Inc.: “In order to assist the board of directors in overseeing our risk management, we use enterprise risk management (“ERM”), a company-wide initiative that involves the board of directors, management and other personnel in an integrated effort to identify, assess and manage risks that may affect our ability to execute on our corporate strategy and fulfill our business objectives. These activities entail the identification, prioritization and assessment of a broad range of risks (e.g., financial, operational, business, reputational, governance and managerial), and the formulation of plans to manage these risks or mitigate their effects.”

Primary Responsibility at Board vs. Committee Level

Eight percent of surveyed companies stated that the primary responsibility for risk management oversight rests with the entire board, 34 percent of surveyed companies stated that primary responsibility is vested in one or more committees and 52 percent reflected that both the board and various committees have responsibility for risk management oversight.

Of those companies where primary responsibility is vested in one or more committees, 65 percent (22 percent of all surveyed companies) identified their audit committees as having primary responsibility, 18 percent had a separate committee expressly dedicated to risk management (all of these companies were in the financial services or insurance industries) and 18 percent stated that various board committees were responsible for overseeing the management of risks relating to the committee’s primary areas of responsibility.

Regardless of where primary responsibility rested, over half of the surveyed companies included descriptions of the specific types of risks that various committees of the board oversee.

Compensation Committee Responsibility for Determining Compensation Risk Disclosure

As discussed above, the new SEC disclosure rules require companies to discuss their compensation policies and practices for employees as they relate to risk management practices and risk-taking incentives if the risks arising from those policies and practices are reasonably likely to have a material adverse effect on the company. The new rules do not require a company to include any disclosure if the company has determined that the risks arising from its compensation policies and practices are not reasonably likely to have a material adverse effect.

RiskMetrics has announced that it does not take a position regarding whether companies should disclose their risk determinations where the company has determined that a material adverse effect is not reasonably likely. RiskMetrics does, however, advise companies “at a minimum” to discuss their process in reaching a determination and any mitigating features (such as clawbacks or bonus banks) that they have already adopted. RiskMetrics views this disclosure “as an opportunity for communication, not simply compliance” and expects that shareholders will be looking for a reasonably substantive discussion of the board’s process for determining whether the company’s incentive pay programs motivate inappropriate risk-taking and what they are doing to mitigate that risk.

Our survey shows that many companies elected to provide disclosure about their compensation risk determinations and the process the company undertook to make the determination.

– Compensation Committee Responsibility to Assess Risks. Sixty-eight percent of surveyed companies stated that their compensation committee was charged with either determining that the compensation policies and practices do not encourage excessive risk-taking or determining whether the risks arising from such policies and practices are reasonably likely to have a material adverse effect on the company.

– Disclosure of Determination. Seventy-four percent of surveyed companies expressed a determination that their compensation policies and practices either did not encourage excessive or unnecessary risk-taking (or used words of similar effect) or were not reasonably likely to result in a material adverse effect on the company. Of the 37 companies that disclosed a determination, 17 of them (46 percent) phrased their conclusion in terms of the absence of a material adverse effect, 15 companies (41 percent) expressed their conclusion in terms of not encouraging excessive or unnecessary risk-taking and the remaining companies phrased their conclusions in terms of a determination of an “appropriate level of risk-taking” or an “effective balance of risk and reward” or words of similar effect.

– Who Made the Determination. Companies varied widely as to who made the risk determination regarding compensation programs and policies. Twenty-three companies (62 percent of those disclosing the determination) stated that the determination was made by the compensation committee, 10 companies (27 percent of those disclosing the determination) phrased the determination as being made by the company or “we” and, in the remaining instances, “management” made the determinations.

– Process for Determination. Sixty-five percent of those companies disclosing a risk determination provided disclosure of the process that the company or compensation committee undertook to make the determination.

– Location of Determination. Companies varied widely on the location of the disclosure in their proxy statements. Almost half of the companies included the disclosure in Compensation Discussion and Analysis. Other popular disclosure locations included under a separate heading in the corporate governance section, in the discussion of board oversight of risk or under a separate heading near discussions of compensation committee interlocks and compensation consultants.

– Risk-Mitigating Features. Regardless of whether a company disclosed a risk determination with respect to its compensation policies and practices, almost three-quarters of the surveyed companies discussed various features of their compensation programs and policies that are designed to mitigate excessive risk-taking.

