– Broc Romanek, CompensationStandards.com

Given the number of emails I have received in the past two weeks, I could blog about this topic every day. As I blogged recently, there is some confusion about how the new independence of advisors requirement as many law firms have taken different approaches so far – thus, I have calendared this upcoming webcast – “Law Firms & Independence: What to Do Now” – to which I just added two new speakers – Skadden’s Joe Yaffe and Gibson Dunn’s Ron Mueller – to the existing duo of Troutman Sanders’ Brink Dickerson and Bryan Cave’s Randy Wang.

Until that webcast occurs, you can feed your hunger with this Wachtell Lipton memo and Duane Morris blog on the topic – and this blog from Gibson Dunn:

As discussed in our April 26th blog, under recently amended NYSE Rule 303A.05 and NASDAQ Rule 5605(d), board compensation committees cannot select or receive advice from a compensation consultant, legal counsel or other adviser without first taking into consideration that adviser’s independence, including consideration of the factors enumerated in the rules. As compensation committees and their advisers are preparing for the July 1 effective date of these new listing standards, three observations are important:

First, a critical issue is what triggers the requirement. While it will be apparent when a compensation committee has “selected” an adviser, a more difficult issue is determining when a compensation committee will be deemed to have received advice from an outside adviser. Because the NYSE and NASDAQ listing standards were mandated by Exchange Act Rule 10C-1(b)(4), the SEC staff has been providing informal commentary on the application of the rules. The staff’s most recent commentary, presented by the chief counsel of the Division of Corporation Finance at a meeting this week with representatives from the Society of Corporate Secretaries and Governance Professionals, reiterated that outside counsel and other advisers may be deemed to provide advice to a compensation committee indirectly–even if the adviser is not meeting with or speaking directly to the compensation committee. As an example, if in-house counsel reports what outside counsel has advised, that can constitute “receiving advice” from outside counsel. However, the fact that in-house counsel may have consulted with a number of outside lawyers in developing a recommendation or advice for the compensation committee does not mean that the compensation committee will be deemed to have received advice from each of those outside lawyers. In other situations, it will be a facts-and-circumstances determination.

In considering these issues, companies should consider the purpose of the listing standards, which is for compensation committees to be aware of and consider factors that could be viewed as affecting the objectivity of advice they receive. When that advice is effectively coming from outside counsel, or outside counsel is being invoked as the source for particular advice, the requirements of these new listing standards should be borne in mind. As we have previously noted, because of the requirement that compensation committees consider an adviser’s independence in advance of receiving advice from the adviser, companies should consider which consultants, outside counsel and other advisers work regularly with the committee or with management on matters that fall within the committee’s areas of responsibility and whether advice from those advisers will be presented to the compensation committee. If so, those advisers should be requested to provide information on the various factors specified in the listing standards so that the information may be presented for the committee’s consideration. While this information does not have to be presented to the compensation committee before the July 1 effective date of these new listing standards, it should precede the first post-July 1 instance of the adviser’s advice being presented to the compensation committee. After the initial assessment, compensation committees should conduct a similar assessment at least annually.

Second, companies should bear in mind that the independence consideration applies to any compensation consultant, outside counsel or other adviser whose advice is received by the compensation committee, regardless of the nature or subject of that advice. In other words, the listing standards are not limited to advisers addressing executive compensation matters, but could also apply to advisers addressing director compensation, management succession or other issues that are handled by a board compensation committee.

Finally, the listing standards do not require that a board compensation committee use only independent advisers. Moreover, the listing standards do not state that the committee must make a formal determination about whether an adviser is independent, but instead require the compensation committee to consider the adviser’s independence, taking into account certain factors. We expect that, in connection with conducting the assessment required under the listing standards, many compensation committees will continue the practice of making a formal determination as to whether a compensation consultant that is retained by or provides advice to the compensation committee is independent, and that companies will continue to voluntarily disclose in their proxy statements that a particular compensation consultant has been determined to be independent. We expect, however, that it will continue to be less common for companies to provide voluntary disclosure addressing other advisers.

