– Broc Romanek, CompensationStandards.com

In this 50-second video, Cap’n Cashbags fakes his own death to avoid giving a raise to a long-time employee. Stick around til the end for a dog clip:

– Broc Romanek, CompensationStandards.com

Check out this report by Semler Brossy about trends in supplemental letter responses…

– Broc Romanek, CompensationStandards.com

Leading up to the SEC’s adoption of its pay ratio rules, a familiar refrain was that shareholders didn’t care about ratio disclosure. This new study by Professors Khim Kelly and Jean Lin Seow reveals what we have been pushing for a long time – that the most meaningful disclosure about ratios is when you compare a company’s own ratios over time – rather than comparing ratios to peers.

This is exactly what we wrote about over a decade ago – that internal pay equity is an internal look. Here’s an excerpt from our thinking:

To start the internal pay process, boards should start by evaluating the relationships for both total direct compensation and total remuneration (i.e., including special executive benefits and perquisites, assuming these are significant). Then, if these analyses raise red flags, the analysis can be pursued by component of total compensation, including a break out by long-term incentive component.

Boards should choose a relevant time period for the internal pay audit to cover. In some cases, companies may choose to go back 10 to 20 years (e.g., although this won’t be possible for all companies, since some companies and managers have not been around since the mid-80s; in addition, some business models have changed so dramatically that too far a look-back may not be sufficiently relevant).

It is important to choose a time frame that will allow a good understanding of how the current pay program and pay for particular executive officers came to be, and the changes that have evolved over time. For companies that are already looking at multi-year tally sheets, they can use this data for this analysis.

Once a company has conducted an internal pay equity audit, management and the board should determine whether they feel comfortable both with the internal pay equity relationships that exist today and the changes in those relationships that have taken place over time.

It is important to note that the internal pay audit is intended to be an internal look, not something that is benchmarked across companies. This might be one reason why the practice has diminished in recent years – benchmarking databases maintained by compensation consultants provide no help here. This is an exercise that must be undertaken internally, although guidance from experienced consultants can help guide you through the process

The new study is based on an experiment in which MBA students were asked to make judgments about a hypothetical company. Those to whom high CEO-to-employee pay ratios were disclosed were significantly more likely than others to regard the CEO’s pay as unfair – and the more unfair they regarded it, the less likely they were to view the firm as a worthy investment. This latter finding is particularly noteworthy, the professors believe, because one of the criticisms leveled against Section 953(b) is that it engenders overreach by the SEC, requiring it to meddle in issues of income inequality rather than stick to its intended job of protecting investors.

Here’s more from a press release about the new study:

Says Prof. Kelly: “Here were men and women with an average of six years’ work experience and a fair degree of sophistication about business and accounting, and clearly disclosure of a lopsided CEO-to-employee pay ratio turned out to be relevant to an investment decision. Actually it would be surprising if it didn’t. As a recent nationwide survey conducted by Stanford University suggests, the whole issue of CEO pay is in bad odor. Seventy-four percent of the respondents to that survey said CEOs were overpaid relative to the average worker; yet, ironically, when asked what they believed the pay of Fortune-500 CEOs to be, they vastly underestimated the amount. In this climate of opinion, how could perceiving the CEO-to-employee pay ratio as unfair not be relevant to investment decisions?”

The 75 participants in the experiment were asked to assume they worked in the investment department of a corporation and were assigned to assess the potential of a fictional firm in which their company was considering making a medium- to long-term investment. They were informed that the firm was in the semiconductor industry and was regarded a leader in market share and innovation. The subjects were provided with company financial data and information on CEO compensation, both of which were adapted from an actual NASDAQ-listed semiconductor firm.

One third of the subjects were informed that the CEO’s total compensation in the most recent year was about $4.3 million and that this amount was roughly the average for CEOs in the company’s industry.

A second group was informed that the CEO’s total compensation was about $7.4 million, and that this amount was higher than the pay of three fourths of the CEOs in the industry.

A third group was provided the same information as the second group plus the fact that the median pay for employees of the company (other than the CEO) was about $45,000 and, additionally, that this meant the CEO-to-employee pay ratio was about 162-1, well above the average industry ratio of about 96-1.

Asked their opinion of the CEO’s level of compensation, on a scale of -7 (very unfair) to +7 (very fair), the groups offered significantly different views, as follows:

– The first group produced an average positive fairness rating of +1.12.

– The second group, on average, bestowed a neutral fairness rating of +0.12.

– The third group rated fairness negatively at -1.32.

