This Equilar blog says that although there’s high-level consensus around peer group criteria – with most companies using some combination of industry, talent pool, revenue and market cap – the number of criteria actually used varies widely – and so does peer group size. And if your peer group rationale is unconvincing, investors are less likely to accept the benchmarks that underlie all your executive pay decisions.
So it’s not a bad idea to revisit your peer group selection process, with an eye toward the best practices in this FW Cook memo. And while you’re at it, be wary of these common pitfalls:
– Using “aspirational peers”: Attracts negative scrutiny from proxy advisors and shareholders who think the selection is being used to ratchet up benchmark pay
– “Cherry-picking” peers: Focus on objective criteria, don’t select companies to maximize benchmarks or justify certain pay practices
– Focusing on non-executive talent pool: Often, there’s a more diverse universe of companies that compete for non-executive talent, but these companies may not be relevant for executive benchmarking purposes
– Defaulting to valuation peers: Valuation peers often don’t comply with peer group standards used by compensation consultants, proxy advisors or institutional investors
Some pundits like to say that “everything is securities fraud” – and one pretty common example is lawsuits and penalties stemming from cybersecurity or privacy issues. Now it’s starting to feel like everything that could be securities fraud could also, on the front end, be an executive pay metric. For instance, Disney’s proxy statement includes this shareholder proposal from Jim McRitchie:
RESOLVED: Shareholders of The Walt Disney Company (the “Company” or “Disney”) ask our board of directors (the “Board”) to publish a report (at reasonable expense, within a reasonable time, and omitting confidential or propriety information) assessing the feasibility of integrating additional cyber security and data privacy metrics into the performance measures of senior executives under Disney’s compensation incentive plans.
In opposing the proposal, Disney makes the case in its proxy and additional soliciting materials that it already considers data security & data privacy in its executive compensation design – by factoring non-financial performance factors into awards for individuals who have direct responsibility for those matters. In his supporting statement and voluntary exempt solicitation, Jim emphasizes the cost of data breaches and privacy issues and argues that the metrics should apply to all high-level executives. Shareholders voted down a similar proposal last year at Verizon.
Tune in tomorrow for the webcast — “How to Use Cryptocurrency as Compensation” — to hear Perkins Coie’s Wendy Moore and Morrison & Forester’s Ali Nardali and Fredo Silva discuss the groundswell in the use of cryptocurrency as compensation among private companies — and the legal framework that applies.
Nobody expects the repeal of Section 162(m)’s “performance-based” exception to cause companies to limit CEO pay to less than $1 million. This research from two economists finds as much when looking at tax deduction limits in the health insurance industry imposed by the Affordable Care Act. Here’s an excerpt:
The ACA prevented insurers from deducting more than $500,000 of a CEO’s pay from their profits for tax purposes. This meant that instead of CEO pay costing the firm 65 cents on the dollar (the tax rate was 35 percent at the time), it cost them 100 cents on the dollar, effectively raising the cost of a marginal dollar of CEO pay by more than 50 percent.
If health insurers are setting the pay equal to the value the CEO adds to the shareholders, the increased cost of pay to the company from the loss of tax deductibility should have unambiguously had the effect of lowering CEO pay, after controlling for other factors. We ran a large number of regressions, controlling for increase in revenues, profits, share prices, and other factors that could plausibly affect pay.
It was a small sample size – but in none of them did we find any evidence that CEO pay in the health insurance industry had been lowered by this provision in the ACA. This would seem to support the view that CEO pay does not bear any relationship to the returns CEOs produce for shareholders.
That last sentence is…disturbing? Incorrect? I’m not sure. You would think shareholders would care about lower returns – but rightly or wrongly, I think they’re more likely to blame the government than CEO pay for any reduction in earnings that’s caused by changes to the Internal Revenue Code. But there is an outside chance that shareholders will do more to limit CEO pay – e.g. by voting down “say-on-pay” or voting against directors – now that they bear the full cost. Here’s what the economists concluded:
In order to limit CEO pay it may be necessary to alter the rules of corporate governance in ways that increase the power of shareholders over the CEO.
About a year ago, Broc blogged about ISS’s acquisition of EVA Dimensions – and how it would likely impact the pay-for-performance analysis. Sure enough, in the 2019 updates to its voting policies, ISS said that it would start showing EVA measurements in its research reports and would consider adding them to its quantitative pay-for-performance screens in 2020. This Sullivan & Cromwell memo says that ISS essentially defines EVA as net operating profit after tax, less the cost of providing an acceptable return to capital providers.