– Broc Romanek, CompensationStandards.com

Nice analysis from Steve Seelig and Andrew Goldstein of Towers Watson in this article:

Today, many institutional shareholders consider recommendations from proxy advisors who rely on proprietary pay-for-performance models as their first level of review in making their say-on-pay voting decisions. Over the years, these models have been subject to criticism for imposing quantitative testing regimes that focus on pay opportunity relative to total shareholder returns (TSR). In response, proxy advisors have honed their models to be more granular and more qualitative, although some critics have suggested these analyses don’t focus quite enough on the particular results the programs seek to elicit.

This may be changing. In working with clients in the 2013 proxy season, we’ve reviewed a number of proxy advisor reports regarding qualitative matters and their focus on how incentive programs are structured and precisely what those programs reward. The companies examined in these reports may have failed a quantitative test on pay for performance that necessitated closer scrutiny from the proxy advisor. Understanding these reports is important because, as has become clear in the say-on-pay era, every company is just one bad performance year away from coming in for increased proxy advisor scrutiny. Fortunately this does not mean that all companies end up getting a negative vote recommendation. For example, when we examined S&P 500 companies that triggered a qualitative review by Institutional Shareholder Services (ISS) in 2012 based on their quantitative test results, we found that three-quarters of those companies ultimately received a favorable vote recommendation.

Nonetheless, from our consulting experience we have begun to see a pattern of analysis from proxy advisors on pay structures they find objectionable. Here’s a look at some of the issues they’ve been focusing on:

Degree of difficulty for annual incentives: This gets to the essence of whether compensation committees are setting goals that are challenging enough for executives to warrant a target bonus. While the proxy advisers are not yet making subjective determinations on this issue for all companies, we’ve seen the issue raised for companies where above-target bonus payouts were made in previous years for good performance, but where current-year payouts remained at the same levels even though year-over-year performance declined on key financial metrics such as revenues, earnings or cash flow. Influencing the advisor’s concerns could be payouts above target even though some performance metrics under the annual plan fell below target or where the target itself did not signal improved corporate financial results. While the proxy advisors could be right in their assessment, in most cases they are making such determinations without the benefit of knowing critical factors relevant to the goal-setting process. If the proxy advisors push further on this issue (which we believe is a logical path), then it will be incumbent on companies to provide a descriptive rationale for the incentive plan goals in the CD&A, particularly in cases where performance goals are not higher than the prior year’s results.

Justification and performance conditions for retention awards: It’s established that proxy advisors tend to be skeptical of large retention awards, particularly in circumstances where options are under water or annual bonuses are not earned, but companies will accede to retention grants that include performance hurdles. We’ve seen circumstances in which advisors have questioned whether retention awards should ever be used as they may indicate a company that is not committed to pay for performance. Companies that do not offer a clear explanation of the need for retention awards and for awards granted without meaningful performance conditions are inviting scrutiny.

Duplicate performance measures for both annual and long-term incentives: Proxy advisors tend to favor multiple vehicles for long-term incentive programs and reward companies that focus on performance goals for these plans. But this favorable view can evaporate in cases where a company’s long-term performance share plan uses the same metrics (e.g., net income, total cash flow) as its annual plan, creating a duplication of payouts albeit in different forms: cash and equity. This concern may be exacerbated where the performance period under the long-term plan is shorter than three years or where the plan’s weighting is not pro-rata over the performance period, resulting in more concentration on the same metrics to determine payouts.

Increases in maximum payout potential: Increases in payout maximums from 150% to 200% of target or higher are not common, but there are companies that had lowered their maximums during the recent recession as a mechanism to limit payouts (and avoid windfalls) where goal-setting was challenging. There are also companies that will raise the maximum payout to be more consistent with market practice or to incent even higher levels of stretch performance. We’ve seen cases where proxy advisors have criticized such changes in the annual or long-term plan in years when shareholder returns are down under the assumption that executives are earning more for less, even when that is not really the case.

Absolute metrics for long-term incentives: Finally, we’ve seen proxy advisors find an emphasis on absolute metrics under long-term incentive plans to be inappropriate because performance may reflect economic factors or industry-wide trends beyond the control of executives, rather than the executives’ own performance. Instead, they have insisted that companies should incorporate relative measures to determine awards granted under a long-term incentive plan, regardless of the known pitfalls associated with relative performance goals.