Statistical analysis indicated opinion of CEO pay fairness to be significantly related to assessment of the company’s investment worthiness. In other words, the less fair the chief executive’s compensation was perceived to be, the less potential the company was judged to have as an investment.

Why didn’t comparatively high CEO pay by itself push fairness ratings into negative territory? One important reason, the researchers found, was that participants viewed high compensation levels as beneficial in attracting executive talent. But this belief is evidently outweighed by the sense of unfairness created by the additional disclosure of a lopsided CEO-to-employee pay ratio.

Further research by Profs. Kelly and Seow has resulted in still another intriguing finding from a similar experiment, this one involving 100 MBA students who were asked to assess a hypothetical company in the restaurant industry. The experiment, reported in a working paper, tests not only the three conditions described in the JMAR study but a fourth condition in which both the CEO’s compensation ($4.3 million) and the CEO-to-employee pay ratio (96-1) are average for the industry. The professors find that the combination of the lower CEO compensation level and lower pay ratio evokes a fairness rating that is just as negative as the one produced by above-industry averages of $7.4 million and 162-1. In short, in the words of the study, “pay-ratio disclosures, even when they reveal less extreme CEO-to-employee pay multiples that are comparable to those in peer companies, can result in negative perceptions of CEO pay fairness and workplace climate that indirectly reduce perceived investment potential of companies.”

Prof. Kelly sums up: “High CEO-to-employee pay ratios, whether 100-1 or 200-1, clearly made a special impression on the participants in our experiments. It seems eminently plausible that high ratios will also impress actual investors, with concomitant effects on companies, when they stare out from proxy statements.”

– Broc Romanek, CompensationStandards.com

A while back, I blogged about this fascinating Stanford/Rock Center survey about how people perceive CEO pay. Surprisingly, the survey got less attention from the mass media than I expected – but there were a number of articles – including this CNBC piece entitled “This CEO got $142 million more than he deserved.” Here’s an excerpt:

The real problem isn’t just lofty dollar figures. As Rosanna Landis Weaver, the lead author of the As You Sow report, details, the more nettlesome issue is the fundamental disconnect between CEO pay and performance: “CEO pay grew an astounding 997 percent over the past 36 years, greatly outpacing the growth in the cost of living, the productivity of the economy, and the stock market, disproving the claim that the growth in CEO pay reflects the ‘performance’ of the company, the value of its stock, or the ability of the CEO to do anything but disproportionately raise the amount of his pay,” Weaver writes.

A regression analysis conducted by HIP Investor, which rates investments by factoring in environmental, social and governance factors, found 17 CEOs who made at least $20 million more in 2014 than they would have if their pay had been tied to performance. Based on HIP Investor’s calculations, Zaslav, the Discovery Communications chief, made $142 million more than would have been warranted if his pay was more directly linked to performance.

Anyways, as I continue to be fascinated by the original set of survey results about how the public perceives pay (see my blog about it) – check out this second study from Stanford about how CEOs & directors perceive pay. As you can imagine, there are huge gaps between how the public and CEOs/directors perceive pay, including:

– 55% of CEOs and directors believe that CEOs are paid the correct amount relative to the average worker; 29% believe they are not; and 16% have no opinion. In contrast, only 16% of the public believe CEOs are paid the correct amount relative to the average worker, and 74% believe they are not.
– Only 12% of CEOs and directors support a relative limit (compared to the average worker) to CEO pay, while 79% oppose it, compared to 62% of the public favoring a pay cap – with just 28% opposed.
– 34% of directors – compared to 70% of the public – believe that CEO compensation is a problem.
– 97% of CEOs and directors agree that the government should not do anything to change CEO pay practices. In contrast, 49% of the public favors government intervention, and 35% oppose it.

Here’s an excerpt from Cooley’s Cydney Posner’s blog about the second study:

But the disconnect is not limited to the one between the public and directors. Directors also disagree with CEOs about the most appropriate methods of determining CEO comp. For example, while both groups might agree that the extent of value creation is an important element of the equation, they tend to differ on the appropriate method of measuring value creation. According to the paper, directors think total shareholder return (TSR) should be used to measure value creation, while CEOs tend to look instead to profitability measures (such as operating income and free cash flow), which they are more likely to be able to directly influence. In reality, the paper observes, both measures are subject to outside forces, such as broad-market trends, behavioral sentiment or cyclicality.

Which of these measures, the paper asks, is more accurate, and, when measuring performance, are there ways that the board can control for fluctuations in the market and general economy? Would a more effective way of demonstrating “pay for performance” be to “calculate the relation between compensation realized by a CEO over a designated period and value creation during that period…. Would the results of this analysis assuage the controversy over CEO pay or exacerbate it?”

