Companies typically aren’t able to exclude from their proxies shareholder proposals that address matters of executive & director compensation – see the Battle Mountain Gold Company no-action letter and Release No. 34-30851, both from way back in 1992. And frequently, shareholder proponents tie executive & director compensation into proposals that would otherwise be excludable under the Rule 14a-8 “ordinary business” & “micro-management” exceptions, in hopes that the pay component will trump any basis for exclusion. Last fall, Corp Fin issued Staff Legal Bulletin No. 14J to clarify how it would review no-action requests for these types of proposals – we blogged about it on TheCorporateCounsel.net and also did a webcast with Corp Fin’s Matt McNair.
Now that we’re into proxy season, we’re able to get even more insight into the Staff’s no-action analysis for “executive pay” proposals that arguably also relate to ordinary business matters or attempt to micro-manage the company. This Cooley blog summarizes the company & proponent arguments – and Staff conclusions – in these recent no-action letters:
1. AT&T: Staff agreed that a proposal could be excluded, because it focused on ordinary business matter of existing debt
2. Verizon: Staff disagreed with the company that a proposal for cybersecurity metrics that might apply to 300 employees was focused on the general workforce, and denied no-action relief
3. Verizon: Staff denied no-action relief for a golden parachute proposal, because it was a significant compensation matter for senior executives
4. AbbVie and Johnson & Johnson: Staff agreed that a proposal that sought to prohibit performance metric adjustments for legal & compliance costs amounted to “micro-management,” and granted no-action relief
Just in time to double check your proxy statements before sending them to print, this Wachtell memo summarizes frequently overlooked disclosure requirements, including:
1. Non-GAAP Reconciliations: Required for all non-GAAP measures that are disclosed outside of the CD&A or aren’t for the purpose of explaining performance targets
2. NEOs’ Direct or Indirect Personal Benefits: Unless they’re “integrally & directly” related to the executive’s duties, or available on a non-discriminatory basis to all employees, these items need to be disclosed as perquisites
3. Deferred Equity Awards
4. Outstanding Performance-Based Shares: Calculate using target (or higher) performance
5. Above-Market Preferential Earnings
6. Directors’ Outstanding Awards: Include footnote disclosure, whether vested or unvested
7. Item 10 of Schedule 14A: Make sure that you’ve included all line items if you’re seeking approval for a compensation plan – e.g. number of persons in each class of eligible participants and market value of company stock
This Aon memo looks at why companies might be moving away from TSR as a central performance metric – and suggests alternatives for three tech industries:
– E-Commerce Companies: Internet-related businesses have historically focused on top-line growth as the primary measure of success, but since growth can be rapid and unpredictable, we recommend e-commerce firms consider using measures like revenue, operating income and EBITDA. This focuses executives’ attention on key goals and reduces the importance of precise goal-setting that is typically required for bottom line or return metrics. Smaller e-commerce companies might want to focus on volume-based metrics (e.g., number of customers or transactions), revenue growth and market share as these will be key measures of success for firms not yet reporting a profit.
– Software companies: This high-growth, high-profit industry should focus on metrics that are balanced across various operating and financial measurements. Indeed, our research finds software companies are moving toward a combination of market and operating metrics — from 28% that reported using both in 2015 to 33% in 2016 (based on 2016 and 2017 proxy statements ). The most common operating metrics include revenue growth followed by operating income and earnings per share, according to the 2017 Radford Performance-Based Equity Report for Software Companies (available for $750).
– Semiconductor companies: The semiconductor industry is unique in that it is inherently more cyclical because the business is more directly related to consumer spending. As such, we find there are two common approaches companies take to designing incentive plans. The first is designing performance plans with aggressive metrics that pay out big when business is booming, while the alternative approach is more conservative, developing consistent payouts at, or slightly below, target most years. When deciding which approach is best for your organization, we recommend semiconductor companies think about what approach aligns best with their compensation philosophy, culture and what their employees value.
