– Broc Romanek, CompensationStandards.com

This column by the Editorial Board of the NY Times – regarding stock buybacks & their impact on executive pay – ran yesterday:

In theory, “pay for performance” — linking executive pay to a company’s stock price — aligns the interests of executives and shareholders. It’s supposed to ensure that executives are not tempted to enrich themselves at the expense of shareholders, who are too numerous and far-flung to influence a company’s behavior.

In practice, it hasn’t quite worked that way. Instead, beginning around the 1970s and becoming increasingly common in the leverage-buyout era of the ’80s, the defining characteristic of pay for performance has been an explosion in chief executive pay that exceeds the value that any human being who isn’t Midas could reasonably be credited with producing. In 2015, the median pay package for chief executives at 200 large United States companies was almost $20 million per year, nearly 400 times the pay of a typical worker.

Because executive pay is an expense, excessive pay means that shareholders are losing money. A new study, analyzed in a recent report in The Times, explores that loss and provides fresh evidence that should reinforce the mounting calls for reform of executive pay practices. The study, by Wintergreen Advisers, a money management firm, looked at two hits that shareholders absorb from executive stock awards. The first hit is well known. When a company issues shares under an executive-pay agreement, the increase in the number of shares outstanding dilutes the value of existing shareholders’ stakes.

The second blow, involving share buybacks, is less obvious. Buybacks, in which management reduces the number of publicly held shares by repurchasing the company’s stock, are often pitched as a way to boost a company’s earnings per share. But the study points out that buybacks are aimed not necessarily at benefiting shareholders, but rather at offsetting the dilution that results from awarding stock to executives.

That observation is reinforced by the fact that corporate buyback activity increases when stock prices are high — exactly the opposite of what prudent investing would dictate. In all, the study estimates that the shareholder costs of the dilutions, and the buybacks to reduce that dilution, at companies in the S.&P. 500 index amounted to 4.1 percent of each company’s shares outstanding and 10.2 percent at companies with the highest combination of awards and buybacks. That implies a hefty sum of shareholder money spent to funnel money to executives. Research into the motives and consequences of share buybacks is continuing, so other approaches could yield different figures, but even the lower estimates would represent a significant cost to shareholders.

Excessive executive pay is deservedly blamed for rising income inequality, because worker pay has stagnated as executive pay has soared. But it has not been as widely faulted as a drag on shareholders because the durable pay-for-performance narrative still persuades many investors that they benefit when executives are lavishly rewarded. The Wintergreen study suggests otherwise, that oversized awards can mean diminished shareholder wealth.

Here are two other recent NY Times articles:

– Investors Get Stung Twice by Executives’ Lavish Pay Packages
– How to Fix Wall Street’s Flawed System of Compensation

– Broc Romanek, CompensationStandards.com

Here’s this blog by Mark Cuban (“Shark Tank” TV show; owner of Dallas Mavericks) from way back in ’08:

There is a game played by CEOs with the corporate issuance of lottery tickets. Otherwise known as stock. Stock can be issued in any number of ways, shapes or forms. Warrants, options, restricted or unrestricted stock. No matter what you call it, every CEO hired, is asking for equity knowing that their only goal is to hit the jackpot and create a pool of wealth that puts them in the “fuck you” wealth category. Thats enough money to buy or rent just about anything you can think of and put you in position to never have to work again. You just live off the cash in the bank.

Put another way, every hired CEO is looking to be in a position to look in the mirror , smile and tell themselves they have made it. They are living the American dream. The only way to do that is to grab as much equity equivalents as you can and do everything you can to get that stock price up as high as you can while periodically liquidating the stock and stuffing the cash in your bank account.

There is absolutely nothing wrong with doing so. Any CEO who doesnt take advantage of this golden ticket opportunity is an idiot. In fact, although I don’t have actual numbers, I would hazard a guess that more than 95pct of CEOs hired to run companies with a billion dollar plus public market caps probably do get themselves to the position of having more than 10mm dollars in equity very quickly. While those who manage to hold on to their jobs a while and not screw up too bad, can relatively quickly get past the 25mm dollar in equity mark and reach the 50mm dollar mark with in 10 years. Its actually pretty tough to screw up and not get there if you have any brains at all.

Why?

Because you have the entire Mutual Fund, Hedge Fun and Brokerage industry doing everything they can to get you there. Think about it.

You can’t turn on CNBC or Fox Business without them cheerleading the market to go up. Every man, woman, child, fund, index or interested party who buys the stock is doing everything they can to get the stock of the company to go higher. They don’t really care how you run the company and they care less about the results of the company than they do about the performance of the stock. Heck, even if they did care, shareholders dont really own anything and have zero say in the company. If you really dig into it, its the ultimate in social networking. Everyone who owns the stock belongs to the fan page or group for the stock and they are telling everyone they can how wonderful the company is and why the stock will go up, all while praying it does so.

