– Broc Romanek

This academic paper tracks how the issuance of a ‘going concern’ opinion by a company’s auditors shakes things up, including changes in executive pay…

– Liz Dunshee

There have been murmurings about say-on-pay for directors for nearly a decade now (see this blog). But the idea is getting a fresh look in the wake of Delaware’s Investor Bancorp opinion, as plaintiffs are sending demand letters to investigate director awards – and companies are looking for ways to protect themselves. This blog from Exequity’s Ed Hauder envisions how the approach could work:

Companies might be able to gain some certainty if they have an equity plan that states a “reasonable” limit for annual director compensation, and also put forth on the proxy statement a “Say on Director Pay” vote concerning the next year’s director compensation. Directors’ terms typically run from annual meeting to a subsequent (usually next) annual meeting, so having shareholders approve the directors’ compensation program for the next year period should work. The Say on Director Pay (SODP) vote would create a powerful presumption that shareholders approved the directors’ compensation (assuming directors only receive compensation that was detailed in the approval), which should enable the company to shut down any nuisance suits concerning director compensation.

Of course, care would need to be taken in drafting the SODP. The SODP should apply for the next year period or until shareholders are asked to approve a different compensation program for directors. In this way, companies would only need to present a SODP on their proxy statements when director pay changes. For some companies, this might mean it becomes an annual item in the proxy. But for other companies, it could be a less frequent item on the proxy.

As Ed notes and as I blogged last summer, OvaScience has agreed as part of a settlement to conduct a say-on-director-pay vote every three years. And a few years ago, Broc blogged about a vote at Digirad. So there’s some precedent, but it’s still pretty rare.

Keep in mind that adopting a “high-water” limit (with compensation committee discretion to make awards below that), is probably just a retooling of the old “meaningful limits” standard – and not enough on its own to let you avoid the entire fairness test.

Outside of having shareholders approve specific director awards, plaintiffs will likely be deterred by companies who appear to have their act together. Review & document your process for determining director pay, and beef up your disclosure to show those decisions are reasonable. You probably won’t be worth plaintiffs’ time if you disclose that you’ve used a compensation consultant and made director awards based on robust data and a defensible director pay philosophy.

– Liz Dunshee

This Pearl Meyer survey says that at this point, it’s not very common to incorporate ESG goals into incentive plans. But a shift is underway. Companies are no longer bound by the constraints of Section 162(m) – and shareholder interest in the corporate risks posed by climate change & human capital issues is greater than ever.

In fact, Shell announced just a few days ago that it would link pay to carbon reduction targets for as many as 1300 high-level employees, following shareholder engagement on the topic (also see this BBC article). Other comp committees should also start exploring whether using ESG metrics would benefit their company.

If your compensation committee is considering going down this path, Pearl Meyer’s Jim Heim proposes this process:

1. Evaluate the overall compensation philosophy to confirm it continues to send the right signals to shareholders, employees and potential candidates about the type and level of performance on which the company is focused and how results will be reflected in compensation. ESG measures may have a role to play as companies evolve their performance priorities over time.

2. Assess the prevalence of incentive compensation design practices among peers and the broader market. If sector-relevant companies are clearly shifting their incentive designs to include consideration of ESG measures, they may merit closer investigation (as would be the case for any shift in peer practice). Peer practices may also provide specific examples of how such a shift may be implemented.

3. Incorporate ESG goals into pay-for-performance assessments. While such assessments typically focus on financial categories of performance, investors have indicated that they have found positive correlations between sustainability or “good governance” ratings and shareholder value creation in certain sectors. Companies considering implementation of ESG performance measures may wish to supplement traditional pay-for-performance assessments with an examination of whether there is in fact such a relationship between ESG and shareholder value creation among their peers.

For more on this topic, check out the resources in our “Sustainability Metrics” Practice Area – including the transcript from our recent webcast – “The Evolving Compensation Committee.”

– Liz Dunshee

My husband recently interviewed with a start-up – and like many private companies, a big portion of the pay package was equity. If you’re an optimist who thinks you’ve found the next Uber – and you don’t expect any major expenses before their potentially far-off liquidity event – that’s pretty exciting. But if you’re married to a securities lawyer who tends to see more risks than benefits…you keep looking.

