As roughly 40 companies in the US face the prospect of failing say-on-pay for a second time (and perhaps one company already has, depending on the math – also see this blog about the large number of abstentions), this article about Australia’s new “two strike” law bears reading, repeated below:
Australia’s new “two strikes” law giving shareholders more power to curb excessive executive pay packets, promises to shake up some businesses. Homewares company GUD Holdings has already been hit with a protest vote from 42% of shareholders over the company’s remuneration report, under the new legislation introduced in July.
Under the new amendment to the Australian Corporations Act, if 25% or more of votes cast at two consecutive AGMs oppose the adoption of a remuneration report, then the company must formally respond by asking all board members except the managing director to stand for re-election within 90 days. In addition, key management personnel whose remuneration is disclosed in the remuneration report are excluded from voting, ensuring those with an obvious interest in the outcome cannot vote.
There are few more controversial issues than executive pay. Here in Australia, Qantas chief executive Alan Joyce found himself in the firing line for his large pay increase despite a damaging industrial dispute. Last week, the Australian Shareholders Association indicated it would oppose the remuneration package of Wesfarmers chief Richard Goyder and financial officer Terry Bowen at the company’s AGM in November.
Non-binding vote
Since 2005, Australian shareholders have had the right to vote on the remuneration report of their companies at an AGM. The tougher Australian laws parallel similar moves in the Netherlands, Norway, Sweden and the United Kingdom which have responded to public outrage about executive pay levels. The US has also introduced similar legislation effective from the 2011 proxy season in the wake of public concern about the role of excessive remuneration in the global financial crisis.
New research
Our new research backs the idea that shareholder voting is an effective way to discipline boards over unsatisfactory executive pay arrangements. Using a sample of 240 ASX listed firms between 2001 and 2009, fellow UQ researchers Peter Clarkson, Shannon Nicholls and I investigated the pay-for-performance relationship and its effect on governance. Pay-for-performance is an important metric because it measures how much executive pay changes or varies with firm’s performance. That is, it captures the incentive effect of the remuneration structure. Not surprisingly, a weak pay-for-performance relationship is a focus for shareholder dissent.
Research around the effects of the UK advisory vote, for instance, showed shareholders were more likely to vote “no” on remuneration packages that are excessively high, had a weak pay-for-performance link or were greatly dilutive. We found the average “no” vote on the remuneration report for our sample has increased steadily from 5.4% in 2005 (the first year of the vote) to 11.4% in 2009.
Pay-for-performance
The pay-for-performance relation strengthened across the nine year period, with enhanced remuneration disclosure and the non-binding shareholder vote the most important avenues to achieve greater monitoring and greater shareholder control of the executive remuneration process. Our research findings have important implications for Australian regulators and company directors. Shareholders are increasingly voicing their concerns about excessive executive pay and have used the advisory vote effectively to flag inappropriate remuneration packages to the board.
Our research suggests that boards of directors have listened to their shareholders and have adapted pay packages to be more in line with shareholder expectations. This season, the two-strikes rule gives shareholders an even stronger say on pay and there is every reason to believe that shareholders will use it. For their part, company boards need to listen closely to what shareholders have to say about the remuneration report and respond accordingly. Transparent and careful disclosure about remuneration is more critical than ever this reporting season if company boards are to avoid “striking out” with their shareholders.
On October 4th, we blogged about the dismissal of a series of lawsuits filed in New York by Goldman Sachs shareholders. We noted that a similar shareholder suit against Goldman Sachs was pending in the Delaware Chancery Court. Last week, that suit was dismissed.
With respect to executive compensation issues, the shareholders in the Delaware case claimed that Goldman’s directors breached their fiduciary duties by (1) failing to properly analyze and rationally set compensation levels for Goldman’s employees and (2) committing waste by “approving a compensation ratio to Goldman employees in an amount so disproportionally large to the contribution of management, as opposed to capital as to be unconscionable.”
Ruling on Goldman’s motion to dismiss for failure to make a pre-suit demand upon the board and for failure to state a claim, the Delaware Chancery Court found that a pre-suit demand was not excused because the plaintiffs failed to plead demand futility with sufficient particularity. In other words, the plaintiffs failed to plead particularized factual allegations that raised a reasonable doubt as to whether (1) Goldman’s board lacked independence because of its financial ties to Goldman, (2) the board’s compensation structure was the product of a valid exercise of business judgment and (3) the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.