Its the American way and it works ! Hundreds of millions of dollars are spent every year by brokerages telling every American that the stock market over time will go up 7pct per year. All you have to do is diversify and hold onto your stock long enough. For better or worse, everyone believes it.

With all of that social networking power, call it stocksourcing behind stocks, how can CEOs not get rich ?

The problem with all of this is that there is a huge disconnect between the CEO and shareholders doing well and those who work for the company doing well

Yes, its true, particularly in markets like we are experiencing now, stocks can hit 52 week, or even multi-year lows.(although more often than not, in spite of low stock prices, market caps have increased).

Yes, its true that CEOs see the value of their holdings shrink. However, unlike lottery tickets whose value goes to zero when you dont hit the number, the CEO equity positions retain their upside and history has shown us that if they go far enough underwater, they will get repriced and /or reissued. All in the name of keeping the CEO happy. So while CEOs may get “less rich” for awhile, the game is stacked so that a downturn gets them happy real fast when the upturn comes.

The disconnect is that there is a big difference between not making Wall Street happy and not making money.

The pressure from Wall Street is to grow earnings forever. Not matter what it takes. This isnt a problem when a company is doing well. EVeryone is happy. But when the economy hits a bump like it has now, when the market is hitting a bump and stock prices are declining, like it is now, the pressure comes. Everyone owning the stock reacts and whats to know what the CEO will do to get the price back up. This, as they say “is where the CEO earns their pay” Unfortunately, what this really means is that everyone who works for that company is at risk. At risk of losing their jobs, benefits, raises, you name it. Its at risk.

All of which is a long winded way of saying that employees live in the corporate cash zone, CEOs and the top few in management live in the equity/lottery ticket zone.

Those in the cash zone always take the first hit. People,places and things that consume cash are the first things to go because cash expenses immediately reduce earnings. If you or anyone like you consumes cash, unless someone upstairs thinks you generate a straight to the bottom line return on the cash expenditure, you are about to become a corporate ghost. Your person, place and thing will be memorialized as a cut to increase earnings mentioned in a press release that wall street will cheer and use to push up the stock price.

What makes me sad about all of this is that I really think that in this country if there truly was a connection between shareholders and management, that if given a choice by profitable companies, most of us would choose to hold on to our shares and accept an expanded PE for some period of time in exchange for people keeping their jobs.

I would love to receive an email from a company I own saying something to the effect of:

Dear Shareholder,
We are facing a very difficult decision that we would like your feedback on . Our earnings per share last quarter were 20 cents, and for the entire last year, 80 cents. Because of a downturn in business caused by XYZ factors, we face the choice of making 10 pct less, or cutting headcount and related expenses in order to maintain our earnings and possibly even grow our earnings a couple cents this year.

As a shareholder, we would like to ask you whether you would consider allowing us to retain these valued employees. We recognize that it would require you accepting a PE multiple 10 pct higher than the current market. We hope you would be willing to make this concession. We think that the jobs this will save will return far greater value to shareholders over the long run.

We look forward to your vote.

Personally, Im willing to give a higher multiple in exchange for saving people’s jobs. At least once.

Unfortunately, this of course is a fantasy that can’t happen in this country.

Which brings us back to CEO Pay.

As long as CEOs live in the equity/lottery ticket zone and employees in the cash zone, CEO pay is going to be outrageous relative to everyone else.

The only possible way to change this is to put CEOs in the cash zone. Make companies generate 100pct of their compensation in cash that is 100pct expensable in the quarter paid. Thats not to say they cant own stock. Hell yes they can own stock. But make them buy it either on the open market, or as part of the programs that make stock available to every company employee, on the same terms. They are getting paid enough in cash and if they believe in their ability to run the company, they can put their money where their mouth is. Eliminate all the free lottery tickets. Make them buy stock, options, warrants, whatever, on the same terms as everyone else can.

Shareholders tend to ignore how much stock is given to management, they don’t ignore cash. Companies will always be a lot more stringent with their cash, whether its paid to the CEO or anyone else. CEO cash compensation will go way up, but total compensation will come way down. More importantly , CEOs getting paid huge sums in
cash will stand out like a sore thumb when things arent going so well. They will be treated like everyone else in the cash zone and held far more accountable for their work.

Of course this is all just my opinion, but to me its a good thing for all involved. The rich can still get richer, but everyone shares in the risk.

