The Advisors' Blog

– Dave Lynn, CompensationStandards.com

Mike Melbinger noted last week on his blog that the disclosure of the relationship between compensation and risk will be an important element of consideration for ISS and investors in the upcoming proxy season, so now is the time to start thinking about how to “do it right.” One thing that I have found helpful in benchmarking risk assessments has been the plethora of data points that can be gleaned from the hundreds of comments letter responses that have been submitted on EDGAR in response to the Staff’s comment asking companies to explain what they did to reach their conclusions as to whether disclosure was required under Item 402(s) of Regulation S-K (which effectively resulted in disclosure that was not otherwise required). In most cases, these responses talk about a process whereby:

– compensation programs were reviewed, particularly focusing on incentive compensation programs;

– program features were identified which could potentially encourage excessive or imprudent risk taking;

– the specific business risks that related to such features were identified;

– mitigating factors (if any) were identified;

– an analysis was undertaken to determine the potential effects of the risks and the impact of the mitigating factors; and

– an analysis was undertaken of the particular situations described in Item 402(s) as they apply to the company.

The findings that companies often reached were similar, focusing on:

– the mix of compensation, which tended to be balanced with an emphasis toward rewarding long term performance;

– the use of multiple performance metrics that are closely aligned with strategic business goals;

– the use of discretion as a means to adjust compensation downward to reflect performance or other factors;

– caps on incentive compensation arrangements;

– the lack of highly leveraged payout curves;

– multi-year time vesting on equity awards which requires long term commitment on the part of employees;

– the governance, code of conduct, internal control and other measures implemented by the company;

– the role of the compensation committee in its oversight of pay programs;

– frequent business reviews;

– the existence of compensation recovery (clawback) policies;

– the implementation of stock ownership or stock holding requirements;

– the use of benchmarking to ensure the compensation programs are consistent with industry practice;

– the uniformity of compensation programs across business units and geographic regions, or alternatively, the differences employed to reflect specific business unit or geographic considerations; and

– the immaterial nature of some plans.

In terms of employee plans, there was a lot of discussion in the comment responses regarding sales incentive plans, often focusing on controls in place on those plans such as caps, negative discretion, prepayment review, and recovery in the event of error or fraud, etc. The responses often note that the analysis was conducted by management with the concurrence or consultation of the compensation committee, and they also frequently referenced the use of compensation consultants in performing the analysis, with that consultant in many cases being the same compensation consultant that the compensation committee used for other compensation matters.