– Broc Romanek, CompensationStandards.com

Here’s the teaser for this recent Pay Governance memo:

Yesterday’s (April 12, 2016) Equal Pay Day produced an extraordinary volume of discourse and disclosure on a vitally important topic – and one that is surfacing more frequently at the Compensation Committee level. As activist shareholders and a Presidential election year bring heightened attention to pay equity in the private sector, companies are increasingly disclosing their own demographic compensation statistics or chartering studies to ascertain where they stand. Further, Board Compensation Committees are showing significant interest in the issue as Committee agendas have begun to include pay equity as a subject for discussion.

Also see this CNN article entitled “One way to close the pay gap for women” that refers to this study…

– Broc Romanek, CompensationStandards.com

As I blogged yesterday, the banking regulators are finally rolling out a permanent proposal under Dodd-Frank’s Section 956 regarding excessive incentive pay. The NCUA kicked the proposing off. Here’s the summary from this Sullivan & Cromwell memo (also see this WSJ article – and this blog):

Earlier today, the National Credit Union Administration issued a notice of proposed rulemaking for a new interagency rule on incentive-based compensation that applies to financial institutions with consolidated assets of at least $1 billion. Today’s new proposal replaces one originally issued 5 years ago in the first half of 2011. The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency and the Securities and Exchange Commission are all expected to propose the same new rule.

The new proposed rule establishes general qualitative requirements applicable to all covered companies, additional specific requirements for institutions with total consolidated assets of at least $50 billion and further, more stringent requirements for those with total consolidated assets of at least $250 billion. The general qualitative requirements applicable to all covered institutions include (1) prohibiting incentive arrangements that encourage inappropriate risks by providing excessive compensation, (2) prohibiting incentive arrangements that encourage inappropriate risks that could lead to a material financial loss, (3) establishing requirements for performance measures to appropriately balance risk and reward, (4) requiring board of director oversight of incentive arrangements and (5) mandating appropriate recordkeeping (which replaces the annual reporting contemplated by the 2011 proposal).

– Broc Romanek, CompensationStandards.com

With a hat tip to Mike Melbinger, it looks like new proposed rules under Dodd-Frank’s Section 956 will be released this morning – at least by the National Credit Union Administration. The FDIC has already announced its open meeting planned for next Tuesday – and this WSJ article indicates that Office of the Comptroller of the Currency will act the same day. I don’t see anything similar from the SEC planned yet – but maybe the Commission will act in seriatim or will announce an open meeting at some point soon. I’m hearing that the proposed rule will be a re-proposal of the 2011 proposal (i.e. new comment period).

This WSJ article from last month telegraphed much of this – here’s an excerpt:

As part of a hard-fought update of crisis-era compensation rules expected in April, regulators plan to require banks to hold back much of an executive’s bonus beyond the three years already adopted by many firms, people familiar with the matter said. The new holding period has yet to be determined, though it likely will be shorter than the European standard of a decade, one person familiar with the matter said. Also unclear is the portion that will be deferred. The original draft of the rules five years ago said it should be as much as 50%. Whatever the final numbers, the rules will put further restrictions on payouts that already are under pressure as some big trading businesses dry up.

The moves are aimed at giving banks more time to claw back bonuses if it turns out the executive’s actions hurt the firm. They govern pay to risk-taking executives who are in a position to do material damage to their companies. In addition to extending the deferral window, regulators want to broaden the pool of bank employees subject to the new rules by expanding the definition of risk taker to include factors like the amount of money an employee handles. Regulators also are likely to be more specific on the instances in which executives might have to forfeit their bonuses entirely in the event of a material loss at the firm. Curbing executive pay is one of the remaining key issues left unresolved that were envisioned in the Dodd-Frank regulatory-overhaul law, passed in 2010 in the wake of the financial crisis.

The effort to complete the rule got a fresh push this month as President Barack Obama met with financial regulators at the White House, urging them to prioritize wrapping up rules that govern executive compensation during his remaining time in office. New rules ought to ensure that those working for financial firms are “less incentivized to take big, reckless risks” that could wind up harming the financial system, Mr. Obama said after the meeting.

As regulators complete the new version of the rule, they are discussing not just giving it more teeth than the original 2011 proposal but also forcing Wall Street to go beyond current compensation practices. Those have evolved over the past five years to align with the concepts of the original plan, even though it was never implemented. In addition to extending the deferral window for parts of bonuses, regulators want to broaden the pool of bank employees subject to the new rules by expanding the definition of “risk taker” to include benchmarks such as the size of the assets traded by an employee.