We don’t know yet whether investors will develop a preference for EVA-based plans. But if this article is correct in asserting that a focus on economic profit improves long-term results, it stands to reason that having the ISS data point will move everyone in that direction. The article notes that some companies are already starting to incorporate these measures into plans – but customization might be necessary. Here’s an excerpt:
Maximized independently, traditional performance measures – e.g. revenue growth, margins, asset efficiency, and rates of return – can actually destroy value when taken to extremes. Luckily, all of those metrics are captured in economic profit measures such as EVA, where economic profit tells you whether the traditional measures of performance are optimally balanced in a way that maximizes value.
For example, a large capacity investment might drive up asset intensity, driving down rates of return. And the incremental sales growth from increased volumes may come at a lower price and, therefore, lower margins. But the growth from a large capacity expansion can be significant and offset the impact of some of the other measures.
An economic profit measure is the ideal tool to decide if growth is worth it or not. You may still convey it to investors using traditional measures and using statements like, “although margins and returns will come down slightly, the significant new growth potential is so valuable that we expect this investment to drive our share price higher over time.”
I blogged in December about Shell’s decision to link high-level employee pay to carbon reduction targets – following engagement with Climate Action 100+. Now BP, who has decided to support a shareholder proposal from that same coalition, has followed suit – announcing that it will factor greenhouse gas emission reductions into rewards for 36,000 employees worldwide. Here’s how they’ll do it:
In 2018 BP introduced a target to achieve 3.5 million tonnes of sustainable GHG emissions reductions in its operations worldwide by 2025. Progress towards this target has now been incorporated into the assessment of the Group’s performance that is a factor in determining annual bonuses for BP staff worldwide. This will apply to the assessment of BP’s performance in 2019.
Broc’s blogged a couple of times about shareholder proposal campaigns that pressure companies to disclose more info on workforce compensation practices relative to CEO pay – and related settlements. Broc noted that the agreements range from adding “human capital” disclosure, to enhancing workforce benefits, to committing to consider the CEO pay ratio when determining executive pay. This Willis Towers Watson blog takes a closer look at how companies have publicly responded to the shareholder proposals – and outlines things to consider. Here’s an excerpt:
There is no set playbook for how companies respond to shareholder proposals. Some responses are minimalist, while others provide a lot more information about how the company manages its workforce and recent steps taken to ensure pay equality across the workforce. Most piggybacked their responses to planned or completed activities to enhance workforce pay and benefits. It is noteworthy that only one company responded by affirmatively stating that their compensation committee would consider workforce pay levels in establishing CEO pay.
Three key considerations should frame your company’s disclosure:
– What to include
– Where to include it to clearly reflect your compensation committee’s mandate
– How you’ll tell your story so investors truly understand how your organization values its employees
After market close on Friday, Goldman Sachs announced via an Item 8.01 8-K that in light of the ongoing 1MDB investigation, its compensation committee might reduce bonuses to current – and former – senior executives. The board is wise to leave themselves some room, since they’ll likely face shareholder scrutiny for the alleged fraud and all of its fallout. For last year’s annual equity awards, the board added a new forfeiture provision. The 8-K doesn’t go into detail about what types of harm – e.g. strictly financial v. reputational – would result in forfeiture, but simply says:
This provision will provide the Committee with the flexibility to reduce the size of the award prior to payment and/or forfeit the underlying transfer-restricted shares (which transfer restrictions release approximately five years after the grant date) if it is later determined that the results of the 1MDB proceedings would have impacted the Committee’s 2018 year-end compensation decisions for any of these individuals.
For former executives, Goldman’s comp committee decided to defer determinations about LTIP awards that otherwise would’ve paid out in January, since the 1MDB investigation relates to events that occurred during the performance period. This WSJ article reports that the forfeiture wouldn’t apply to former exec Gary Cohn, who was paid out in lump sum when he joined the Trump Administration.
So these aren’t true “clawbacks” – they’re potential forfeitures of unpaid amounts, which are much easier for a company to administer. Remember that a few years ago in a different kind of scandal, Wells Fargo started off with forfeitures – and eventually also clawed back pay.