The following excerpt from Kraft Foods’ proxy statement discusses the compensation committee’s process in evaluating compensation risks, risk-mitigating features contained in the company’s compensation policies and practices and the conclusion of the compensation committee with respect to such risks:

“Analysis of Risk in the Compensation Architecture

In 2009, the Human Resources and Compensation Committee evaluated the current risk profile of our executive and broad-based compensation programs. In its evaluation, the Human Resources and Compensation Committee reviewed the executive compensation structure and noted numerous ways in which risk is effectively managed or mitigated. This evaluation covered a wide range of practices and policies including: the balance of corporate and business unit weighting in incentive plans, the balanced mix between short-term and long-term incentives, caps on incentives, use of multiple performance measures, discretion on individual awards, a portfolio of long-term incentives, use of stock ownership guidelines, and the existence of anti-hedging and clawback policies. In addition, the Human Resources and Compensation Committee analyzed the overall enterprise risks and how compensation programs impacted individual behavior that could exacerbate these enterprise risks. The Human Resources and Compensation Committee collaborated with the Audit Committee in this analysis. Additionally, we engaged an outside independent consultant to review our incentive plans (executive and broad-based) to determine if any practices might encourage excessive risk taking on the part of senior executives. The outside consultant noted several of the practices of our incentive plans (executive and broad-based) that mitigate risk, including the use of multiple measures in our annual and long-term incentive plans, Human Resources and Compensation Committee discretion in payment of incentives in the executive plans, use of multiple types of long-term incentives, payment caps, significant stock ownership guidelines, and our recoupment and anti-hedging policies. In light of these analyses, the Human Resources and Compensation Committee believes that the architecture of Kraft Foods’ compensation programs (executive and broad-based) provide multiple, effective safeguards to protect against undue risk.”

Reporting Processes

As previously discussed, the SEC suggested in the adopting release that, where relevant, companies disclose in their proxy statements whether the officers responsible for risk management report directly to the board or to a board committee or how information is otherwise received from such persons. Thirty-eight percent of surveyed companies identified their principal risk officer or officers by title and disclosed that the officer or officers reported directly to the board or a board committee.

Frequency of Entire Board Review

One-third of surveyed companies reported that the full board reviews risk management at least annually, 22 percent stated that the full board reviews risk management issues “periodically” or “regularly” and a few companies reported quarterly or semiannual reviews by the entire board.

Length of Disclosure

Most companies devoted at least two or three paragraphs to their discussion of the board’s role in risk oversight. The average length of the disclosures was 10 sentences, with the length of the discussion ranging from a high of 27 sentences to a low of three sentences. These numbers do not reflect any specific discussions of risks relating to compensation policies and practices or factors mitigating those risks.

Effect of Board’s Role in Risk Oversight on Leadership Structure

Only 20 percent of the surveyed companies specifically addressed the effect of the board’s role in risk oversight on the board’s leadership structure. Instead, most companies simply stressed in the discussion of their leadership structure the role that a lead director or the independent directors play in providing strong, effective oversight of management.

Set forth below are disclosures by several companies that expressly addressed the matter:

IBM: “The Board’s role in risk oversight of the Company is consistent with the Company’s leadership structure, with the CEO and other members of senior management having responsibility for assessing and managing the Company’s risk exposure, and the Board and its committees providing oversight in connection with those efforts.”

Teco Energy: “We believe that our Board leadership structure promotes effective oversight of the company’s risk management for the same reasons that we believe the structure is most effective for our company in general, that is, by providing unified leadership through a single person, while allowing for input from our independent Board members, all of whom are fully engaged in Board deliberations and decisions.”

The Coca-Cola Company: “The Company believes that its leadership structure, discussed in detail [above], supports the risk oversight function of the Board. While the Company has a combined Chairman of the Board and Chief Executive Officer, strong Directors chair the various committees involved in risk oversight, there is open communication between management and Directors, and all Directors are actively involved in the risk oversight function.”

– Ted Allen, RiskMetrics

Here is something I recently blogged: At Waddell & Reed Financial’s annual meeting on Wednesday, investors will consider a shareholder proposal that seeks an annual advisory vote on executive compensation.

The Kansas-based investment services company has taken the unusual step of including a special solicitation with its proxy statement to oppose the proposal. The resolution is sponsored by Boston Common Asset Management, the California State Teachers’ Retirement System, and Calvert Asset Management. In a March 5 letter to shareholders, CEO Henry Herrmann warned that adoption of this reform would put the company “at a serious competitive disadvantage and could erode the value of your investment.”

While more than 60 U.S. issuers, including JPMorgan Chase, Wells Fargo, and Goldman Sachs, have agreed to hold voluntary pay votes, Waddell & Reed argued that advisory votes would lead to a “loss of executive talent” and would not result in “meaningful dialogue with shareholders.”

