CEO pay is increasingly tied to performance – but while cash pay is at an all-time low (according to this recent Korn Ferry study) – overall pay is continuing to climb. This leaves key institutional investors wondering whether the performance bar is too low. Here’s a teaser from this WSJ article:
For two-thirds of S&P 500 companies, the overall pay CEOs received over the past three years proved higher than initial targets, according to an ISS analysis. That is typically because performance triggers raised the number of shares CEOs received, or stock gains lifted the value of the original grant. On average, compensation was 16% higher than the target.
The values companies disclose for CEO equity awards also show that about one-third of CEOs start the fiscal year expecting to beat the performance targets that determine the size of those stock grants, ISS said.
Boards must juggle a range of factors in setting performance targets. Investors and proxy advisers have their preferred measures, and consultants recommend targets that are challenging but not impossible. They can evaluate how well they have chosen by considering the market’s reaction, said Ira Kay, managing partner at consultancy Pay Governance. “If we beat it and our stock goes down, it was probably not such a hard goal,” Mr. Kay said.
For more thoughts, check out this blog by Cydney Posner & my recent blog on the growing unrest over LTIPs.
Through the end of last month, shareholders approved “annual” say-on-pay votes at 92% of reporting Russell 3000 companies. As noted in this WSJ article, an annual vote can give shareholders an outlet for expressing discontent & protect companies from more drastic action – such as votes against directors. A longer period might be appropriate for some companies – and anecdotally, some shareholders prefer it – but only if solid engagement efforts exist.
Despite the community’s apparent comfort with the status quo, the bill that eventually replaces Dodd-Frank may modify the frequency requirement for say-on-pay votes – to require voting only in years where there is a “material change” to executive pay. Here’s an excerpt from this Dorsey blog:
So, each year the issuer would have to determine if there has been a material change to executive compensation when deciding what proposals are put before shareholders at the annual meeting. Many issuers would likely continue to hold an annual vote to seek feedback from their shareholders even if there was no material change in compensation.
However, given the high profile nature of a negative say-on-pay result, would issuers shy away from the advisory vote in a year of poor company performance (absent an obviously material change to executive compensation)? Will an issuer’s determination not to include the advisory vote bring on another wave of proxy disclosure litigation? Could an issuer determine not to hold a say-on-pay vote for multiple years in a row?
As John has blogged, the Choice Act isn’t likely to survive Senate review, but the Senate is likely to come up with its own replacement bill. And this aspect seems to fall in the category of “if it’s not broke, don’t fix it.” Visit our “Say-on-Frequency” Practice Area to read recent memos that examine the pros & cons of 1, 2, and 3-year voting practices.
Last month, an institutional investor sued United – demanding the board recover $37 million paid to former executives who participated in a 2011 bribery scheme. United’s board says clawing back severance would hinder its ability to recruit executives & cause competitive harm. Some people think the board was initially reluctant to claw back severance because it wanted the departed executives to cooperate in the related DOJ investigation.
Either way, it begs the question of how far a CEO would have to go before they’re denied severance or it’s clawed back. This NY Times article describes the circumstances:
You may recall this inquiry: It centered on United’s reinstatement of a money-losing air route between Newark Liberty International Airport and Columbia, South Carolina. United had canceled the route but re-established it at the behest of David Samson, then the chairman of the Port Authority of New York and New Jersey, who had a vacation home near Columbia.
Mr. Samson, whose position gave him great sway over Newark Airport, wanted access to convenient flights to his second home. He had threatened to bar United from building a crucial hangar on-site if it did not start flying to Columbia.
Mr. Smisek, United’s CEO, didn’t report this pressure. Instead, federal investigators said that he approved the restoration of the route “outside of United’s normal processes.” The same day, the Port Authority approved the airline’s hangar project. In 2015 – after the scandal came to light & the route had lost almost $1 million – Smisek & other involved executives departed United with significant severance packages.
Recently, we held the 4th Annual “Women’s 100 Conferences” – in both Palo Alto & New York City. I’ve been attending these from the beginning & this year’s continued to live up to the hype! Here are 5 things I learned:
1. How To Know Your Shareholders: If you don’t have a centralized database to track notes from your shareholder engagement meetings (and your shareholders’ voting guidelines) – start one. Some companies have added this element to existing IR software – e.g. Ipreo. Others have a more basic approach. The bottom line is that institutional investors expect you to know where they stand on important issues. And they don’t want to rehash the same issues every year – you should just cover how their concerns have been considered or resolved. Your notes should also include your shareholders’ current contact procedures & preferences, which often change from year to year.
