Last week, I blogged that SEC Commissioner Rob Jackson wants the SEC to require explanations & reconciliations when non-GAAP numbers are used in the CD&A. Yesterday, the Council of Institutional Investors announced that it agrees with that suggestion – and it’s filed this petition with the SEC to recommend rule changes. Specifically, the petition requests that the SEC:
1. Amend Item 402(b) of Reg S-K to eliminate Instruction 5 (which says that disclosure of target levels that are non-GAAP financial measures won’t be subject to Reg G and Item 10(e))
2. Revise the Non-GAAP CDIs to provide that all non-GAAP financial measures presented in the CD&A are subject to Reg G and Item 10(e) – and that the required reconciliation must be included within the proxy statement or through a link in the CD&A
CII says it isn’t seeking a ban on using non-GAAP measures in compensation plans. However, it says that its members are concerned about the complexity in executive pay structures – and the challenges in understanding the link between pay & performance.
Here’s the latest 138-page guide for compensation committees from Wachtell Lipton – which includes sample compensation committee charters for NYSE & Nasdaq companies at the back. Just last week, we referred a member to this resource when they asked this question in our “Q&A Forum” on TheCorporateCounsel.net (#9860):
Are ERISA governed severance plans typically approved by a company’s full board or the comp. committee or both? Our compensation committee charter does not specifically address authority relating to benefits plans.
John gave this answer:
I think practice for broad-based ERISA plans varies & there’s not a one-size-fits-all approach. Take a look at Wachtell’s “Compensation Committee Guide” for a discussion of what fiduciary duties might apply when the compensation committee takes on responsibility for these plans.
Even if your committee charter does not expressly extend to ERISA plans, it seems that the full board could opt to delegate those responsibilities to the committee if it desired to do so.
Everyone knows executive pay is rising. None of us can agree about why. Our forthcoming study in The Accounting Review, “Matching Premiums in the Executive Labor Market,” points to one reason—executives are being compensated for the risk they bear when leaving one firm for another.
A company that wants to lure someone from another firm needs to bump up her compensation, as she’ll want a wage premium for sacrificing the comfortable fit with the current employer for the uncertainty of life at a new firm. This risk may be shared by both the company and the executive, but the executive still can command higher pay as a result. Tracking a sample of over 30,000 executives in S&P 1500 firms over 16 years, we show that executives receive about 15 percent higher pay when they jump to new companies.
What does this mean for firms? Hiring from outside, rather than promoting from within, requires firms to pay up. And, as executive tenures shorten, that entails more movement between firms—for which there must be more compensation. Simply put, greater mobility and risk have translated to higher pay.
While critics of executive pay argue greed and nepotism explain rising pay levels, our study suggests a less nefarious explanation—the evolution of the labor market toward greater external hiring is at least partly boosting executive compensation.
Last year, the IRS got enough funding to end its 7-year hiring freeze. But during that timeframe, it “essentially lost an entire generation of employees.” That’s according to this article, which points out that about 45% of the IRS’s total workforce will be eligible to retire within the next two years. And within the next two weeks, they need lawyers.
For all the tax gurus out there (or for those who know tax gurus), we’ve been alerted to five openings in the IRS Office of Chief Counsel – specifically, the program for “Employee Benefits, Exempt Organizations, and Employment Taxes” (EEE). While we don’t normally blog about job postings – we save the info for our “Job Board” on TheCorporateCounsel.net – these positions will only be open for two weeks and we wanted to get the word out for people interested in a government gig. Here’s what’s available:
We are a pretty good place to work – interesting issues, good work/life balance, friendly atmosphere. We are especially good with the smart but not corporate type of person. But also a heads up that all work here is on a team, and all work is reviewed, so we’re not the best fit for some who want to work completely independently.
These positions are for all the practice areas inside EEE, and folks can apply to as many as they want. These are GS-13 and GS-14 positions, so they require 2 or 3 years of experience. You can find the GS pay scale on OPM.GOV but please make sure and look at the DC-Baltimore area grid which has the locality adjustment or you will faint (these are all DC-based positions at the IRS building at 1111 Constitution).
Here’s something that John blogged last week on TheCorporateCounsel.net (also see this Cooley blog): SEC Commissioner Robert Jackson recently co-authored a WSJ opinion piece calling for increased transparency about the use of non-GAAP numbers in setting executive pay. The article notes that Reg G generally requires companies to provide comparable GAAP information & a reconciliation, but acknowledges that this doesn’t apply to the CD&A discussion. The authors think it should:
Unfortunately, those requirements do not apply to the reports that compensation committees of corporate boards disclose to investors each year. Thus, committees choosing to use adjustments when deciding on payouts need not explain why an adjusted version of earnings is the right way to determine incentive pay for the company’s top managers. This increases the risk that adjustments will be used to justify windfalls to underperforming managers.
