Yesterday, ISS opened its “Annual Policy Survey.” Like last year, it consists of two parts. The first is a “Governance Principles Survey” – which consists of 10 questions on high-profile topics including auditor independence & quality, audit committee evaluations, board gender diversity and the “one-share, one-vote” principle. This blog from Mike Melbinger highlights that one of the high-profile topics has a relationship to executive compensation:
If ISS assesses that an individual director has failed in his or her oversight responsibilities at one company and this has resulted in a negative ISS vote recommendation, do you consider it appropriate and useful for shareholders for ISS to note this in the proxy research of other companies where that director serves on the board? . . . What types of oversight shortfalls would you consider to be relevant to the assessment in such a situation,” e.g., pattern of poor stewardship of compensation practices, risk oversight failures relating to fraud, or other forms of corporate malfeasance, risk oversight failures related to business operations (such as cyber security), and/or oversight failures regarding protection of shareholder rights or shareholder value.
The second part is a “Policy Application Survey” that allows respondents to drill down on key issues by region. This Weil blog says that the key issues for the Americas region include excessive non-executive director compensation & pay-for-performance metrics.
As always, this is the first step for ISS as it formulates its 2019 voting policies. In addition to the two-part survey, ISS will gather input via regionally-based, topic-specific roundtables & calls and a comment period on the final proposed changes to the policies.
Not only is Cap’n Cashbags real, he has proteges embedded in boardrooms. This blog from Pearl Meyer’s Jim Heim gives specific examples of how they make the argument for “more, more, MORE!” – and some ideas for inoculating boards against greed. Here are some red flags:
1. Move the goalposts. Your greedy executive may point to success with respect to top-line growth when your investors (and your incentive plans) are focused on margin expansion. Or question why revenue is given greater weighting than operating income when selecting peers for benchmarking purposes. Or raise any of a thousand other objections which all boil down to: “Measure me on the areas where I perform well, not the areas you deem important.”
2. Benchmark by anecdote. Your greedy executive may bring you a proxy filing of a competitor who pays their own similarly-titled executive more, without doing the homework to understand which is the anomaly—your greedy executive’s pay or the pay of this supposed peer. Questions arising from this type of behavior are a weekly occurrence in my work. But I have never heard of an executive asking for explanation as to why a competitor is paid less than s/he.
3. Pay me twice. Following a multi-year period of strong performance, the greedy executive asks whether some form of supplemental award is in order. In almost all cases, there is sufficient leverage in the incentive plans such that the executive has already reaped several years of above-target payouts with respect to both cash bonuses and performance shares earned, and equity-denominated vehicles are now much more valuable than what was expected on date of grant (due to accompanying run up in stock price). The executive has already been paid for the performance.
4. I’d like the reward, you can keep the risk. The greedy executive is eager to sign up for a program that will provide extraordinary rewards for extraordinary performance, but questions the fairness of having similar downside risk in the program. “If we meet these aggressive goals, it is most likely evidence that the management team has executed flawlessly against a well-conceived strategic plan…but if we fail, it’s most likely due to exogenous factors. Since those factors are out of our control, we ought not be held accountable for failure to perform.” Or, more succinctly: “Heads I win, tails you lose.”
5. I didn’t like Mom’s answer, so I’ll go ask Dad. The greedy executive attempts to circumvent his/her CEO and go directly to a board member with concerns over his/her pay. This may be exacerbated by a weak CEO inadvertently (one would hope) encouraging this behavior with a “my hands are tied” aroach to communicating a pay decision.
This “Chief Executive” article highlights the pay gap between public & private executives. It makes sense for public company CEOs to earn more than their private-company counterparts, due to their additional responsibilities and risks. Also, we’re in a rising market and a significant portion of their pay is equity-based. But the pay difference is pretty striking. Here’s how the numbers shake out at companies that have similar revenue:
While CEOs of private companies with $100 million to $249.9 million in revenue earned a median total pay package worth $524,500 in 2014, CEOs of public companies in the same revenue range earned 2.8 times that amount – and the compensation gap between public & private companies grew wider with the size of the company.
We received this note recently from an anonymous member:
I have learned that ISS is aware of the issues with the timing differences caused by proxy filing dates within a peer group – e.g. even if a company and ISS use identical peer groups, only outdated data is available to ISS for the later filers in the group – and that data has no relevance to the most recent performance year. This impacts all of the relative measures that ISS uses in its quantitative pay-for-performance evaluation: Multiple of the Median, Relative Degree of Alignment and Financial Performance Assessment. Because ISS understands that the most recent CEO compensation data isn’t available for all members of a peer group, ISS will rely on its judgment in making a say on pay vote recommendation – which is why only about half of the companies with “high concern” receive an against recommendation.