Severance for departed CEOs: Proxy advisors are taking a close look at severance packages for terminated CEOs, particularly when the separation is the result of an extended period of poor company performance. We’ve seen cases in which companies have been taken to task even where their severance payments are absolutely consistent with prior contractual obligations, with no enhancements granted by the board. We interpret this as another attempt to reign in “pay for failure,” but the new twist is that companies will not be able to rationalize such payments simply by saying they were made according to the terms of a previously executed employment contract or severance agreement, or by structuring the terms to be generally in line with market practice.

– Broc Romanek, CompensationStandards.com

This op-ed piece in the WSJ from Henry Mintzberg is interesting:

These days, it seems, there is no shortage of recommendations for fixing the way bonuses are paid to executives at big public companies.

Well, I have my own recommendation: Scrap the whole thing. Don’t pay any bonuses.

This may sound extreme. But when you look at the way the compensation game is played–and the assumptions that are made by those who want to reform it–you can come to no other conclusion. The system simply can’t be fixed. Executive bonuses–especially in the form of stock and option grants–represent the most prominent form of legal corruption that has been undermining our large corporations and bringing down the global economy. Get rid of them and we will all be better off for it.

The failings of the current system–and the executives who live by it–are painfully obvious. Although these executives like to think of themselves as leaders, when it comes to their pay practices, many of them haven’t been demonstrating leadership at all. Instead they’ve been acting like gamblers–except that the games they play are hopelessly rigged in their favor.

First, they play with other people’s money–the stockholders’, not to mention the livelihoods of their employees and the sustainability of their institutions.

Henry Mintzberg, a management professor at McGill University, explains to WSJ’s Erin White why executive bonuses are a bad idea and dicusses alternative ways to structure CEO pay.

Second, they collect not when they win so much as when it appears that they are winning–because their company’s stock price has gone up and their bonuses have kicked in. In such a game, you make sure to have your best cards on the table, while you keep the rest hidden in your hand.

Third, they also collect when they lose–it’s called a “golden parachute.” Some gamblers.

Fourth, some even collect just for drawing cards–for example, receiving a special bonus when they have signed a merger, before anyone can know if it will work out. Most mergers don’t.

And fifth, on top of all this, there are chief executives who collect merely for not leaving the table. This little trick is called a “retention bonus”–being paid for staying in the game!

This may be nice work if you can get it, but it is awful work if you care about the sustainability of an enterprise. Who, playing such games, wouldn’t take substantial risks? What’s to lose? If more executives these days were as creative in doing their jobs as they are in getting compensated for them, we would be in a period of boom, not bust.

Faulty Assumptions

Surely, you may be saying, there’s a way to fix this system, to make bonuses work for corporate prosperity and economic security.

Plenty of people think so, as evidenced by all the suggestions for changing it. Even the Federal Reserve has weighed in, announcing a new plan to rein in bank compensation practices that encourage too much risk-taking.

But I believe that all these efforts are doomed to fail as well. That’s because the system, and any proposals to fix it, must inevitably rest on several faulty assumptions. Specifically:

• A company’s health is represented by its financial measures alone–even better, by just the price of its stock.

Come on. Companies are a lot more complicated than that. Their health is significantly represented by what accountants call goodwill, which in its basic sense means a company’s intrinsic value beyond its tangible assets: the quality of its brands, its overall reputation in the marketplace, the depth of its culture, the commitment of its people, and so on.

But how to measure such things? Accountants have always had trouble when they have tried, as have stock-market analysts, investors and even potential purchasers of the company. (That’s one of the reasons so many mergers fail.) No board of directors is going to have much luck finding that elusive measure, either.

This flawed assumption, though, does far more damage than simply distorting CEO compensation. All too often, financial measures are a convenient substitute used by disconnected executives who don’t know what else to do–including how to manage more deeply.

Or worse, such measures encourage abuse from impatient CEOs, who can have a field day cashing in that goodwill by cutting back on maintenance and customer service, “downsizing” experienced employees while others are left to “burn out,” trashing valued brands, and so on. Quickly the measured costs are reduced while slowly the institution deteriorates.

• Performance measures, whether short or long term, represent the true strength of the company.

