– Lynn Jokela

Back in December, I blogged about a member’s quest for a “more rationale” CD&A. That conversation continued with a few other members chiming in our Q&A Forum (#1294). First:

Kudos to planning in advance and thinking this way. I think that a good, compliant CD&A should be able to be drafted in about 10 to 12 pages. Instead of long, narrative paragraphs and generic, multiple-year boilerplate, why can’t nearly all of the material information be provided in basic bullet points or charts/tables?

The “what” could be provided very concisely in charts/tables (think salary, bonus and LTI information), and the “why” could be provided in brief bullet points. I also think the other standard narratives (i.e., philosophy, objectives, management/consultant involvement, elements of pay, pay mix, impact of SOP vote, etc., etc.) could be provided in bullet points, or a chart, or other graphic elements.

The original poster responded:

Thanks very much for response. I think that it would be helpful if the SEC mimicked a high school English teacher, as in, “Please write an essay no longer than 2,500 words explaining to shareholders how your executive compensation program works, why your named executive officers received the compensation they did for the performance year, and how that compensation reflects your pay for performance philosophy.” Let’s be honest- virtually no one reads a CD&A, even if they claim to do so (cf. Finnegan’s Wake). Certainly an institutional investor voting 4,000 positions on say on pay is not, your Uncle Joe is not, and the proxy advisory firms, if they read a CD&A at all, only extract certain information necessary to complement their quantitative screens. Because of the involvement of lawyers, compensation consultants, HR personnel, corporate governance experts, and endless “best practices” suggestions, the typical CD&A has become a bloated document that brings to mind the description of a camel as a horse designed by a committee. Not that I mind having a job.

Then Liz recently chimed in by alerting people to this recent Equilar survey (available for purchase):

Maybe some people are taking your advice. Equilar just published a study showing that the average CD&A word count dropped for the first time in 5 years. Looks like companies may be relying more on graphs of alternative pay calculations to tell their stories:

– 75.8.% of Equilar 100 companies used a proxy summary in the annual proxy in 2018

– The word count of Equilar 100 companies’ CD&A portion saw a decline for the first time in five years, dropping to an average of 9,359 words in 2018

– The number of companies that included a pay mix graph fell six percentage points from 2017 to 2018, down to 78.8% of companies

– After hovering around 77.0-79.0%, the number of companies that included a compensation program checklist decreased by 3.3 percentage points from 2017 to 2018, down to 74.5%

– In 2018, 46.5% of Equilar 100 companies included a graph displaying an alternative pay calculation different from those displayed in the summary compensation table, such as realized or realizable pay

Personally, I think one issue is that moving from what most companies produce now to a shorter, condensed CD&A would be considered out of the ordinary and to a certain degree, groundbreaking. And who is willing to be the first to try this really short, concise approach given the risk of SEC comments, plaintiff litigation, and negative votes or recommendations? It’s encouraging to see that there may be a trend in the right direction.

– Liz Dunshee

A recent paper from three B-School Profs might confirm what many people in our community have been advising: don’t over-explain your pay ratio. The research also suggests that high pay ratios are impacting say-on-pay & employee productivity. Here’s an excerpt:

We find that firms with higher pay ratios receive greater dissent on SOP proposals and have a higher likelihood of failing to receive majority support. These findings reinforce extant studies showing that SOP is a means for shareholders to express dissatisfaction with executive compensation practices (e.g., Cai and Walkling, 2011; Brunarski, 2015) and on vertical pay disparity at U.S. banks (Crawford et al., 2019).

We next explore changes in labor productivity, as prior work links employee pay disclosure to worker satisfaction and productivity (Card et al., 2012). We find that employee productivity gains are lower following the initial disclosure of a high pay ratio. These findings are consistent with the notion that larger pay differences between top managers and employees could reduce employee morale, leading to lower productivity (Rees, 1993; Green and Zhou, 2019). We find that most of the negative stakeholder outcomes arise from reporting an unexpectedly high pay ratio and when the value is larger than the majority of its industry peers.

We also present regression results that include the pay ratio and separate controls for CEO and median employee compensation. For most tests, we find the ratio has significant explanatory power beyond compensation levels, suggesting that it contains unique and informative content for stakeholders.

– Liz Dunshee

Tune in tomorrow for the webcast – “The Latest: Your Upcoming Proxy Disclosures” – to hear Mark Borges of Compensia, Alan Dye of Hogan Lovells and Section16.net, Dave Lynn of TheCorporateCounsel.net and Morrison & Foerster and Ron Mueller of Gibson Dunn discuss all the latest guidance – including the latest SEC positions – about how to use your executive & director pay disclosure to improve voting outcomes and protect your board, as well as how to handle the most difficult ongoing issues that many of us face.

