– Broc Romanek

Here’s an excerpt from this interview with Meridian Partner Bob Romancheck:

What catalysts exist today, including the results of the presidential election, that could trigger a reemergence of the use of stock options?

There are multiple catalysts now in place that could prompt an increase in the use of stock options. The single strongest factor is the recently created expectation of economic growth. The articulated policies of President Trump have caused the stock market to jump in anticipation of a much stronger rate of US economic growth than we have seen for years. Recall that from the historic barometer, economic growth means some compensation committees may return to the use of stock options to incent further share price growth and to capture this upside (which is leveraged around 3 or 4 to 1, since economically, it typically requires the grant of three or four stock options to equate to the grant value of one restricted share or performance share—so potential upside is significantly higher with the use of stock options).

Additional catalysts include the much lower dilution rates that now exist across US public companies (making room for option grants). Also, the initial shock of requiring an accounting expense for stock options has long since worn off. The accounting cost is now mostly neutralized, since all types of long-term incentive vehicles require an expense charge of about the same magnitude (note, although the Black-Scholes expense for a stock option, in simple terms, may be approximately one-third of the grant price, since it often takes three times as many NQSOs to equal the grant value of restricted shares, the expense comes out about the same).

Finally, there is still the benefit of a corporate income tax expense and possible cash inflow for the company at exercise. And stock options have always been a great income tax deferral mechanism for executives, although tax deferrals may not be quite as valuable in the future, with the likelihood of lower marginal income tax rates.

– Broc Romanek

Here’s an excerpt from this blog by Roy Saliba, ISS’ Head of Global Compensation Products:

ISS observes actual payout levels for short-term performance awards and finds that the general trends in fiscal year 2015 are consistent with expectations, where 88 percent of companies achieved threshold payouts as defined by their awards, 56 percent achieved target payouts, and while only 7 percent of companies achieved maximum payouts, it is still within the range of expectations. Some differences exist between large-cap, mid-cap, and small-cap companies with S&P 500 companies having the highest achievement rates of threshold payouts and slightly lower achievement rates of maximum payouts, although all indices have achievement rates that are in line with general expectations.

– Broc Romanek

Recently, FW Cook’s 2016 director compensation report came out. Here’s the intro:

In terms of pay levels, total compensation increased by 1.3% at the median of the total sample versus last year’s study, which reflects an apparent stabilization of director pay among large- and mid-cap companies in particular. Large-cap companies in our study pay directors $260,000 at the median and $300,000 at the 75th percentile, unchanged from last year. The mid-cap median of $200,000 reflects only a 1.1% increase from last year, while the small-cap median of roughly $145,000 reflects a larger increase of 6.0%. Technology continues to be the highest-paying sector in our study, and Financial Services the lowest, consistent with recent years.

Also see this blog by Keith Bishop about the bizarre requirement for California corporations for directors to approve of their own compensation by “round robin” voting…

– Broc Romanek

As I’ve blogged before, the “Financial Choice Act” is a House bill that would roll back much of Dodd-Frank (and more). Here’s an excerpt from this Bloomberg article:

Now, though, the drive to wipe out or scale back Dodd-Frank has lost momentum. Trump issued an executive order on Feb. 3 for Treasury Secretary Steven Mnuchin to review the law, but the president made no mention of it in his priority-setting speech to Congress on Feb. 28. As with the Republican vow to repeal Obamacare, the sticking point may be finding a replacement for the law on the books. “We need to regulate more simply, cut back on unintended consequences, and see if we can recalibrate this,” says Douglas Elliott, a partner at management consulting firm Oliver Wyman. “That happens to be an extremely hard thing to do.”

Hensarling does already have a bill in the House, the Financial Choice Act, that’s being given long odds. “We think the chances that the bill becomes law are less than 20 percent—maybe as low as 10 percent,” Brian Gardner, Washington analyst at the investment bank Keefe, Bruyette & Woods, wrote to clients on Feb. 16. Even so, the bill offers a glimpse into Republicans’ thinking on how to shape financial regulation.

– Broc Romanek

Arthur J. Gallagher & Co. recently completed its 8th annual study of short- and long-term incentive plan design trends among Top 200 companies. Some key findings include:

Short-term Incentive Plans (STIPs):
• Of the 200 companies reviewed, 61% of companies with STIPs indicated the use of “umbrella” STIP plans (also referred to as “inside/outside” plans or “plan within a plan”), which along with prior-year results, were the highest in the past five years.
• Many companies use individual performance measures in their STIPs. Of the 198 companies with some form of a short-term incentive, including companies with umbrella plans, 27% included individual, specific objectives for one or more NEOs.
• Earnings per share (EPS) was the most common single measure in STIPs. Thirty-eight percent (38%) of companies with non-discretionary STIPs used EPS in 2015, which is slightly lower than last year (40%).
• Ninety percent (90%) of companies disclosing their STIP measures and metrics used at least one type of income-based measure in 2015, which is lower than last year (93%). This category includes EPS, net income, operating income, EBITDA, etc.
• Median performance over target was 1.4% as compared with 7.0% in 2014. Median payout was 10.8% over target as compared with 21.5% in 2014.
• Of those companies with bonus or short-term incentive plans:
o 86% used at least one financial measure.
o The remaining 14% of companies used discretion (no formula-based determination).
o In all, 64% used discretion in part or in whole in 2015.
Long-Term Incentive Plans (LTIPs):
• Continuing in 2015 and for the seventh consecutive year was the shift away from appreciation awards (stock options/stock appreciation rights (“SARs”)) and towards performance awards that are earned based on achieving performance goals.
• The collective use of performance-based awards (which includes performance shares/units, performance-based restricted stock, performance stock options, premium stock options, and long-term cash plans) totaled 95% in 2014 and 2015, up from 93% in 2013, 88% in 2012, 82% in 2011 and 77% in 2010. On the flip side, the prevalence of stock option/SAR grants, in total, has declined steadily from 82% in 2008 to 61% in 2015.
• TSR is the most commonly used performance measure in LTIPs, with 56% of LTIPs using TSR in 2015, down slightly from 57% in 2014. This measure had steadily increased in use over the past few years, from 46% in 2011, to 51% in 2012 and 55% in 2013.