Taking the New York and Delaware results together, it is clear that for these types of compensation lawsuits, at least based on Delaware law, it is not easy to plead demand futility with sufficient particularity to survive at the motion to dismiss stage. It will be interesting to see for how much longer the plaintiffs’ bar will continue trying. Note that the one say-on-pay-based derivative suit (against Cincinnati Bell) so far that has survived a motion to dismiss, and excused pre-suit demand, applied Ohio substantive law.
Recently, we’ve been asked by several clients if they can craft their performance-based incentive plans to preserve tax deductibility under Code Section 162(m) (the million-dollar pay cap) in the event of a corporate acquisition, reorganization or recapitalization. We’ve also read articles suggesting that this goal can be accomplished through careful planning, with one stating: “If the Compensation Committee’s authority to make adjustments is not properly structured and designed, then any adjustment will cause the bonus award to be considered non-performance-based compensation, and [thus] may not be tax deductible by the company.”
Based on that promising statement, we’ve thought hard about the meaning of “properly structured” and have concluded there is no one-size-fits-all approach that can be employed by all companies in every situation. That said, there are strategies that can maximize companies’ chances for success, depending on their specific circumstances. Also, keep in mind that the Section 280G rules may also come into play with regard to the tax treatment of payments that occur due to corporate transactions; these rules need to be carefully considered in tandem with 162(m). Learn more in our Bulletin.
For the many of you that have registered for our Conferences coming up in less than one week, we have posted the Course Materials (attendees received a special ID/PW later yesterday via email to access them; but copies will be available in San Fran). The Course Materials are better than ever before – with over 50 sets of freshly written talking points comprising 200 pages of practical guidance. Our expert speakers certainly have gone the extra mile this year!
For those seeking CLE credit, here’s a list of states in which credit is available for watching the Conferences live in San Francisco and by video webcast. Note that the list is broken out for each of the Conferences – and note two states are listed as “pending” (check back to determine if the Conferences are approved in those states).
Act Now: As happens so often, there is now a mad rush for folks to register for these Conferences that begin on Tuesday, November 1st. With an aggregate of over 50 panels (including the “19th Annual NASPP Conference“), if these Conferences don’t help get you prepared for the upcoming proxy season, nothing will. You can either register for the three days of the “19th Annual NASPP Conference” (in San Francisco) – or the two days of the “6th Annual Proxy Disclosure Conference” & “8th Annual Executive Compensation Conference” (in San Francisco or by video webcast, or a combination of both). Register Now.
Last week, two more companies failed to gain majority support for their say-on-pay, although one of the companies failed for the second time this year – further obscuring how to count how many failures there have been so far. In this Form 8-K, Synaptics reports that it received 44% in support. And then there’s this news from Ted Allen of ISS that was blogged last week about Hemispherx Biopharma.
Here’s a blog from Barbara Nims and Gillian Emmett Moldowan of Davis Polk:
The Federal Reserve recently released a report detailing its horizontal review of incentive compensation practices at 25 large banking organizations. The findings and recommendations are expressed in highly general terms, and set forth the Fed’s views on what financial institutions are and should be doing to identify practices effective in balancing incentive compensation arrangements and risk and formulate next steps in developing these practices. Because the interagency rule on incentive compensation in the financial sector may provide a roadmap for future regulation in this area extending beyond financial institutions, the insight offered by the report may be helpful in structuring incentive compensation policies at any company.
Based on the report, the Fed would like to see companies implement the following practices when using risk adjustments and deferred compensation to achieve balance between risk and financial reward in compensation arrangements:
– Well-developed and robust compensation policies that clearly identify the weight given to risks taken during the performance year, and improved monitoring of these policies to ensure the effective and consistent use of risk adjustments (this is particularly important for incentive-based deferred compensation plans because, to have a significant impact on risk-taking behavior, plans need to provide employees with a clear understanding of the risk-taking decisions that impact plan payouts);
– Where adjustments to the size of annual bonus pools are used as a risk adjustment mechanism, adjustments in connection with individual incentive compensation awards if individual employees in a single pool have varied levels of impact on risk; and
– Deferral practices that are broader than traditional clawback arrangements – although clawbacks are considered useful in creating balanced risk-taking incentives by discouraging specific types of behavior, the Fed considers their focus (typically, malfeasance, violations of policies, and a material restatement of financial results) too narrow to impact most risk-related decisions.