2. How To Know Your Potential Shareholders: We didn’t debate whether “the law of attraction” applies to shareholder engagement – but several people recommended thinking not only about your existing shareholders, but also the type of shareholders you’d like to get. This plays out in governance structures (e.g. single v. dual-class shares), environmental & social initiatives and your outreach efforts. Don’t overlook the communication value of your public disclosures for both existing & potential shareholders.
3. The Art of Using Directors in Off-Season Engagement: Shareholders might ask to meet with a director if there’s been a big strategic or executive pay change – or if there was low support for a company proposal at the annual meeting. They want to understand the board’s decision-making process & how it’s processing shareholder feedback. Directors can be really helpful, particularly if there are messages that are difficult to convey in a written proxy statement. But it’s extremely important to prep them on that shareholder’s policies & concerns – and how they relate to the company & its existing disclosures. Avoid cringe-worthy moments like “we just approved the pay package because the consultant recommended it.”
4. Icebreakers Work: Everyone introduced themselves at the beginning of both events – super helpful for anyone trying to connect with a particular person. On the West Coast, we all described our practice – but almost everyone’s was similar. On the East Coast, we had everyone say a “favorite” – book, movie, band, travel destination, etc. In addition to getting some good recommendations, I learned that this 10 minutes can really set the tone for the day. People were relaxed & jumped in with lots of questions during the panels.
5. We’re Building Community: I’ve always loved these conferences because the format encourages lots of interaction – you can meet heavy-hitters during speed-friending & connect over lunch with peers at the same career stage. So it was especially cool to meet two women who are now close friends, after meeting at the conference a few years ago. We hope this becomes common!
Sights & Sounds: “Women’s 100 Conference ’17”
This 1-minute video captures the sights & sounds of the “Women’s 100” events that just wrapped up in Palo Alto & NYC:
This Seeking Alpha blog by Steven O’Byrne examines pay-for-performance in the S&P 1500. Here’s a summary of key findings:
1. CEO pay for performance at S&P 1500 companies is roughly 1/8 of the way to perfect pay-for-performance (i.e. relative performance explains only 12% of the variation in ten-year relative pay).
2. Pay-for-performance could be dramatically improved by better director supervision of CEO pay. If directors were able to achieve CEO pay alignment (r-sq) at their own company of 50%+ and limit their own company’s CEO pay premium to the current interquartile range, CEO pay at S&P 1500 companies would be roughly 3/4 of the way to perfect pay for performance (i.e. relative pay would explain 76% of the variation in ten-year relative performance across companies).
3. Only about a fifth of S&P 1500 companies have relatively well-managed CEO pay (i.e. only a fifth have alignment (r-sq) of 50%+ with an interquartile pay premium at industry average performance).
4. Say-on-Pay voting shows little ability to discriminate between companies with high alignment and moderate pay levels on one hand and companies with low alignment and extreme pay levels on the other. The average SOP vote support of companies with relatively well-managed CEO pay is only 1.2 percentage points greater than the average SOP support of companies with poorly managed CEO pay.
5. Directors have two readily available tools to improve pay for performance:
– The first tool is sharing analysis. Perfect alignment of relative pay with relative performance requires a fixed relationship between the CEO’s excess pay share of excess value and the CEO’s market pay share of expected value. The CEO’s market pay share of ex-ante expected value is easily calculated and should be a guideline for incentive plan sharing, but sharing concepts have largely disappeared from board deliberations and CD&A disclosure.
– The second, and more powerful, tool is “perfect” pay plans that lead automatically to perfect correlation of relative pay and relative performance. One perfect pay plan is the Dynamic CEO Compensation plan developed by finance professors Alex Edmans of London Business School and Xavier Gabaix of NYU. A second perfect pay plan is the perfect performance share plan developed by Stephen O’Byrne of Shareholder Value Advisors.