The SEC’s disclosure rules have not kept pace with changes in compensation practices, so investors cannot easily distinguish between high pay based on good performance and bloated pay justified by accounting gimmicks. That’s why we’re calling on the SEC to require companies to explain why non-GAAP measures are driving compensation decisions—and quantify any differences between adjusted criteria and GAAP. A few public companies already provide investors with this kind of transparency. Others can too.
Meanwhile, I’ve blogged a few times about how ISS research reports now include “Economic Value Added” metrics in the pay-for-performance analysis. This Willis Towers Watson memo notes that there are 15 non-GAAP adjustments underlying ISS’s EVA calculation. Things could get rough in CD&A land if these aspirational metrics collide with Reg G reconciliations.
In the “Pay Ratio” Chapter of our “Executive Compensation Disclosure Treatise,” we note that although Item 402(u) allows companies to use the same “median employee” for three years, some companies are either required to identify a new median due to significant changes in the workforce or the prior-year individual, or voluntarily calculate a new median because they want to keep the pay ratio as precise as possible and don’t want to risk a big triennial change. What we haven’t known – until now – is how this would play out in practice.
According to this Compensation Advisory Partners memo, which takes a close look at pay ratio’s second year trends, using a new median employee is actually more common than not. For the 201 companies they analyzed, only 36% used the same median year-over-year. Here are all the key takeaways:
1. CEO Pay Ratio: While CEO pay ratio summary statistics (e.g., 25th percentile, median, and 75th percentile) were flat across the sample, two-thirds of the sample companies had pay ratios that fluctuated up or down by more than 10 percent. The significant volatility in individual company pay ratios is masked in the overall sample, so proxy readers should not be surprised if a company’s pay ratio moved year-over-year.
2. CEO Pay: CEO compensation increased 7 percent at median with two-thirds of CEO pay fluctuating by more than 10 percent. This may be driven by incentive compensation changing year to year, by CEO transitions and by changes in pension value calculations where applicable.
3. Median Employee: Only 36 percent of companies used the same median employee year-over-year – and about 80% of those re-ran the selection analysis versus selecting an employee who was substantially similar to the prior-year median. For the companies that use the same median employee, the pay of that employee went up 7 percent at median. Where companies selected a new median employee, the year-over-year change in pay was 4 percent at median. This indicates that companies that want to maintain a lower CEO pay ratio (for a couple of years) may be better off keeping the same median employee from year to year if possible.
4. Additional Disclosures: Despite interest expressed by some institutional shareholders in greater disclosure about the workforce, only 16 percent of companies disclosed additional information about the median employee (e.g., geographic location, role with the company, full-time vs. part-time, etc.). This is up from 12 percent of companies providing additional disclosures last year.
Within the last decade, median pay for S&P 500 CEOs has increased by 50% – to $12.2 million – and median pay for S&P 600 CEOs has nearly doubled. That’s according to this blog posted on Tuesday by ISS Analytics (which also hints at the motivation behind the “pay ratio” law by pointing out that pay to median workers increased by 20% during the same period).
Of course, those CEO pay numbers are based on the “total compensation” figures in companies’ Summary Compensation Tables – which can overstate what executives are actually taking home. Specifically, a record portion of pay now comes in the form of stock, and the grant date fair value has been…more than pocket change. Here’s more detail:
Increases in compensation are primarily driven by greater portions of pay paid in stock. So far in pay fiscal year 2018, the average stock grant to S&P 500 CEOs amounts to $7.2 million, compared to $3 million in pay fiscal year 2009. Stock-based compensation continues to increase, while the aggregate of all other components of pay remains relatively unchanged.
In fiscal year pay 2018, stock-based compensation comprises the majority of CEO pay at S&P 500 and S&P 400 companies for the first time. The trend is the same for smaller companies with stock-based compensation reaching 49 percent and 42 percent of total CEO pay for S&P 600 companies and Russell non-S&P 1500 companies, respectively.
Coinciding with these increases, the blog notes that there’s also been a big shift to performance-based compensation for both equity & cash awards. Even with recent changes to Internal Revenue Code Section 162(m), the percentage of total compensation that was performance-based increased to 58% last year (compared to 34% in 2009). TSR, earnings & returns are the most popular metrics.