– Broc Romanek, CompensationStandards.com

There’s a bunch of interesting stats in this 26-page study by Meridian Compensation Partners…

– Broc Romanek, CompensationStandards.com

Here’s a chart of the problematic pay practices identified by ISS in its voting policies from Paul Hastings’ Mark Poerio through his ExecutiveLoyalty.org site…

– Broc Romanek, CompensationStandards.com

Here’s the intro from this blog from Manifest about the “Financial Services and General Government Appropriations Bill” for fiscal year 2017:

The US House of Representatives last week voted on a series of proposals designed to dismantle key aspects of Dodd Frank reforms. After June’s vote to propose regulation of proxy advisors and rescind the conflict minerals rule, the latest intervention on watering down shareholder rights and ESG removes:

– the SEC’s authority to enforce the CEO median pay ratio disclosure rules;
– the ability for the SEC to mandate companies disclose material climate-change risks; and
– the ability for SEC to give shareholders voting by proxy the ability to vote for a mix of of management and opposition board candidates on the same “univeral ballot card”. At present, only shareholders physically present at a meeting are allowed to vote for a mix of candidates from different slates. Shareholders voting by proxy must choose one full slate or another.

The proposals were put forward as “poison pill riders” to a financial-services agencies appropriations bill for the federal budget year beginning October 1. Although the bill was passed and sent to the Senate, the future of the most controversial aspects is uncertain. It is understood that due to the timing of the presidential elections, Republican leaders do not want to pass a budget bill that could lead to a presidential veto that they could not override. A previous vote to reduce SEC funding by $50 million was opposed by Senator John Boozman.

I did a quick Google search & couldn’t find these poison pill riders – but I did find this version of the bill, which would also bar the SEC from rulemaking on political contribution disclosures (Section 625 on page 134)…

– Broc Romanek, CompensationStandards.com

Here’s the intro from this Equilar blog:

Since the passing of Dodd-Frank in 2010, executive compensation has become increasingly scrutinized in light of increased transparency and enhanced disclosure. Nowadays, shareholders expect corporations to have well-rounded and fair compensation programs, and to achieve this, companies often use compensation consulting services and compensation surveys to supplement data reported in public filings. A majority of public companies engage compensation consulting firms to advise on their compensation programs, and many others use survey data for benchmarking executive pay—often hand-in-hand with consultant advisory services.

In 2015, 38.5% of Russell 3000 (R3K) companies that retained a compensation consultant for advisory services also used at least one compensation survey, down from 46.6% in 2011, according to disclosure in annual proxy statements. For those that did not utilize consultancy services, only 24.7% used survey data in 2015, down 3.8 percentage points from 2011. Companies that retain consultants for compensation advice are more likely to also use compensation surveys, though the tie between consultant engagement and survey usage is weakening over time.

– Broc Romanek, CompensationStandards.com

Here’s a note from Sarah Wilson, CEO of Manifest (a proxy advisor in the UK) about the proxy advisor reform bill pending in the House that I have blogged about several times on “TheCorporateCounsel.net Blog” (here’s the latest):

Remember that so few companies have failed to earn majority support for say-on-pay in the United Kingdom because the proxy advisors there drive the process in a way that companies know what likely will pass – and what won’t.

The issue is that “yes, the investor group guidelines are largely public – but not everyone thinks they are good and have their own views” but more importantly in the UK, we just don’t need to resort to voting against because although we have a very pro-shareholder legal framework:

– Voting isn’t mandatory per ERISA
– Most votes are binding and so therefore very robust – we CAN get rid of a director with a single AGM vote rather than wonder why after 4 votes nobody is doing much about it
– Company law rights haven’t been watered down by the securities regulators because company law is a separate branch and firmly embedded with common law
– Investors would rather solve problems through engagement
– In the UK, we have 2 vendors who are non-recommendations focussed, Manifest and IVIS.

Then there is the concern about: “We should at least worry that their advice might fail just like the advice of the credit ratings agencies failed.” Well, if the law passes, then you effectively get issuer control over research – which is exactly why credit rating agencies DID fail.

Oh the irony, Citizens United gives corporations free speech – but not the critics of the corporations. But the biggest question mark that I have is just where do companies get off with interfering with asset owners and asset managers freedom to choose and freedom to contract. And, as we have with common law, the freedom of quiet enjoyment of property rights? (Voting is a property right under UK common law). This is an infringement of an investor’s human rights (yes, investors have human rights as well as humans).

The proxy advisor reform bill is a truly ill-considered SLAPP suit and deserves to be exposed for what it is – a cowardly piece of lobbying by the Chamber of Commerce which daren’t criticize asset owners and managers, the providers of their capital.

Also see this blog from the CFA Institute railing against this House bill…

– Broc Romanek, CompensationStandards.com

As noted in this Steve Quinlivan blog and this Ning Chiu blog, the SEC approved Nasdaq’s golden leash disclosure rule last Friday – just before it’s July 4th extended deadline. Here’s the 14-page order from the SEC. Both of those blogs were written before Nasdaq released Amendment No. 2 yesterday. Amendment No. 2 contains the actual rule language (starting on page 30). The new rule will be effective in approximately 30 days. I’m posting memos in our “Director Compensation Practices” Practice Area.