That said, maybe we’ll revisit the discussion now that this Stanford memo has compiled info & stats about resale restrictions, the secondary market and average discounts. Based on a sample of 34 companies, 56% allow employees to sell or pledge a portion of their vested equity awards. Among those that allow sales:

– 67% allow sales back to the company

– 40% allow sales on a secondary marketplace – e.g. SharesPost, Equidate, EquityZen, Nasdaq Private Market

– 47% allow sales to third-parties not through a private company exchange

– 7% allow pledges.

– Employees who sold averaged a 39% discount to subsequent IPO pricing

As you’d guess, many companies have a right of first refusal. What surprised me was that 40% of companies allow employees to sell at any time at their own election – and 14% don’t require any company approval. And here’s one other thought to chew on:

Perhaps more important for the company is that allowing the sale of vested equity awards potentially distorts employee incentives. In structuring their compensation programs, companies decide on the correct mix of cash and equity to attract, retain, and motivate employees to pursue company objectives. An employee who is allowed to sell vested equity awards is effectively being allowed to convert variable, performance-based pay to a fixed amount of cash, significantly reducing (and distorting) the future incentive value of the compensation program.

– Liz Dunshee

Clawbacks & forfeitures were a hot topic at our “15th Annual Proxy Disclosure/Executive Compensation Conference” and the accompanying NASPP conference. We dove into what’s discussed in this Washington Post article – the trend of broadening clawback provisions to cover hard-to-define concepts like “reputational damage” – and the emerging concept of whether to penalize executives for undisclosed sexual misconduct that occurred before they were hired.

In these scenarios, a clawback (or forfeiture) could be triggered by termination for “cause” – with a few approaches to defining that term:

– Employment agreement includes a representation that the executive hasn’t been the subject of a sexual harassment claim, guilty of prior claims or even that they’d never engaged in harassment or misconduct – with a breach of that representation constituting “cause” for termination

– Explicitly refer to sexual harassment in the wording of severance arrangements or in the employment agreement definition of termination for “cause”

– Employment agreement refers to a violation of company policies (while an employee) as “cause” for termination – and prohibited behavior is defined in the code of conduct

There are pros & cons to going down this path – our “Executive Compensation Disclosure Treatise” describes them on pg. 103 of the CD&A Chapter – also see the resources in our “Clawbacks” Practice Area.

And since this is all part of a bigger trend, there eventually could be some convergence with the types of reps that are making their way into merger agreements (see our DealLawyers.com blog on that) – or even venture capital deals. This WSJ article says investors in that space are trying to craft a standard provision that would penalize portfolio companies for executive or employee sexual misconduct, harassment and other issues. Here’s an excerpt:

Eamon Devlin, managing partner at MJ Hudson, a law and advisory firm that works with private-equity funds and investors, says that with pension funds increasingly being held accountable for where their money is invested, such a clause could become standard practice in investment agreements.

To be sure, finding usable wording for a #MeToo clawback clause that covers different countries and a range of different types of bigotry and harassment, without being pages and pages long, has proved challenging, says Bill Liao, a general partner in a VC firm. Lawyers who have donated their services to the initiative have run 30 different versions past him already, he says. Mr. Liao has been drumming up support among investors and venture capitalists. He aims to have the clause ready within the next year.

– Liz Dunshee

We talk a decent amount around here about performance targets for incentive awards – here’s a blog about how they tend to compare to earnings guidance. And it’s easy for shareholders & the media to run with that shorthand. But when you’re doing the detailed work to help compensation committees develop performance plans – and maybe also, when you’re communicating to shareholders, that’s not exactly the best thing to emphasize. As articulated in this Semler Brossy memo, it’s the performance range around target that actually drives payouts.

How can compensation committees reduce the risk of ending up below threshold or above maximum? The memo suggests changing threshold & maximum performance levels annually to keep likelihood of achieving those levels at a set percentage – e.g. threshold performance expected to be exceeded 90% of the time & maximum performance expected to be achieved 10% of time. Here’s some recommendations on how to come up with those numbers:

– Review historical results for the company and its peers to assess probabilities

– Assess the current drivers of performance and the sensitivity of the various drivers on performance to supplement historical data & get a forward-looking perspective on an expected range of outcomes

– Understand how the incentive goals stack up against other Wall Street inputs – e.g. whether achieving target payout means that consensus earnings were achieved

– Test “sharing ratios” – how much of the company’s incremental earnings are being paid out in incremental bonuses – to confirm you’re within industry norms

– Establish guidelines for incentive adjustments at the beginning of the year – and ensure the adjustments are fair & adequately disclosed