At about a quarter of S&P 500 companies, CEO incentives are tied (at least in part) to qualitative criteria. There’s a chance that figure will rise now that a company’s tax deductions aren’t tied to whether pay is “performance-based” – but probably not, since proxy advisors and shareholders disfavor plans that give a lot of discretion to the comp committee. This recent study finds that those misgivings might be warranted – company performance is negatively associated with the use of qualitative or subjective metrics in CEO bonus contracts.
As summarized in this CFO.com article, that’s because of these three shortcomings (meanwhile, this 2017 Pay Governance blog gives some ideas for overcoming these hurdles):
1. Qualitative performance criteria are ill-defined, providing the CEO with limited guidance regarding what exactly needs to be achieved going forward. For instance, the 2017 annual bonus of David Zaslav, CEO of Discovery, was based 50% on the accomplishment of six qualitative goals – e.g. “further develop and integrate [the company’s] overall digital and ‘over the top’ strategy” and “develop robust succession plans for key operational roles, while continuing to attract, retain, mentor, and reward exceptional talent.” Although those qualitative goals relate to important aspects of business (e.g., developing human capital), they involve a great deal of ambiguity.
2. Qualitative criteria and related performance targets are likely to be selected arbitrarily. No systematic supporting evidence can be collected and presented by compensation consultants and committees because of the idiosyncratic nature of the criteria under examination. In contrast, relevant data can be collected and tested regarding various quantitative criteria used in CEO bonus contracts.
3. Whereas assessments based on the same quantitative data always lead to the same outcome, this does not hold true in the case of qualitative assessments. The subjective nature of such assessments may induce bias into performance evaluations, possibly reducing the effectiveness of the CEO’s incentive plan in driving better firm performance.
Here come more shareholder suits using routine proxy disclosures to challenge non-employee director compensation. Here’s an excerpt from this Goodwin Procter memo:
Two cases asserting allegations of excessive director compensation have already been filed in 2019, and at least 10 cases were filed in 2018. In Stein v. Benioff, Civil Action No. 2019-0028 (Del. Ch. Ct. Jan. 15, 2019), the plaintiff alleges that the non-employee directors of Salesforce awarded themselves excessive cash and stock compensation (averaging $608,406) when compared to the company’s self-selected peer group (averaging $366,524). The plaintiff also alleges that the compensation plan had no meaningful limits and that attempted ratification of the compensation plan by shareholders was ineffective because the proxy disclosures concerning stock compensation were false and misleading for several reasons. Specifically, the plaintiff asserts that the proxy misstated that prior-year grants were restricted stock when they were actually fully vested shares, omitted the grant date fair value of stock compensation, falsely approximated the total value of stock compensation under the new plan to be $427 million (when the 10-K subsequently disclosed actual value of $997 million), and misstated where to find the assumptions for the calculation of stock awards.
Similarly, in Heng Ren Silk Road Investments LLC v. Chen, Civil Action No. 2019-0010 (Del. Ch. Ct. Jan. 7, 2019), the plaintiffs allege that the average $138,000 compensation for non-employee directors of China Automotive Systems Inc. was three times that of non-employee directors of comparably sized Nasdaq-listed Chinese companies, who all averaged $50,000 or less in compensation.
Complaints frequently contain some variation of the following allegations:
– When compared to similar companies — either a company’s self-selected peer group or similar companies by industry or market cap — the non-employee directors are compensated at least twice as much as the average non-employee director.
– The plans under which the non-employee director’s compensation was granted were not ratified by shareholders, the shareholder vote to approve the director compensation plan was ineffective because of misstatements in the proxy, or an approved compensation plan has been amended or changed since initial shareholder approval.
– Proxy statements seeking shareholder ratification of compensation plans contain any number of materially false or misleading statements or omissions, including: the grant date fair value of prior stock compensation, the expected value of stock compensation to be granted, the types of shares or equity granted, and the assumptions used to calculate stock compensation under a plan.
– If approved, the compensation plan fails to contain meaningful limits on either the number or value of shares that may be granted.