For years, the idea was that a company’s short-term performance represented its long-term health. The banks and insurance companies have pretty much laid that assumption to rest.

So now there is focus on trying to link bonuses with longer-term measures. Well, I defy anyone to pinpoint and measure such performance in any serious way and attribute it to one or a few executives.

How do you assess the long-term performance of a chief executive? Some proposals look at three years, others as many as 10 years. But can we even be sure of 10 years? Is a decade long enough in the life of a large company, with all its natural momentum? How many years of questionable management did it take to bring General Motors to its knees?

Conversely, if a company’s stock price goes up and stays up for several years, does that signify the definitive success of the current chief executive? What if the previous CEO made some good decisions that later kicked in? Don’t we all talk about the long-term influence of executive decisions? Have we forgotten about that?

• The CEO, with a few other senior executives, is primarily responsible for the company’s performance.

What if the CEO was lucky enough to have been in the right place at the right time? When it comes to a company’s current performance, history matters, culture matters, markets matter, even weather can matter. How many chief executives have succeeded simply by maneuvering themselves into favorable situations and then hanging on while taking credit for all the success? In something as complex as the contemporary large corporation, how can success over three or even 10 years possibly be attributed to a single individual? Where is teamwork and all that talk about people being “our most important asset?”

More important, should any company even try to attribute success to one person? A robust enterprise is not a collection of “human resources”; it’s a community of human beings. All kinds of people are responsible for its performance. Focusing on a few–indeed, only one, who may have parachuted into the most senior post from the outside–just discourages everyone else in the company. Sometimes, there is the impression that a forceful chief executive has turned around a troubled company. But how sure can we be that such a turnaround will be long-lasting? After all, so many of these supposed corporate resurrections eventually go sour.

Bad Signals

Put differently, executive compensation these days reinforces a class structure within the enterprise that is antithetical to its effective functioning. Because of its symbolic nature, executive compensation as currently practiced sends out the worst possible signal to everyone in the enterprise.

One alternative, of course, is to pay bonuses to everyone, perhaps according to their base pay. That solves one problem but not another: how to ensure that the goodwill is not being cashed in by everyone, collectively. Once again, who is to come up with the measures that assess performance correctly?

So, again, there is but one solution: Eliminate bonuses. Period. Pay people, including the CEO, fairly. As an executive, if you want a bonus, buy the stock, like everyone else. Bet on your company for real, personally.

Bonuses as a Screening Tool

Actually, bonuses can serve one purpose. It has been claimed that if you don’t pay them, you don’t get the right person in the CEO chair. I believe that if you do pay bonuses, you get the wrong person in that chair. At the worst, you get a self-centered narcissist. At the best, you get someone who is willing to be singled out from everyone else by virtue of the compensation plan. Is this any way to build community within an enterprise, even to foster the very sense of enterprise that is so fundamental to economic strength?

Accordingly, executive bonuses provide the perfect tool to screen candidates for the CEO job. Anyone who insists on them should be dismissed out of hand, because he or she has demonstrated an absence of the leadership attitude required for a sustainable enterprise.

Of course, this might thin the roster of candidates. Good. Most need to be thinned, in order to be refilled with people who don’t allow their own needs to take precedence over those of the community they wish to lead.

Many Motivations

People pursue the job of chief executive for all kinds of reasons: the prestige of the position, the sheer pleasure of heading up a major company, the chance to make a real difference to an institution they cherish, and, of course, remuneration. When push comes to shove, do you think pay is more consequential to these people than the other factors? All this compensation madness is not about markets or talents or incentives, but rather about insiders hijacking established institutions for their personal benefit.

Too many large corporations today are starved for leadership–true leadership, meaning engaged leadership embedded in concerned management. And the global economy desperately needs renewed enterprise, embedded in the belief that companies are communities. Getting rid of executive bonuses, and the gambling games that accompany them, is the place to start.

– Broc Romanek, CompensationStandards.com

Here are the latest failures – Kilroy Realty has now failed for the third time, each time garnering a lower level of support:

– Atlas Air Worldwide Holdings – Form 8-K (38% support)
– Geron – Form 8-K (49% support)
– Dynamic Materials – Form 8-K (33%)
– Annaly Capital Management – Form 8-K (28%)
– Kilroy Realty – Form 8-K (22%)
– Strategic Hotels & Resorts – Form 8-K (49%)

Thanks to Karla Bos of ING for the heads up on these!

