Recently, Willis Towers Watson evaluated year-end performance for the S&P 1500 – looking at median results for common pay-for-performance metrics. Here’s a teaser:
The results reflect low single-digit growth, a mixed bag in the balance sheet, less than stellar cash flow results, yet strong stock valuations and shareholder returns. This reminds us that the stock market looks forward, i.e., to 2017 and beyond. This is an important reminder when thinking about pay-for-performance alignment because most bonus plans and a sizable portion of long-term incentive plans pay based on past financial performance.
For 2017, investors appear optimistic – as analysts expect typical performance metrics to increase by 1-3%. But an uncertain policy & business outlook has made goal-setting more difficult…
According to a recent Equilar report, relative total shareholder return remains the most popular pay-for-performance metric – used by 57% of the S&P 500. But its use has leveled off amid recognition that executives can only control factors that influence TSR – not the final outcome.
How are companies implementing this shift away from TSR? Return on capital & earnings per share are gaining popularity – along with other metrics that drive TSR. Here’s a blurb from Equilar’s summary:
As a result, other popular metrics like ROC and EPS saw a resurgence in 2015. Only ROC consistently increased every year in the Equilar study, rising from 26.1% in 2011 to 30.6% in 2015 for CEOs. While EPS declined each year between 2011 and 2014, use of this metric in 2015 increased from 27.3% of companies to 29.2% in 2015, though still below its high in 2011 of 34.6%.
Most commonly, companies simply reduced how TSR was weighted, and half of the companies in the study employed this strategy. Companies redesigned these awards so that they were no longer contingent on one factor, instead using multiple measures to drive executive performance.
Interestingly, each company split its weighting in half, with one company reducing its impact on the award’s payout from 50% to 25% and four companies reducing it from 100% to 50%. These four companies balanced the use of TSR as a performance metric by incorporating at least one additional metric that affected the awards’ payouts.
While five companies balanced the use of TSR by introducing other metrics, four out of the 10 changed how TSR affected award payout by transforming it from a weighted metric to a modifier. Weighted metrics determine the initial award payout, while modifiers provide a final adjustment.
Three companies instituted a standard multiplier, which can adjust the final payout up or down. In the study, the smallest multiplier could adjust payout down by 90% and up by 110%, whereas the largest could adjust payout down by 75% and up by 125%. Pfizer had a unique modifier among the set of companies—while unlikely, the modifier has the power to reduce the award level to zero or boost it to the maximum in cases of extreme TSR performance.
Finally, one company completely removed TSR from their award design, shifting from a 100% TSR focus to a 100% EBITDA focus.
This article in “Proxy Insight” (pg. 3) by EY’s Rupal Patel in the UK proposes a new model for executive pay. Here’s an excerpt:
EY’s view is that this simplification agenda cannot be addressed by tweaking aspects of the traditional package. This is not about the number of performance measures used or the length of deferral applied. It is about acknowledging that a desire for simplification requires agreement on what is core to an executive pay strategy and to focus on that exclusively.
EY feels that many aspects of today’s pay structures, which have been viewed as integral to the traditional model, may not be the most efficient way to deliver remuneration or may simply be no longer relevant.
Speaking of the UK, this Manifest blog notes how BP simplified its pay policy in the wake of a failed say-on-pay vote in the UK last year…
This interesting memo from Pay Governance’s John Ellerman & Lane Ringlee describes the benefits of disclosing prospective compensation in the CD&A. Here’s a teaser:
In recent years, the SEC has developed extensive rules and regulations regarding the reporting of executive compensation in the company annual proxy. Such reporting includes the narrative discussion of CD&A executive compensation policies and practices as they pertain to the CEO and NEOs. Additionally, the SEC requires that companies provide numerous prescribed tables and schedules reporting the historical elements of executive pay for the most recently completed fiscal year as well as the past 2 fiscal years.