In the report the Fed makes clear that it expects boards to actively oversee the development and operation of incentive compensation policies and be attentive to risk taking incentives created by the incentive compensation process. The Fed also expects directors to monitor carefully the effectiveness of incentive compensation arrangements in balancing risk-taking incentives, for example, through reviewing periodic reports that monitor incentive compensation awards and payments relative to risk outcomes. Note that the Fed’s expectations for board responsibility and oversight are not limited to incentive compensation of senior executives, but extend to incentive arrangements throughout the employee ranks. This could result in a significant expansion of the board and/or compensation committee process at many companies.
A few days ago, in the “NASPP Blog,” Barbara Baksa summarized the findings in the NASPP’s 2011 Domestic Stock Plan Administration Survey (co-sponsored by Deloitte) that came as a big surprise to her – the design and usage of stock ownership guidelines. Here is Barbara’s blog:
Maybe I haven’t been paying attention, but the significant increase in companies that have ownership guidelines was a big surprise for me. 73% of respondents in the 2011 survey report having ownership guidelines, up from only 54% of respondents in the 2007 Domestic Stock Plan Design and Administration Survey (also co-sponsored by Deloitte), a 35% increase. Back in 2007, we also asked how many respondents were considering implementing ownership guidelines in the next two years. Based on the responses to that question, I would have expected around 65% of respondents in the 2011 survey to have ownership guidelines, quite a bit less than 73%.
In case you are wondering, 25% of respondents to the 2011 survey that don’t currently have ownership guidelines said they are considering implementing them in the next three years. That would add around 35 companies to those that have guidelines, so I’d expect the percentage of respondents with ownership guidelines in 2014 (the next year the survey is planned for) to be close to 80%. All the cool kids are doing it, is your company one of them?
What Counts?
Everyone counts shares owned outright, whether purchased on the open market or through some type of compensatory or private arrangement. Of the respondents that offer the following types of arrangements, here’s the percentage that count them toward their guidelines:
– 70% count unvested restricted stock
– 60% count unvested phantom stock and RSUs
– 93% count vested phantom stock and deferred RSUs
– Only 31% count unvested performance shares
72% of respondents indicated that they offer stock options but don’t count them toward the guidelines.
We asked about a bunch of other types of arrangements in the survey, but the ones I list above are the most interesting.
Who Counts?
Ownership guidelines are largely applied only to top executives–98% of respondents said that the guidelines apply to their CEO and CFO and 95% apply the guidelines to their other NEOs. Only 71% apply the guidelines to other senior executives. From there, application of the guidelines drops off sharply, with only 12% applying the guidelines to other management.
How and When to Count
Most, or 78%, of respondents base required ownership levels on a multiple or percent of compensation. 68% allow up to five years to meet the guidelines; another 13% percent require guidelines to be met in three years.
How Much to Count
For CEOs, required ownership levels are pretty high. 74% of respondents require the CEO to own stock equal in value to five or more times his/her compensation (49% of respondents require exactly five times compensation). That is perhaps reflective of how much CEOs get paid in stock. For the CFO and other NEOs, the requirement is a little lower, with 78% of respondents indicating that their requirement for these positions falls in the range of two to four times their compensation.
Need to Catch Up?
For more on stock ownership guidelines, don’t miss the double session at the NASPP Conference coming up in 10 days: “A Sensible Approach to Stock Ownership Guidelines” and “Stock Ownership Guidelines: Towards the Achievable, Meaningful, and Manageable.” You can also check out the articles and tools in the NASPP’s new “Stock Ownership Guidelines Portal.”
Hemispherx Biopharma, a micro-cap biotech firm based in Philadelphia, has failed to win majority support (based on votes present) for its executive compensation practices for the second time. The company, which restated its 2009 results, conducted its 2011 annual meeting on Oct. 13 after holding its 2010 meeting in March 2011. Hemispherx is the first issuer with a failed Dodd-Frank Act advisory vote to face shareholders again.