LTIPs
• Similar to STIPs, some type of income measure is commonly used in LTIPs. Fifty-one (51%) of companies with LTIPs used at least one measure of income in 2015, up from 49% in 2014 but less than the 53% prevalence in 2013. Of the income measures, EPS is still used most often with 58% prevalence in 2015 as compared to 57% in both 2013 and 2014.
• The use of revenue measures was flat with 2014 at 20% of companies, up from 18% in 2013. This was just below the high of 21% over the last six years.
• Forty-seven percent (47%) of the companies used a capital efficiency measure in 2015, which has increased from 31% in 2009. This category includes return on invested capital, return on equity, return on capital, and return on net assets, economic profit, and economic value added.
• Median payout was 4.0% over target, up from 2.0% over target in 2014. For those companies disclosing results, performance was 5.0% over target as compared with 4.6% in 2014.
• Seventy-five percent (75%) of performance periods reported were three years in length. which is up from 69% in 2014. Twenty percent (20%) used one-year performance periods, down from 27% in 2014. Twenty-one percent of these plans added two or more additional vesting years to get to at least three years of vesting. Also, for those companies using one-year performance periods, over half (56%) of them set performance goals annually over a three-year period.

Thirty-eight percent (38%) of companies with STIPs and LTIPs used one or more of the same measures in both incentive programs, which is slightly more than 37% in 2014.

– Broc Romanek

In case anyone out there is worried that we have seen the last of greedy executives, check out this recent US District Court-SDNY opinion by Judge Jed Rakoff. You cannot read this first paragraph of the case without taking an interest!

Why would the executives (and former principals) of a paddle-board division of a sports and recreation company cause the company to make a one-time $60,500 purchase of one million stickers that the executives themselves immediately attempted to repurchase from the company for approximately $4 million?

The answer is that they thereby hoped to stick the company with a $10 million “earnout” payment to the executives, thus netting themselves a cool $6 million. Thanks, however, to the age-old doctrine of good faith and fair dealing, and similar legal protections, in the end it is these executives who are stuck.

– Broc Romanek

Here’s the intro from this article in the “Harvard Business Review” (hat tip to Board Advisory’s Paul McConnell for pointing this out):

For much of the 20th century, workers at big companies were paid better than workers at small ones. An employee of a company with more than 500 employees historically earned 30%–50% more than someone doing the same job at a firm with fewer than 25 employees, for instance. But the pay gap between large and small companies has narrowed in recent years, and that decline is one reason for rising inequality in America.

It’s also a reminder that inequality is deeply intertwined with the day-to-day decisions companies make, say, about outsourcing manufacturing, or contracting with a caterer, or aiming for vertical integration, or focusing on the core. Big firms began doing countless things differently over the last few decades, for just as many reasons. But one major difference in big companies today compared to 40 years ago is that today’s giants pay less generously than the giants of the past, especially when it comes to their lowest-paid employees.

There are multiple reasons why big firms historically paid better than smaller ones. Part of it was related to the people who worked there. Bigger companies could attract qualified, sought-after employees who could demand higher wages. And big companies tended to be more efficient than smaller firms, which meant their workers were more productive and therefore better paid.

Bigger firms also seemed to resist too much inequality developing between pay at the top and bottom. That may have been because of unions, social norms, or the belief that equal pay would make employees work harder or stay longer. Whatever the reason, firms couldn’t get away with paying their top employees less — or else they’d leave — so they ended up paying their less-well-paid employees more. That meant the primary beneficiaries of higher pay at big companies were the lowest-paid people who worked there.

– Broc Romanek

As a follow-up to this recent blog by Choate’s Art Meyers, here’s the intro from this article:

The proliferation of state pay ratio proposals continued this week as legislators in the deep blue states of Massachusetts and Illinois introduced new pay ratio measures, with Massachusetts becoming the first state to eschew use of the SEC’s pay ratio calculation in favor of a pay ratio which focuses on comparing a company’s highest paid employee to median U.S. employee pay. The addition of the Illinois and Massachusetts legislation brings the number of states which have introduced or passed pay ratio legislation to five, not including the cities of San Francisco and Portland, Oregon. Interestingly, the two new pay ratio legislative efforts do not follow the templates used previously, which primarily imposed surtax penalties on companies based on the pay ratio:

See this Choate memo about the Massachusetts legislation…

– Broc Romanek

Here’s the intro to this Willis Towers Watson memo:

Companies with a significant presence in the U.K. face a new disclosure requirement taking effect in several months. In December, the U.K. government published the final version of its Gender Pay Gap Reporting Regulations. These rules will come into effect on April 5 of this year and will apply to all employers with more than 250 “relevant” employees in Great Britain (i.e., excluding Northern Ireland).

The requirement applies to any legal entity with operations in Great Britain, regardless of the parent company’s country of origin or structure (i.e., public or private). While the future of the CEO pay ratio requirement in the U.S. remains unclear, this new U.K. rule adds to the data-gathering and analytical burden many companies may be facing.

– Broc Romanek

Recently, ISS posted 11 new & updated FAQs about its US proxy voting policies. There’s now a total of 88 FAQs. None of them directly relate to executive pay – but you still might care. Some new & interesting ones about director attendance disclosures…