When asked if diversity objectives should be included in the management incentive plan, Ms. Mulcahy said that one cannot “comp” everything. Diversity goals should not be hardwired to the compensation plan, but they should be part of management’s subjective evaluation – part of a people engagement dashboard – where the board and/or the CEO can provide constant feedback to management. The management team will soon get a picture of how it’s doing. “It is a system and not just one thing you are doing…When it becomes consistent over the long term and successive leaders are championing it, you develop a reputation and that compounds the benefits of it. We created that reputation (at a former employer) and had diverse candidates lining up.” I&D has to be embedded in every part of the employee life cycle from recruitment, to promotion and separation.
Mr. McCormick shared that one company deliberately conducted exit interviews using senior leaders who had the same diverse attributes as those of the departing employee. This led to more honest feedback and better insights on why employees were leaving.
This report from Semler Brossy gives us the final tally for last year’s say-on-pay results. The firm also does a nice job of recapping what it predicted correctly – and incorrectly – about pay developments over the last year…
Following a low say-on-pay vote, you might earnestly try to right the ship with something like this 14-point recovery plan. But however you get there, this Equilar blog says that the way the data shakes out, most companies with a failed vote end up cutting CEO pay via a shift in the pay mix. Specifically, by reducing option awards. Here’s an excerpt:
Breaking down the average pay mix of companies that failed Say on Pay depicts a trend that could be a major player in a failed vote: options. According to the 2018 Equilar CEO Pay Trends report (available for purchase), options made up an average of 11.8% of CEO pay mix in 2017. However, of the companies that failed Say on Pay in 2017, options made up 23.2% of pay mix, almost double the amount. Over time, compensation professionals realize the power of Say on Pay and take appropriate actions.
Diving into the details on a per-company basis allows for a highlight of an example among companies that have failed Say on Pay proposals. Bed, Bath and Beyond (BBBY) is particularly illustrative of the trend in CEO compensation. After its first time failing Say on Pay in 2014, rather than reducing CEO Steven Temares’ pay, BBBY increased the option and stock awards granted to Temares. Perhaps not surprisingly, after this increase in options and stock, BBBY then failed its Say on Pay vote in 2015.
As a result, option award values decreased by 52.4% in 2016 and then were decreased by about $850,000 the following year. Though the company failed Say on Pay in both 2016 and 2017, the total compensation of the chief executive decreased by 20.9% from 2014 to 2017. This shows that the company made a concerted effort to gain approval in the eyes of its shareholders. Additionally, it seems as if companies that fail Say on Pay consecutively make a greater point of altering their CEO pay plans, especially when it comes to options.
In December, Broc reported that ISS had released its “Equity Compensation Plan” FAQs – and its final “Executive Compensation Policies” FAQs. As part of those updates, the proxy advisor confirmed that it wants companies to continue some practices that initially became common because of the now-repealed Section 162(m) performance-based compensation exemption.
Specifically, it’s encouraging companies to continue frequently submitting equity plans for approval (by increasing the weighting of the plan duration factor in its Equity Plan Scorecard) and discouraging any shifts away from performance-based pay to discretionary or fixed-pay elements (by defining that behavior as a “problematic pay practice”). Here’s what Ron Mueller had to say about this in our recent webcast, “The Latest: Your Upcoming Proxy Disclosures“:
Not surprisingly, the repeal of the exemption is not having dramatic effects, at least among my clients. Everyone is still aligned with pay for performance. Some of those compensation plans that have had two sets of performance goals – one for 162(m) and one that were the determinative goals – now might only have the determinative goals.
There is still alignment with pay for performance, and ISS has reiterated that it very much expects some of the practices from 162(m) to continue. I think that will be the case as well, and that there will be a continued focus on setting pre-established performance criteria.
There will be continued frowning upon discretionary increases above what a performance goal allows, other than just perhaps some percentage of the target being based on personal performance, generally positive discretion. I don’t think we’re going to see that being widespread.
Companies should consider whether they need to amend their proxy discussion of the implications of tax rules on their compensation programs. One company, Unum Group, in their 2018 proxy had a good statement that reaffirmed the comp committee’s commitment to a pay for performance alignment. I think we will see more of this in 2019.