Last year, the company initially reported that a “say on pay” proposal received majority support; the company later petitioned a Delaware judge for permission to count additional votes, which pushed the support level below 50 percent. Pay vote proponents have been surprised by the company’s efforts to oppose this resolution.

“Waddell & Reed is one of the outliers in its aggressive campaign against this important reform, and that concerns us as shareowners,” said Dawn Wolfe, associate director of ESG Research at Boston Common.

Here is an update since I wrote the above: According to Dawn Wolfe of Boston Common Asset Management, Waddell & Reed did not disclose preliminary vote results at the meeting or indicate that the proposal passed or failed. Most companies usually indicate whether a proposal passed or failed at the meeting. Under the new SEC disclosure rules, Waddell had to disclose results within 4 business days in a Form 8-K, which it did on Friday.

– Fred Whittlesey, Hay Group

Following up on Broc’s recent blog on semiannual bonuses, we should remember that a lot of technology companies have had shorter incentive compensation cycles for many years and the practice appears “indefinite.” This is a fairly common practice for technology companies with roots going back to the early days of Silicon Valley culture, the quarterly “cash profit sharing” plans. The founders would gather all employees together at the end of every quarter in the employee cafeteria and pass out the quarterly bonus checks one by one. The system has matured a bit over time but the quarterly and semi-annual basis remained.

So, while this is “news” for some of the traditional industries, it’s old news in the tech sector. (My colleague in our Retail Sector practice notes that semiannual incentive plans have been common in that sector as well, due to the spring/fall cycles for many retailers.)

Messrs. Feinberg and Bebchuck should take a total pay perspective and realize that in some companies the same employees who are purportedly incented to “cut corners” also have a large portion of their pay in stock-based compensation, more so than executives in some companies. There might even be a correlation between these “awful” compensation practices and the high levels of innovation that have brought us the iPod, iPhone, Amazon.com, Google, broadband internet access, wifi, Twitter, Facebook, LinkedIn…the list goes on.

Just a little history for context in this discussion.

– Broc Romanek, CompensationStandards.com

We have posted the transcript for our recent webcast: “What the Top Compensation Consultants Are NOW Telling Compensation Committees.”

– Broc Romanek, CompensationStandards.com

While I was on vaca last week, John Plender wrote the following column – entitled “To avoid a backlash, executives must act on pay” – in the Financial Times that I thought was noteworthy (note the internal pay equity ratios provided):

Richard Lambert, director-general of the Confederation of British Industry, drew attention this week to a very inconvenient truth: that the chief executives of the UK’s 100 largest companies will, according to Income Data Services, have earned 81 times the average pay of full-time workers in 2009. This is up from 47 times the average wage in 2000. While performance has no doubt improved at many of these organisations over the period, it is hard to see how pay increases on this scale could possibly be justified.

Yet this differential is dwarfed by that in the US, where the Institute for Policy Studies estimates that in 2008 top executives earned 319 times more than average US workers. That compares with the benchmark of 20 times that Peter Drucker, the great management guru, thought sensible. In both countries income inequality and corporate profits as a percentage of gross domestic product have recently touched their highest levels since 1929, a year in which the Jazz Age gave way to a financial crisis second only in historical impact to the one we have just experienced.

Meanwhile, another inconvenient truth has emerged at Kraft Foods, where chief executive Irene Rosenfeld was awarded a 41 per cent pay increase to $26.3m partly on the basis of her performance in acquiring Cadbury through a hostile bid. Given that a majority of takeovers fail to work and the widespread suspicion that Kraft could suffer a “winner’s curse” for overpaying, this looks objectively crazy.

It also suggests the Kraft board has learnt little from the banking crisis, despite having a compensation committee led by Ajay Banga, a banker from Citigroup. One of the big lessons was that rewards should be related to the period over which returns are earned and that, if upfront payments have to be made, they should at least be subject to a clawback.

All this comes against the background of a growing political backlash against bankers’ bonuses on both sides of the Atlantic. This may be populist, but it is based on yet another inconvenient truth. We now know that much of the profit on which bank bonuses were based before the crisis was fictional. Much of the phenomenally high return on equity that did exist arose from banks riskily shrinking their equity capital rather than boosting the return on assets.

At the same time, academics Thomas Phillipon and Ariell Reshef estimate that 30 to 50 per cent of the wage differential between the US financial sector and the rest of the private sector comes from rent-seeking – the economist’s euphemism for ripping off customers in opaque and inadequately competitive markets. This is probably also true of the UK.