The new version of the rule is likely to codify for the first time as government policy a requirement that companies claw back some of their top officials’ incentive pay if they have to reinstate financial results. That provision wasn’t in the 2011 proposal but has become a common practice on Wall Street in recent years.

– Broc Romanek, CompensationStandards.com

Here’s a nice survey by Semler Brossy about the trends in equity plan proposals…

– Broc Romanek, CompensationStandards.com

Here’s an excerpt from this Forbes article:

And there’s some truth to all of those things. But the ultimate culprit here is something for which until recently Valeant was lauded far and wide as a role model for other corporations: its executive compensation plan.

Valeant’s plan was praised for years by everyone from activist hedge fund billionaire Bill Ackman to top executive-pay experts at the University of Chicago and Harvard Law School for its unique incentive model. Pearson and other top executives would receive relatively little in the way of cash compensation but massive amounts of incentive stock and options. And that stock would be tied up for extremely long periods (an extended vesting period–then for Pearson another three years). In short, Pearson and his team would be paid handsomely if they could create long-term value, in lockstep with their shareholders. There would be no easy cash-out.

On paper it worked brilliantly, and Pearson went on a tear that created tens of billions in value and continued for several years. Ackman, who invested $4 billion in the company, compared him to Warren Buffett. But the plan also put an inordinate amount of pressure on Pearson to sustain the growth, and the stock price, by whatever means he could. Valeant was built to become a pressure cooker. And eventually the lid exploded, taking the chef out with it.

– Broc Romanek, CompensationStandards.com

Here’s this blog by Glass Lewis (also see this note from Manifest):

The 2016 UK AGM season has hardly begun and already two major shareholder revolts have surfaced at FTSE 100 issuers. In one of the most publicised spats over executive pay in recent years, a number of BP plc shareholders voiced their displeasure over the level of pay awarded to Bob Dudley, the company’s CEO, in the lead up to the Company’s 2016 AGM. As a result, the passing of the remuneration report was always likely to be a close-run affair. Investors of all shapes and sizes were angered by the clear disconnect between increasing pay and tumbling financial performance, exemplified by the maximum payouts under the company’s bonus plan and the reporting of a $6.5 billion loss. When the votes were announced, investor discontent was even higher than expected, with shareholders resoundingly rejecting the Company’s advisory proposal on the remuneration report– in total, just shy of 60% of voting shareholders registered against votes at the Company’s heated AGM.

Voting at the Smith & Nephew AGM took place only hours later, and shareholders at the medical-device maker followed the lead of their counterparts at BP, although for materially different reasons. Here, the rebellion focused on the remuneration committee’s decision to override the formulaic outcome of the long-term incentive plan, which stipulated that awards would only vest if TSR was at or above the median of a small, bespoke peer group. After the peer group shrank due to market consolidation and the Company found itself below the median of the partial group, the committee exercised its discretion to permit awards to be released as if the median target had been met. The committee’s detailed disclosure regarding its decision, which included pointing to the company’s significant outperformance of the FTSE 100 and S&P 500, did not placate shareholders’ clear unease surrounding any discretionary uplifts in pay, which remains a red button issue for UK and international shareholders alike.

Prior to Thursday, only seven FTSE 100 companies had failed to secure approval of their remuneration report and the two defeats within hours of one other will undoubtedly call to mind memories of the 2012 AGM season, referred to as the “shareholder spring” due to a spate of revolts relating to executive pay, some of which engendered CEO resignations. It is too early to assess the full extent of the fallout from these latest shareholder rebellions; however, while the proposals were put to shareholders on an advisory basis, it is clear that remuneration structures and levels of pay continue to be areas under intense scrutiny from both investors and the general public, and have the ability to cause a level of discomfort for board members through major PR hiccups.

Both companies expressed their disappointment with the results, while committing to increased dialogue with investors over the coming months; however, both also stood over the decisions made in the past fiscal year. As such, speculation remains rife as to potential board changes in light of the defeats, particularly with regard to remuneration committees who have overseen payments and decisions that have driven some of the highest levels of shareholder discontent the UK market has seen; the Institute of Directors, a body representing company directors, has gone as far as to state that the reaction of BP’s board “will determine the future of corporate governance in the UK.”

It remains to be seen if an increased focus on engagement with shareholders in advance of the 2017 AGMs, when both companies will be required to seek shareholder approval of their remuneration policies on a binding basis, will lead to a softening of shareholder anger. One thing is for certain however, an early shot has been fired across the bow of UK boards: Pay remains a highly contentious issue, and one which shareholders are willing to provide management with bloody noses and public embarrassment over.