In any event, this illustrates the difficulty ISS faces in quickly analyzing and formulating say on pay voting recommendations for a company and highlights the degree to which ISS substitutes its judgment for that of a board of directors without a firm quantitative basis for doing so. I have seen passing references to this disclosure timing issue in some law firm memos and academic articles, but I don’t think most companies have a reason to focus on the issue as long as they receive a “For” SOP voting recommendation.
I actually have some sympathy for the difficulties ISS has in processing thousands of SOP management proposals each year with a very short turnaround period (cf., Lucy and Ethel working on the candy factory conveyor belt). That said, ISS may wish to consider clarifying the degree to which its SOP voting recommendation for a company relies on the relative quantitative measures as opposed to its own judgment.
You can find more insight into ISS’ methodology by perusing their FAQs and the other resources that we’ve posted in our “Proxy Advisors” Practice Area.
Most companies have now made their first pay ratio disclosure – and held their first say-on-pay vote in which shareholders could consider that information. It’s looking like shareholders consider pay ratio as a factor – but it’s not a primary driver of votes. This Semler Brossy memo analyzes the results in detail. Here’s some highlights:
– Average say-on-pay support of 87% for S&P 500 companies that disclosed an above-median pay ratio, compared to 91.6% support for companies with a below-median pay ratio. This correlation was weaker among Russell 3000 companies.
– Say-on-pay results were 31% lower at companies that received an ISS recommendation “against.”
– While only 21% of the Russell 3000 disclosed a pay ratio above 175:1, those companies made up 46% of all say-on-pay failures.
– Pay ratio typically is more influenced by the CEO’s pay than the median employee’s – especially for ratios below 100:1. This means the ratio tends to grow with company size & revenue (factors which typically lead to higher CEO pay but not higher median employee pay). The median pay ratio of the S&P 500 is more than 2x the median ratio of Russell 3000.
– Pay ratios differ greatly by sector – e.g. utility companies have lower ratios due to unionized labor and higher median employee pay. Companies with bottom quartile median employee pay have significantly higher ratios, driven by part-time or seasonal workers.
According to Korn Ferry’s survey of the largest 300 companies, median CEO pay increased by almost 9% last year – double last year’s increase & the highest percentage increase since 2010. The increase was driven by both annual & long-term incentive pay along with overall stock market growth. This excerpt predicts what we might see going forward:
Looking to next year, Korn Ferry expects changes in the mix of CEO total direct compensation, due to significant changes to the executive compensation deduction rules in Section 162(m) of the Internal Revenue Code.
“Much will depend on each organization’s financial performance during the coming year, but with the changes in the tax rules governing executive compensation, we expect we will see slightly higher increases in base salaries than in recent years, and that base salary will represent a larger share of the overall mix of TDC for the CEO,” said Donald Lowman, Korn Ferry Executive Pay & Governance Practice Leader for North America.
A change in pay mix could also have a nominal impact on pay ratio: this Korn Ferry blog elaborates on how base pay for the average US worker is increasing at a faster rate than CEO base pay.
As you can see from our list of SEC perks cases (posted in our “Perks” Practice Area), the SEC has averaged one perks enforcement case per year for the past dozen years. That’s why it’s so surprising that the SEC has now brought two perks cases in one week. Coincidence or a theme?
In this new case against Energy XXI, the CEO & board were charged with hiding more than $10 million in personal loans that the CEO obtained from company vendors and a candidate for the company’s board. The company wasn’t charged, interestingly. Here’s a blog about last week’s case.
The list of perks in para 56 of this complaint raises a couple of interesting issues. Is a bar stocked with cigars and liquor – on company premises for use in entertaining customers – necessarily a perk? You might ask what is a “Denny Crane” room? (Hint: TV show “Boston Legal” – that’s the character played by William Shatner). Come learn what you need to know as Mark Borges & Alan Dye lead a panel devoted just to perks at our upcoming “Proxy Disclosure Conference” – to be held September 25-26 in San Diego and via Live Nationwide Video Webcast.
As always happens this time of year, our Conference Hotel – the San Diego Marriott Marquis – is nearly sold out. Reserve your room online or by calling 877.622.3056. Be sure to mention the NASPP conference or Executive Compensation Conference or Proxy Disclosure Conference. If you have any difficulty securing a room, please contact us at 925.685.9271.