The thrust of the SEC’s current mandated reporting of executive compensation to shareholders is a “lookback” at executive compensation earned. Current SEC rules require companies to report on the executive compensation that was most recently earned and paid for the fiscal year just completed. For a typical public company that has a fiscal year of January 1 through December 31, the proxy is normally submitted to shareholders in April or May of the ensuing calendar year. Compensation reported for the preceding fiscal year in the proxy may be based upon decisions executed by the Compensation Committee as early as 16 months prior to the proxy reporting to shareholders.
The Delaware Chancery Court recently dismissed a derivative suit – “In re Investors Bancorp Stockholder Litigation” – challenging $50 million worth of director equity grants under a shareholder-approved incentive plan. The business judgment rule protected the directors because the plan limited awards by specific category of beneficiary – in this case, non-employee directors & employees – and the proxy statement adequately disclosed the impact of those limits. This excerpt from Steve Quinlivan’s blog gives more detail (also see this Mark Poerio blog):
The opinion notes the Court of Chancery recently performed an exhaustive review of the law of stockholder ratification with regard to director equity compensation in Citrix. The Citrix court noted that there is a distinction between stockholder approval of a plan that features broad parameters and “generic” limits applicable to all plan beneficiaries on the one hand and, on the other hand, a plan that sets “specific limits on the compensation of the particular class of beneficiaries in question.” Approval of broader plans will not extend to subsequent grants of awards made pursuant to that plan; approval of plans with “specific limits,” however, will be deemed as ratification of awards that are consistent with those limits.
According to the Court, once a plan sets forth a specific limit on the total amount of options that may be granted under the plan to all directors, whether individually or collectively, it has specified the “director-specific ceilings” that Citrix found to be essential when determining whether stockholders also approved in advance the specific awards that were subsequently made under the plan.
As noted on page 45 of their voting report, the UK institutional investor – Legal & General Investment Management – voted against 42% of pay proposals at US companies in 2016, based on its position that at least 50% of long-term equity awards should be based on achieving pre-set performance targets. Compare that number to ISS’s recommendations “against” at “just” 9% of US companies!
LGIM also voted against management on at least one proposal at 65% of its US portfolio companies (see chart on page 10). As noted on page 23, it’s one of those companies that want to see pay ratio disclosure…
The thrust of Norges’ positions is that long-term creation best aligns the company’s interests with what shareholders want. Here’s the 1st of four positions that brings this point home:
1. The board should ensure that remuneration is driven by long-term value creation and aligns CEO and shareholder interests. A substantial proportion of total annual remuneration should be provided as shares that are locked in for at least five and preferably ten years, regardless of resignation or retirement.
The 2nd position takes on targets:
2. The board should develop pay practices that are simple and do not put undue strain on corporate governance. Allotted shares should not have performance conditions and the complex criteria that may or may not align with the company’s aims.
The 3rd position looks to install a cap on overall pay:
3. The board should provide transparency on total remuneration to avoid unacceptable outcomes. CEO remuneration should be determined and settled in cash and locked-in shares each year. The board should also disclose a ceiling for total remuneration for the coming year.
The 4th position challenges termination payouts:
4. The board should ensure that all benefits have a clear business rationale. Pensionable income should constitute a minor part of total remuneration. The board should commit to not offering any end-of-employment arrangements that effectively shorten or dilute the lock-in of shares.
As noted in this WSJ article, the bartering to tweak the “Financial Choice Act” continues. Most of the Corp Fin-related notables in the bill remain untouched (eg. pay ratio would still get the axe) – but there are a few proposed changes that would impact you, such as changes to the ownership thresholds under Rule 14a-8, the shareholder proposal rule. This chart contains the changes – so far – from “Financial Choice Act 1.0.”
Of course, it’s still too soon to say what form the Choice Act will ultimately wind up taking – and even too soon to know if this legislation will eventually be “the one” put forward to replace Dodd-Frank…
Recently, Semler Brossy put out a pair of new resources – this memo describing the first failures of the proxy season. And this one predicting how the overall season will go…