6. Better pay is correlated with better performance (i.e. ten-year relative TSR).
Recent corporate scandals hammer home the importance of board oversight for pay-related risks. This NACD article covers this area – and suggests asking these 6 questions:
1. Do we have an appropriate balance of metrics?
2. Are we calibrating goals & upside opportunity appropriately?
3. Are we considering the quality of performance?
4. How robust are the controls on data that is used as inputs to the compensation plan?
5. How are our board’s committees collaborating on developing & monitoring incentive plans?
In this 26-minute podcast, former CEO Steven Clifford discusses the problems with CEO pay – and describes his plan about how to fix it (as noted in his new book “The CEO Pay Machine“), including:
1. Why did you write this book?
2. Can you explain the role of boards in setting pay – and how they might be “collectively” delusional?
3. Why might CEOs not be as important as many think they are?
4. Can you get into the topic of “peer groups” and how CEOs may not be portable?
5. How can excessive pay actually be a de-motivator?
6. I’ve always argued that any pay is “pay-for-performance” by definition. How are most P4P arrangements detrimental to a company’s long-term health?
7. How is “shareholder alignment” not the gold standard that many think it is?
8. What is your plan to fix the “CEO Pay Machine”?
This podcast is also posted as part of my “Big Legal Minds” podcast series. Remember that these podcasts are also available on iTunes or Google Play. Use the “My Podcasts” app on your iPhone and search for “Big Legal Minds”; you can subscribe to the feed so that any new podcast automatically downloads…
Here’s an excerpt from this blog by Steve Seelig & Puneet Arora of Willis Towers Watson:
If the SEC follows the lead of the Department of Labor (DOL), which recently decided it will not further delay its controversial fiduciary rule, we may not get a delay of CEO pay ratio. In essence, the DOL determined that as a matter of regulatory procedure, it cannot move to delay a final rule without reopening the rulemaking process for additional comments.
Regarding pay ratio, we think Acting Chairman Michael S. Piwowar’s request for additional comments earlier this year may have been anticipating this regulatory hurdle, so it is possible the SEC would view those comments as supporting a delay.
Even if this was the thinking, the question would not be considered until the SEC has a sufficient number of Commissioners in place. As of today, Jay Clayton (R) is Chairman, with Kara M. Stein (D) and Mr. Piwowar (R) holding the other seats. SEC rules require three commissioners to constitute a quorum, and the thinking is that Commissioner Stein would not agree to attend a meeting where delay of the CEO pay ratio rule would be on the agenda.
Recently, Bud Crystal sadly passed away. Bud was the first superstar in the compensation consulting industry. A dynamic person, he really knew how to relate to others. After his iconic career as a consultant, Bud did a 360 & became a vocal critic of outsize pay packages. Here’s an excerpt from this Bloomberg article:
“My switch from henchman to gadfly incensed many CEOs, some of whom called me a Judas and asked where they should deliver the 30 pieces of silver,” Crystal wrote in a 1996 article for Slate.com. “In a sense, though, those CEOs and I were operating on the same wavelength. They were quoting from the Bible, while I was beginning to think seriously about the need to save my immortal soul.”
For more than four decades, Crystal made a good but quiet living advising clients such as American Express Co. and General Electric Co. But once a critic, he found himself in the middle of controversies such as the alleged excesses of the employment contract that he helped Walt Disney Co. negotiate with Hollywood superagent Michael Ovitz.
Here’s an excerpt from this blog by Morgan Lewis’ Gina Lauriero & Amy Pandit:
The following equity plan provisions should be considered:
– Companies should review their equity plans and confirm whether such plans permit share withholding in excess of the minimum applicable tax rate.
– Shareholder approval is not generally required to amend an equity plan to permit share withholding in excess of the minimum applicable tax rate. However, because of certain stock exchange rules and in light of recent Institutional Shareholder Services (ISS) guidance, a company with a plan that permits withheld shares to be added back to the plan’s share reserve should consider whether to limit the number of shares that can be added back for withheld taxes.
There are several securities law issues that can affect share withholding for taxes by Section 16 of the Securities and Exchange Act of 1934 (Section 16) officers, including the following:
– In order to exempt the disposition of shares through share withholding from being a “sale” of shares under Section 16 (the short swing profit rules), a company’s compensation committee or board of directors must approve the share withholding before any shares are withheld for Section 16 officers. The resolutions authorizing share withholding should be as specific as possible.
– The company should not retain discretion to determine whether shares will be withheld, or the amount of share withholding, for Section 16 officers.
– Share withholding for Section 16 officers should not exceed the participant’s estimated tax obligations attributable to the award, in order to avoid creating a separate derivative security.
Unresolved Section 16–related litigation has been instituted with respect to open market purchases occurring within six months of share withholding transactions (even though the transactions were reported as exempt). Until this issue is resolved, Section 16 officers should carefully consider whether to engage in nonexempt purchases of company stock in the six months before or after a tax withholding share transaction.