Mr Lambert rightly fears that the hostile perceptions of a public that is paying for bank bail-outs will rub off on the wider business community so that wealth creation is damaged. Society’s tolerance for high levels of inequality is also being tested to destruction. In a country such as China, the current very high level of inequality is just about tolerable on the basis of real growth rates of 10 per cent or more. In debt-sodden developed countries facing years of low growth as balance sheets are rebuilt, the political consequences could be much more harsh. So where do we go from here?

Some natural corrective mechanisms are at work in both the political marketplace and the economy. High levels of profit will come down as anti-business sentiment prompts heavy-handed regulation and increased taxation, causing animal spirits to flag. It is possible that labour will win back ground relative to capital as rising living standards in Asia lead to a weakening of the downward pressure Asians have exerted on pay in the west. In finance, a return to more utility-style banking will mean less spectacular profits, while financial jobs will become less skill-intensive, complex and highly paid.

Yet huge increases in top pay regardless of performance represent, among other things, a failure of leadership. They also reflect a failure of accountability and stewardship. So if the boardroom pay ratchet is to be stopped, incentive structures and boardroom behaviour have to change.

Mr Lambert wants businesses to hold up a mirror to themselves and see how they look to the outside world. The trouble is that Lloyd Blankfein of Goldman Sachs has done this and found, notoriously, that he is “doing God’s work”. For others the problem is more that well-intentioned directors are locked in a procedural box, advised by pay consultants who are conflicted and using metrics that are flawed. Even where money is not the chief motivation, it is a race in which no chief executive wants to fall behind his or her peers.

Institutional shareholders, in the UK though not the US, have engaged in intensive dialogue with management on pay. They have done well in eliminating rewards for failure and improving incentive structures. Yet they have been unable to address absolute levels of compensation.

Breaking this vicious circle requires a catalyst. If business leaders and institutional shareholders do not address the conflicts of interest inherent in their respective positions more directly, there is a danger that government will.

The remedy of disclosure has failed, simply encouraging the ratchet effect. Boards must raise their game – but that in itself will not be enough. So maybe the time has come for institutional shareholders, with encouragement from politicians, to take a majority of the seats on remuneration committees, as they do in Scandinavia on nomination committees.

If business is not to suffer from a permanent legitimacy deficit, with all that that implies for the economy and society, something radical has to be done.

– Gregory Schick, Sheppard Mullin Richter & Hampton

The April 5th issue of Business Week included an article – “CEO Pay Drops But . . . Cash is King” – that provided an early look at 2009 compensation for CEOs at 81 large companies. The article’s survey data covered companies whose CEOs had been the same person in both 2008 and 2009. The data was obtained from proxy statements that were publicly filed by March 12, 2010.

For corporate governance advocates who have been railing against perceived excessive compensation, the article happily reports that CEO compensation dropped by 8.6% as compared to 2008. But, the article also reports that CEO cash compensation rose 8.3%. Furthermore, employer contributions to CEO pension plans reportedly gained an average of 15.4%.

As noted in the article, for cash and pension compensation to have materially increased at a time when economic growth (and inflation) were at relative lows does not appear to be consistent with paying for long-term performance and which seek to ensure that CEOs have skin in the game.

The article reports that, apart from TARP companies which were subject to federal limitations on compensation, declines in equity compensation were the principal reason why total compensation decreased. This would mean that at-risk long term incentive compensation was being replaced with short-term cash compensation which is not as directly linked with the welfare of shareholders.

The article measures the drop in equity compensation in dollar terms and reported that option values decreased by 30% and stock awards by 12%. Ideally, all of the survey’s proxy statement data would reflect the SEC’s new equity compensation reporting rules which now utilize FASB ASC Topic 718 grant date values, rather than annual expense amounts so that equity value comparisons are one-to-one (calendar year companies filing their Form 10-Ks and proxy statements before February 28, 2010 would have been permitted to file under the SEC’s pre-amended rules).

Note that a decline in reported FASB 718 dollar values would not necessarily translate to a decrease in the magnitude, or potential value, of equity awards. This is because, all other things being equal, lower share prices at the time of grant will result in lower FASB 718 grant values. The article did not comment on whether differences in stock prices (or other option valuation variables) at the times of grant were accounted for in concluding that equity compensation values had decreased.

In the very near future, there will be much more 2009 CEO compensation data to digest and analyze. It will be interesting to see if the Business Week survey findings will continue to be representative of CEO pay trends when compensation information from other companies becomes available.