– Broc Romanek, CompensationStandards.com

Wow, the first company with single digit support for say-on-pay. Alexandria Real Estate Equities wins that distinction as noted in its Form 8-K with only 9% support! It’s a new record low since say-on-pay was born.

And as noted in its Form 8-K, Ultimate Software Group failed with 49% support – and Boston Properties failed (see this Form 8-K) with 19%. Thanks to Karla Bos of ING for the heads up!

– Broc Romanek, CompensationStandards.com

With just a little over a week left in the last extension of our 15% early bird discount – and on a pace for record attendance – we have just posted the full agenda for the NASPP Conference to be held in Washington DC on September 23rd-26th. Combined with the proxy disclosure pre-conference, there are over 60 panels! Here is the NASPP Conference Brochure. The panels cover a wide range of topics, featuring many representatives from federal agencies, stock exchanges and proxy advisors – and covering hot buttons like “Say-on-Pay Litigation 2.0” which features both the lawyer most responsible for bringing these cases and lawyers who are defending them. Register before the Friday, May 31st early bird deadline.

– Broc Romanek, CompensationStandards.com

With companies grappling with the upcoming July 1st deadline of the new comp committee listing standards (see the March-April Issue of The Corporate Executive, featuring a comprehensive article by Mark Borges about an action plan for the new comp committee & advisor rules), I have just calendared a webcast – “Law Firms & Independence: What to Do Now” – for next month. I know it’s late, but better late than never – particularly because there is some misinformation about what Corp Fin Chief Counsel Tom Kim said at a meeting between the Staff and the ABA’s JCEB recently.

Anyways, check out this blog by Davis Polk’s Bill Kelly:

A key question under the new standards taking effect July 1 (described in our client memo) is whether a particular firm or person should be deemed to be serving as an “adviser to the compensation committee” and therefore subject to the requirement that the committee make a prior determination as to independence. Advisers retained directly by the committee are of course covered by this term, but what about advisers to the company who also provide advice to the committee?

We think that a company adviser who regularly presents to the committee should be deemed an adviser to the committee, and therefore should be subject to an independence determination now. Companies should also consider making a predetermination as to other advisers who have been retained by the company and who may be called on to provide advice to the committee. The reason to consider predetermining independence now is that the determination should be made prior to the committee receiving the advice. If you would like company advisers to be able to provide advice to the committee if an unplanned situation develops during the year, predetermining independence now could avoid a scramble later.

Remember that the new rules merely require compensation committees to consider the independence of their advisers. They do not provide or imply that committees must or should retain independent advisers. Thus a finding that an adviser is not independent should not of itself impair the committee’s ability to rely upon the advice. Nor is any aspect of the mandated independence review required to be disclosed publicly, other than proxy disclosure concerning compensation consultants. This disclosure requirement does not apply to other advisers such as legal counsel.

– Broc Romanek, CompensationStandards.com

Digirad is the first company that I’m aware of that placed non-executive director compensation on the ballot, per this proxy statement. This Form 8-K shows that agenda item got 61% support – just somewhat below the level of support for executive officer say-on-pay…

– Broc Romanek, CompensationStandards.com

Here are the latest failures:

– Golden Star Resources – Form 8-K (38% support)
– Everest Re Group – Form 8-K (38% support)
– OraSure Technologies – Form 8-K (46%)
– The Middleby Corporation – Form 8-K (48%)
– Hecla Mining – Form 8-K (48%)
– Volcano Corporation – Form 8-K (38%)
– Apache Corp – Form 8-K (49%)

Thanks to Karla Bos of ING for the heads up on these!

Here’s a Forbes article on Apache’s close vote…

– Broc Romanek, CompensationStandards.com

As noted in this Pittsburgh Post-Gazette article, Heinz shareholders recently voted down the company’s say-on-parachute – but the deal is going forward anyways. Here’s the related Form 8-K – and here’s my list of failed say-on-parachutes so far. Here’s a WSJ article about it…