While the shift to stock-based compensation has worked to the benefit of most executives as the market has climbed, there’s still a possibility that it will be a double-edged sword. I’ve blogged that now’s the time to recession-proof your compensation plans – and these stats really drive that point home.
Don’t let the name deceive you – a supplemental executive retirement plan doesn’t have to focus strictly on payouts in retirement. And if your company is trying to retain up-and-coming execs in their 40s, you probably don’t want it to. This Longnecker blog illustrates why you might want your plan to be more flexible. Here’s an excerpt:
Executive A is 57 years old. He’s married and has adult children who live on their own. A is maxing out his deferrals into the company 401(k) plan but still hasn’t saved enough for retirement. His employer wants to reward him for his 15 years of service and keep him around another 10 years until he plans on retiring. Putting a SERP in place that promises to pay him 40 percent of his final pay for life will accomplish the employer’s goal, because 10 years and retirement are foremost on the executive’s mind.
Now let’s take a look at his successor in training: Executive B is 40 years old. He’s married with three children, ages 4, 6 and 8. B’s wife stays at home to care for the children and doesn’t have formal employment. B is contributing to his 401(k) but is nowhere near maxing out contributions. His employer wants to retain him long term to succeed Executive A. The employer offers B the same SERP that will pay him 40 percent of final pay at retirement. Three years go by, and Executive B leaves the company for a higher-paying job. The plan did not achieve the employer’s goal. Why did it fail, and how could it improve?
Here’s a dispute out of Delaware – Batty v. UCAR International – in which a company and their former employee of 34 years are arguing over $1.5 million because of ambiguous defined terms in a nearly 20-year-old agreement. You’d think they’d settle! But there must be good reasons not to do that (yet) – which is lucky because now we all get to see how things blew up and carefully check our own forms. This blog from Steve Quinlivan explains why the court recently denied the company’s motion to dismiss:
The defendants argued that “accrued Incentive Compensation” was limited to cash compensation and thus excluded equity awards. The defendants relied on Section 1(f), which defined “Incentive Compensation” as “any compensation, variable compensation, bonus, benefit or award paid or payable in cash under an Incentive Compensation Plan.”
According to the defendants, Section 1(f)’s phrase “paid or payable in cash” modifies all preceding nouns (“compensation, variable compensation, bonus, benefit or award”). In the alternative, the defendants argued that they prevail even if “paid or payable in cash” modifies only the nearest noun, “awards,” because equity awards are “awards” and thus subject to the cash limitation. To bolster their interpretation, the defendants point to the definition of “Incentive Compensation Award,” which too is limited to “cash payment or payments awarded to [Batty] under any Incentive Compensation Plan.”
The Court noted the defendants’ interpretation of Section 2(a)(ii) was reasonable, but that it was not the only reasonable interpretation. Just as conceivable, according to the Court, was that the term “Incentive Compensation” could mean certain items that may be paid in cash or equity (“compensation, variable compensation, bonus, benefit”) as well as one item that is only paid or payable in cash (“award”). According to the Court, under this interpretation, regardless of whether the equity awards are “paid or payable in cash,” they would be included in Batty’s accrued Incentive Compensation. Because Section 2(a)(ii) is susceptible to multiple reasonable interpretations, the defendants’ motion to dismiss failed.
A few months ago, I blogged that Citigroup was the first US company to post unadjusted “pay gap” numbers on its website. That effort has landed it at the top of this “Gender Pay Scorecard” from Arjuna Capital & Proxy Impact, which ranks 46 large companies on their pay equity disclosures. Of course, half of the companies got a failing grade (report cards like this only come out when there’s something to complain about). The scorecard also recaps the five-year history of these proposals and says that the proponents won’t be letting up any time soon. Here’s an excerpt:
As of April 2019, 27 proposals have been filed with several more likely to be filed before the end of the year. The healthcare sector has seen the largest increase in shareholder activity this year. Only seven proposals have been withdrawn so far, partly since more investor proposals are asking for companies to provide unadjusted median pay data like the reporting requirement in the U.K. This data helps identify the opportunity gap for women. More detail regarding the difference between adjusted “equal pay” and unadjusted “median pay” disclosures is provided in a subsequent section.
In the last four years, at least 64 companies have faced more than 100 shareholder resolutions on the gender pay gap, along with many more shareholder dialogs in the absence of a formal proposal. The shareholder campaign has primarily focused on the information tech, financial services, retail, and healthcare sectors. It shows no signs of slowing down and will likely expand to more sectors in the future.