– Liz Dunshee

Here’s some pay-related proxy season recommendations from Hunton Andrews Kurth’s Tony Eppert:

1. Adopt an annual grant policy – this can act as an affirmative defense to any allegation that the company is timing the market

2. Consider a stock price forfeiture provision to avoid the drag of underwater stock options – but make sure such does not trigger the cancellation/regrant provisions of NYSE and NASDAQ listing rules

3. Adopt a separate equity plan for non-employee directors – since the ISS Equity Plan Scorecard doesn’t apply to a non-employee director equity plan, a separate plan would make it easier for the company to meet the minimum vesting requirements for its employee plan

4. Consider whether all or some of a non-employee directors’ compensation should be approved by the shareholders – e.g., annual fees, compensation caps/limits, fixed formulas, etc. – in order to help protect the decisions of the non-employee directors with respect to their own compensation

5. Consider bulking up your proxy’s “director pay” disclosure – the narrative that proceeds the non-employee director compensation table could discuss the pay philosophy, how pay is assessed, and benchmarking efforts

6. Consider revisiting “executive officer” determinations, implementing a deferral program, or restructuring severance payouts – to reduce the number of people subject to IRC Section 162(m) and thereby increase the deductibility of executive compensation

7. Consider whether to amend the equity incentive plan to allow for a higher net withholding rate – this might require shareholder approval (depending upon the design of the amendment), but the upside is that any equity plan with liberal recycling provisions should enjoy a longer life expectancy associated with the share reserve

– Liz Dunshee

This Equilar blog summarizes the most common changes that companies make to their pay programs following a failed say-on-pay vote – the key is to emphasize pay for performance, not just to pay executives less. Here’s an excerpt (also see this Deloitte memo):

Just over half of the companies that failed Say on Pay in 2017 elected to make changes in compensation metrics or weighting. Compensation metric changes in 2018 generally consisted of modifiers or the addition of line-of-sight metrics to long-term incentive plans. iStar, for example, established a metric that would cap funding at the threshold level for the Annual Incentive Plan if total shareholder return is negative.

The second- and third-most prevalent changes embodied a shift toward performance equity and a reduction in overall pay or position. A shift toward performance equity resulted, most frequently, in a pay mix leaning heavily on variable pay, while a reduction in overall pay was marked by the removal of unique or one-time incentives.

Bed Bath & Beyond attracted significant attention in the last year with its Say on Pay results after another year of poor company performance. Following the vote in 2017, which only received 43.9% approval, the company only made one change to its compensation plan—the reduction of overall pay for its former CEO, Steven Temares. In 2018, Bed Bath & Beyond reduced CEO target compensation by 19%, which involved a $2.2 million decrease in the value of equity awards as well as the voluntary waiver of $500,000 of the Temares’ annual base salary.

However, these actions did little to appease shareholders and the 2018 plan garnered even less support, with only 21.4% of votes in favor. Bed Bath & Beyond serves as an example of how simply paying executives less will not suffice—shareholders want to see clear compensation plans that will result in visibly improved company performance.

– Liz Dunshee

As Lynn blogged a few weeks ago, the IRS recently proposed regulations to implement changes to IRC Section 162(m) that are necessary under the 2017 Tax Cuts & Jobs Act. This Ropes & Gray memo takes a closer look at the impact that the proposed regulations would have on deductibility following IPOs, M&A deals, spin-offs, and other transactions (we’re continuing to post memos on the proposed regs in our “Section 162(m) Compliance” Practice Area). Here’s a few takeaways:

1. The Post-IPO Transition Relief for Newly-Public Companies Has Been Eliminated. The existing regulations under Section 162(m) provide a special transition rule for companies that have gone public. Under the transition rule, executive pay pursuant to plans and agreements that pre-date the Company’s initial public offering and that are disclosed to prospective shareholders are exempt from Section 162(m) for a certain period following the initial public offering as long as those arrangements are not materially modified. The proposed regulations preserve the existing rule for companies that went public on or before December 20, 2019, but eliminate it for companies that go public after that date.

2. Predecessor” Rules Will Make More Pay Nondeductible. Section 162(m) applies to any individual who was a covered employee of a publicly held corporation or any predecessor of a publicly held corporation for a preceding taxable year. The proposed regulations take a sweeping approach to determining what it means to be a “predecessor of a publicly held corporation.”

These rules are significant because the TCJA introduced the “once a covered employee, always a covered employee” requirement, which means that if executives of a predecessor company remain employed or otherwise in service or receive transition or exit packages, their compensation may be wholly or partially nondeductible.

3. Go Private Transactions. Many “go private” transactions in which publicly held corporations are acquired by private equity funds or other non-publicly traded acquirers result in a short taxable year for the target that ends on the closing. The proposed regulations make clear that compensation for this short taxable year in which the target was a publicly held corporation would be subject to Section 162(m). The result is that the deductibility associated with often substantial transaction-based pay to executives in such transactions (e.g., option or RSU cash-outs) would now be sharply curtailed or eliminated.