– Liz Dunshee

This Pay Governance memo examines the relationship between “problematic” pay practices – as identified by ISS (pg. 22) and Glass Lewis (pg. 26) – and three-year performance. Key takeaways include:

– Companies that maintain pay practices viewed as “problematic” by proxy advisory firms (e.g. excise tax gross-­ups, lower target annual incentive goals without a corresponding reduction in target pay, and target payout for median TSR performance) tend to underperform companies that do not maintain these “problematic” pay practices.

– Companies that maintain legacy excise tax gross­‐up protections for NEOs, a common irritant for many investors, do not appear to underperform those companies that have eliminated excise tax gross-­ups.

– Companies that have lowered annual incentive goals year-­over­‐year without a corresponding reduction in target incentive opportunity tend to underperform on three-­year TSR compared to companies with flat or increased incentive goals year-­over-year. Because the lower TSR performance negatively affects pay, we continued to see pay-for-performance alignment in these companies.

– Companies that set rigorous relative TSR goals (i.e., above‐median performance required for target payout) tend to outperform companies that maintain traditional relative TSR performance-payout structures (target payout provided for median performance) based on three­‐year TSR results.

– Liz Dunshee

The FASB’s new revenue recognition standard – which applies starting in 2018 – is mainly getting attention for its impact on disclosure & internal controls (see my blog last week on TheCorporateCounsel.net). But if your pay metrics are keyed to revenue, you should also be discussing how the change will affect multi-year & future plans – and how to handle it. Check out this excerpt from Cydney Posner’s blog:

How to address that problem? Two approaches have surfaced so far: “One approach is to keep two sets of books, one under the new standard and another for purposes of the compensation plan or bonus arrangement…..The second approach is to change the comp plan or bonus arrangement.

Neither approach is an ‘obvious’ solution and comes with challenges and complications. ‘Can you do that unilaterally—there’s probably some legal implications—can you just say this was the bogey we had set up and we’re going to change that because we changed the way we’re keeping score for revenue we’re going to change the plan—not obvious how you just go ahead and do that….I’ve come across this with a number of companies and it’s presented some real issues in terms of how do we deal with this.’”

Delay in dealing with the issue, and in involving others outside of accounting, will just make it more complex.

– Liz Dunshee

These days there’s a lot of uncertainty around executive compensation laws, particularly given recent events in DC. Recently, Equilar collected views from a group of folks about what to do. Here’s some themes:

– Given its administrative complications, continue preparing for compliance with the pay ratio rule

– Monitor efforts to repeal or revise Dodd-Frank mandates – and redirect internal & external resources as matters evolve

– Continue to focus on shareholder engagement & proxy messaging – legislative changes won’t eliminate public critique of excessive executive pay

– Comply with current requirements for comp plans – e.g. 409A – until any rule changes are actually made

– Don’t get distracted from long-term goals

– Liz Dunshee

In this Pearl Meyer survey, 60% of companies said that ESG issues were a top concern. Not only is there a global regulatory trend to require disclosure on things like environmental & employment policies – but investment dollars are flowing to companies with demonstrably strong ESG metrics & shareholders are demanding that boards & comp committees proactively drive “sustainability” performance.

It can be an intense process to link pay to appropriate ESG measures for your company – but this memo suggests some whys & hows:

– Identify long-standing activities already taking place in your company that fall into the ESG category. Existing HR goals like hiring diversity or environmental, health & safety measures can easily be reported as ESG-related actions. Supply chain practices, energy usage & resource conservation efforts may also apply.

– Consider whether the identified actions are already indirectly represented as a component of some executives’ performance-based pay – particularly health & safety. If present at all, the metrics are most likely indirect & folded into larger measurement components – you may be able to create an explicit link.

– Catalogue the benefits of directly tracking these activities. For one, they can be packaged as a corporate social responsibility report – to meet regulatory requirements or serve as a positive corporate communication tool.

Check out Alcoa and also Exelon for examples of directly linking pay to sustainability goals & other operational metrics.

– Liz Dunshee

Recently, a member asked in our “Q&A Forum” (#1180) whether there were any quarter-by-quarter checklists for compensation committees. In response, we posted some new resources in our “Compensation Committees” Practice Area – including this detailed chart in Word from Mike Melbinger – and this high-level governance calendar for the board & all key committees.

– Liz Dunshee

As a follow-up to my recent blog, here’s an update from Steve Quinlivan:

The shareholder has now dismissed the case with prejudice. From the docket, you can’t rule out Intel from having entered into some sort of settlement agreement. If they did, let’s hope it was less than modest, so that we can thank Intel for holding the line and not encouraging this behavior.

– Broc Romanek

I worry that some companies might be relying on Congress to step in and delay the implementation of the pay ratio rule. That’s looking less likely by the day. So the time that you have to prepare is narrowing.