Here’s an excerpt from Cydney Posner’s blog, which she tweaked after Amendment No. 2 was released:

Rule 5250(b)(3) will require each listed company to disclose, by the date the company files its definitive proxy statement for its next annual meeting, the parties to and material terms of all arrangements between any director or nominee and any person or entity other than the company relating to compensation or other payment in connection with that person’s candidacy or service as a director. A company must make the required disclosure at least annually until the earlier of the resignation of the director or one year following the termination of the agreement or arrangement.

The accompanying interpretive material indicates that the terms “compensation” and “other payment” as used in the rule are not limited to cash payments and are intended to be construed broadly. The disclosure requirement encompasses non-cash compensation and other forms of payment obligation, such as indemnification or health insurance premiums. Note that the rule does not separately require the initial disclosure of newly entered arrangements so long as disclosure is made under the rule for the next annual meeting. The information must be disclosed either on or through the company’s website (in which case it must be continuously accessible) or in its definitive proxy statement.

Nasdaq also explicitly states that, if a company provides disclosure in a definitive proxy or information statement, including to satisfy the SEC’s proxy disclosure requirements, sufficient to comply with the proposed rule, the company’s obligation to satisfy the rule is fulfilled regardless of the reason that the disclosure was made.

No disclosure will be required for arrangements that:

– relate only to reimbursement of expenses in connection with candidacy as a director;
– existed prior to the nominee’s candidacy (including as an employee of the other person or entity) and the nominee’s relationship with the third party has been publicly disclosed in a definitive proxy or annual report (such as in the director or nominee’s biography); or
– have been disclosed under Item 5(b) of the proxy rules (interests of certain persons in connection with a proxy contest) or Item 5.02(d)(2) of Form 8-K (description of arrangements in connection with election of a new director) in the current fiscal year. (However, this disclosure would not obviate the need for the company to comply with its annual disclosure obligations under the rule.)

Nasdaq cites as an example of an agreement or arrangement falling under the exception for arrangements that existed prior to the nominee’s candidacy is a director or a nominee employed by a private equity or venture capital firm or a related fund, “where employees are expected to and routinely serve on the boards of the fund’s portfolio companies and their remuneration is not materially affected by such service. If such a director or a nominee’s remuneration is materially increased in connection with such person’s candidacy or service as a director of the company, only the difference between the new and the previous level of compensation needs to be disclosed under the proposed rule.”

So long as a company has undertaken reasonable efforts to identify all arrangements — including asking each director or nominee in a manner designed to allow timely disclosure — if the company then discovers an agreement or arrangement that should have been disclosed but was not, then the company can remedy the inadvertent failure to disclose by prompt disclosure after discovery of the error by filing a Form 8-K, where required by SEC rules, or by issuing a press release; in that event, the company will not be considered deficient with respect to the rule. However, remedial disclosure, regardless of its timing, would not satisfy the annual disclosure requirements. In all other cases, the company must submit a plan showing that the company has adopted processes and procedures designed to identify and disclose relevant agreements or arrangements, subject to approval by Nasdaq.

Nasdaq is also amending Rule 5615 to provide that the required disclosure of third-party payments to directors will be among the provisions allowing a foreign private issuer, upon satisfying specified conditions, to follow home country practice.

– Broc Romanek, CompensationStandards.com

As noted in this Audit Analytics blog, nearly 60% of proxy statements include non-GAAP financial measures this year – up from a 20% rate in ’09. Thus, the new Corp Fin CDIs aren’t merely directed at earnings releases, 10-Qs and 10-Ks. Learn more in our oodles of memos about the new CDIs posted in the “Non-GAAP Disclosures” Practice Area on TheCorporateCounsel.net.

Tomorrow’s Webcast on TheCorporateCounsel.net! “The SEC Speaks on Non-GAAP”

Since we’ve still been getting so many questions about what the SEC Staff expects in the wake of Corp Fin’s recent issuance of new non-GAAP CDIs, we’ve calendared a new webcast – “Non-GAAP Disclosures: The SEC Speaks!” – that will be held tomorrow, Wednesday, July 6th with Mark Kronforst, the Chief Accountant of the SEC’s Division of Corporation Finance! Dave Lynn & Meredith Cross will join Mark as they parse the questions that Corp Fin has been receiving since the CDIs – as well as the type of comments that the Staff has been issuing (those comment letters aren’t public yet since the files aren’t “closed”).

If you can’t make the webcast live, the audio archive will be posted immediately after the program ends – and a transcript will be posted about 10 days after that. If you’re not a member of TheCorporateCounsel.net, try a “Half Price for Rest of ’16” no-risk trial now…