At the most recent meeting, as reported in this Form 8-K, the company said it received 44.1 percent support for its pay practices, while there was 37 percent opposition and 18.9 percent in abstentions. The company pointed out that there was “very little stockholder voting on this resolution, with only 20.7% of the outstanding shares eligible voted.”
The company’s CEO, William A. Carter, received a 72 percent base salary increase in 2012, according to the proxy statement, while the company has posted negative one-, three-, and five-year total shareholder returns. In its proxy statement, the company pointed out that the CEO agreed to a 50 percent reduction in base salary during the first five months of 2009. At the same time, the CEO’s 2010 salary and fees still represent a significant increase from the 2008 level, according to the ISS report on the company.
The company also said that its compensation committee had acted “to better align the compensation options with our stockholders’ interests in supporting long-term value creation.” Hemispherx pointed out that it renewed expired stock option grants for a 10-year term at the same exercise price of the original option grants, rather than at current market price, and the company said that future non-executive employee compensation could include company stock.
While Hemispherx shareholders used the advisory vote again to express concerns over pay, most of them did not withhold support from directors. The directors all were reelected by more than a 8-1 margin. Some institutional investors have said they may take a “red card/yellow card” approach and withhold support from directors in 2012 if companies fail to adequately address significant opposition during 2011 advisory votes.
Yesterday, as noted in this blog, ISS opened the comment period for it’s 2012 policies, as it has for the past several years. Here is their policy gateway where you can input your views – and here are the draft policies. The comment period is short – ending on October 31st.
Given the importance of this proxy season, this would be a good time to get involved if you haven’t before. Come hear from ISS and Glass Lewis about their policies during our upcoming pair of say-on-pay conferences (one regarding disclosure and one regarding pay practices – both combined for one price) that takes place in less than 2 weeks. You can attend online or in San Francisco. Register now.
UK companies could face a binding vote on executive compensation under new proposals outlined by the government yesterday. Vince Cable, the UK business secretary, has launched a consultation paper on executive pay that questions whether the non-binding votes companies currently undertake are a strong enough incentive to link pay and performance.
The consultation paper , which is open for responses until November 25, states some shareholders believe a binding vote would encourage shareholders to be more active and prompt companies to take the issue more seriously. ‘If introducing a binding vote, its legal status would need to be established, including what expectations this would place on a company to revise its remuneration proposals in the event of a vote against, and whether revised proposals would then need to be verified by a second shareholder vote,’ states the paper.
The consultation document also acknowledges, however, that many shareholders and other stakeholders view a binding vote as a bad idea. Critics argue it would be costly and inconvenient, could run into legal problems and is unnecessary as shareholders that want to take concrete action can already vote against the chair of the remuneration committee.
The Netherlands, Norway and Sweden have all adopted a binding vote on remuneration but the majority of countries that mandate a vote on pay call for a non-binding poll only.
The proposal is part of a wide range of ideas set out by Cable in two consultation papers covering executive pay and narrative reporting. They will run alongside a review into the UK equity markets launched last week, also at the behest of Cable. On the topic of pay, the government is also looking at questions including whether it should make remuneration committees more diverse, and whether the ratio between the CEO’s pay and median earnings in a company should be published.
The main proposal for narrative reporting is to split the existing narrative report into two documents:
– a ‘strategic report’ for shareholders, including information on results, strategy, risks, pay and social and environmental issues
– an ‘annual director’s statement’, containing information underpinning the strategic report, which would be published online.
In a move that will be welcomed by the UK’s IR community, Cable says part of the aim of his proposals on reporting is to streamline bloated annual reports. ‘The average length of an annual report is now almost 100 pages, even longer for FTSE 100 companies,’ he notes in a statement. ‘It has become unwieldy, complex and hard to understand, so investors cannot easily find the information they need. ‘Changing the way companies do their annual reports will provide investors with better information on how well businesses are performing and what their directors are being paid, increase transparency and reduce the burden on businesses, freeing them up to concentrate on growing and focusing on the long term.’