It’s also far from clear whether the SEC would take action to delay implementation of a rule required by Dodd-Frank. Then-Acting SEC Chair Piwowar’s re-opening of comments earlier this year did not result in an outpouring of complaints from companies. Beyond 13,000 form letters in favor of pay ratio disclosures, the SEC received about 180 comment letters – of which only about 15% were against the rule. In this blog a few months ago, I linked to some of the comment letters from specific companies. And Ning Chiu blogged yesterday about a specific comment letter.

Our upcoming “Proxy Disclosure/Say-on-Pay Conferences” will comprehensively cover what you need to be doing now to implement pay ratio – with 20 panels spread over two days. Many of the panels will be drilling down into pay ratio issues. Act by June 9th for a 20% early bird rate. You can attend in-person in Washington DC – or watch by video online.

– Broc Romanek

Here’s a piece from Willis Towers Watson about private companies & LTIPs. Here’s an excerpt:

These are the core LTI-related questions that should be addressed by companies that plan to stay private:

– Is the company willing to use real stock to compensate its executives? If so, securities law (i.e., registration exemption) must be considered. But most private companies, especially family-owned businesses, are not willing to offer such LTIs. Our data indicate that about 80% of these “permanent private” firms do not use real equity in their lLTI programs.

– How important is long-term value creation to the company’s owners? Long-term value creation frequently isn’t paramount to owners who don’t plan to sell in the near future. While value is certainly important, many private companies, notably family- and founder-owned businesses, tend to emphasize consistent long-term growth, profitability, cash flow and dividends over long-term value creation.

– How do business owners define and measure long-term success? When defining and measuring long-term objectives, private companies tend to emphasize growth, profitability, cash flow, sustainability, liquidity and risk level. They may also focus on reinvestment of cash in the business versus paid as dividends to shareholders. Moreover, several studies have shown that private companies are more likely to focus on mission-based objectives related to employees, community, customers and the environment.

– How long is “long term?” Not surprisingly, private businesses tend to think of the long term as 5 to 10 years versus the 2- to 3-year time horizons of public companies. In line with this, private companies are more likely to emphasize loyalty and longevity with regard to employees, customers, suppliers and other stakeholders. This longer-term time horizon is often reflected in LTI design.

– How important is long-term retention of employees and wealth creation? In private companies, LTI often plays a dual role of performance-reward and retirement-funding vehicle, which must be figured into incentive plans.

– How and when will the LTI plan be paid out or monetized? This is particularly important for a value-based plan where there is no market for the stock or phantom stock. In particular, monetization presents thorny tax code issues, including fairly rigid requirements around the timing of vesting and payment.

– Is the LTI plan affordable over the long term? It’s critical to model the LTI plan over at least 5 to 10 years to assess its accounting and cash costs to the enterprise.

– Broc Romanek

Here’s an excerpt from this European article entitled “Why It’s Right to Be Mad About Executive Pay”:

The critics are right and the defenders of CEO pay are wrong, according to a study for Handelsblatt Global Magazine by Zurich-based economist Gerhard Fehr. There is, on average, no discernible relationship between executive pay and company performance – suggesting that executives generally reward themselves regardless of whether they succeed or fail. Digging into the data for 70 leading companies in Germany, Switzerland and Austria – and comparing board members’ compensation with shareholder returns relative to other companies – Fehr found no pattern at all. “The idea that executive pay is generally based on performance is post-factual,” he says. Fehr is the founder and CEO of Fehr Advice, a consultancy and research group based on his work in behavioral economics.

If the idea were true that executives’ lavish pay checks were a reward for performance, then the data should show higher pay at companies producing higher shareholder returns – and vice versa. But in reality, Fehr and his researchers found no such connection, no matter how they sliced and diced the data. Pay goes up regardless of how companies perform.

Fehr’s study does not mean that there aren’t individual companies that reward their management for good performance, or cut pay when they do worse. What it does show, clearly, is that there is no such trend across all companies. For every company that rewards its executives for good performance, there is another where paychecks go up when times are bad. Many show little variation at all, signaling that these executives have managed to insulate themselves from the effects of their actions.

Unlike many company bonus systems, Fehr measures executives’ performance by looking at shareholder returns in relation to a company’s peers – what he calls a market-adjusted performance index. Executives shouldn’t be rewarded, he says, for share prices moving up or down with the general market.

– Broc Romanek

Here’s a few articles about how pay levels look this year based on this season’s proxy statements:

– WSJ’s “It’s Good to Be a CEO, Again: Stocks Rise, and So Does Pay”
– ISS Analytics’ “As 2017 Filings Pour in, U.S. CEO Pay Hits Record Levels”
– Equilar’s “Highest-Paid CEOs at the Largest Companies by Revenue”
– IR Magazine’s “CEO pay rises despite companies’ performance, study finds”
– Willis Towers Watson’s “Closer look at the findings of our 2017 proxy analysis”
– Willis Towers Watson’s “Total CEO pay in U.S. companies rose 6% in 2016”