I’ve blogged before about the impact of Covid-19 and potential use of discretion in making adjustments to executive compensation. A recent Semler Brossy memo says now is when the board and compensation committees should begin preparing for potential discretionary compensation adjustments at year end. No doubt use of discretion can invite criticism so early planning can be a big help.
The memo provides a framework for tracking the impact from Covid-19 and setting a foundation for any future pay adjustments. Here’s an excerpt about how to begin:
Boards won’t know the full impact of the pandemic on their company’s business results for some time yet. But they can identify metrics where the company is likely to be most vulnerable and see how their performance compares with previous years and with competitors’. At the early stages, it is important to be fairly exhaustive in the exercise, exploring first-, second-, and possibly third-order impacts.
Discretionary adjustments aren’t without scrutiny and the memo says boards will want to take care in setting consistent and transparent expectations in light of the current environment with an eye to concerns of all stakeholders – investors, employees, customers and the community at large.
Preparation ahead of time will result in a thoughtful CD&A, grounded in a clear rationale, which in turn will make investors less likely to disagree with the committee’s judgment. Employees and the public will be more likely to see exceptions as logical and justified.
Not to overload the compensation committee, but another item that companies may want to add to the committee’s agenda, if they haven’t already, is a review of their compensation peer group to determine whether changes should be made. As the economic fallout from Covid-19 continues, companies may find that it no longer makes sense for certain companies to be in their compensation peer group.
Each company has its own methodology for selecting peers and the process to make changes varies. The ISS identified peer companies often overlap with a company’s peers but may not line up exactly and recently, ISS issued a memo with suggested peer group strategies for companies to consider. The memo notes that shareholders are quick to scrutinize executive compensation and 2020 pay decisions, including the peer group used, will be no different.
ISS lists common selection criteria for identifying compensation peers, company size being one. Due to recent swings in the market, the memo suggests some companies may want to look at data using a longer time horizon to help smooth out comparisons. Here’s an excerpt:
– Market Capitalization: Rather than using spot-price market cap values, utilize a market cap based on the 200-day average price for a more reliable and less volatile measure of company size.
– Revenue: For revenue or other measures of company size, rather than using the most recently disclosed quarterly or yearly values, look at revenue data over a longer-term period such as 2-year or 3-year averages for a helpful approach to approximate the company’s size under normal conditions. Additionally, analyst estimates of future financials, when available, can help shed additional light on where certain peers are headed and whether they will remain valid comparisons in the coming year.
– M&A, Spinoff, Bankruptcy Activity: Some existing peers may no longer be in operation due to merger, acquisition, or spinoff activity, or are at risk of no longer being viable standalone companies, in which case those could be considered candidates for removal; and these factors can be added as peer screening criteria.
Recently, Vanguard issued its insight about executive pay during Covid-19. Vanguard’s general message is that directors should be guided by good judgment on critical matters such as financial survival and workforce safety as well as longer-term factors that align with a company’s purpose and strategy. The asset manager provided the following pay-related considerations for boards:
– Variable pay: the asset manager may support plans in which variable compensation makes up the majority of executives’ total pay and is measured with a long-term focus beyond the next quarter or year.
– Performance target adjustments: Vanguard doesn’t believe it’s appropriate for compensation committees to adjust or create “easier” performance targets – it wants at-risk pay to remain at-risk.
– Relative performance metrics: Vanguard views these as crucial amid market downturns. In volatile markets, comparing relative performance metrics with those of a relevant set of peers helps guard against outsized payments for market recovery versus true long-term company outperformance.
– Social perspective: the asset manager encourages boards to apply both a financial and, increasingly, a social lens when considering how executive pay, human capital, or capital allocation decisions factor into the overall context and public perception of a company’s practices.
– Use of discretion: Vanguard welcomes adjustments to timing or amount of payouts to better align with the experiences of shareholders and stakeholders. When applying discretion, the asset manager will be looking for disclosure about the decision process and rationale.
Back in February, I blogged about recent trends in stock ownership requirements. Obviously, a lot has happened since then and a recent Hunton Andrews Kurth blog serves as a reminder that, depending on how companies structure stock ownership guidelines, some companies might want to consider granting a temporary waiver of stock ownership requirements. With volatile markets and many companies having experienced a stock drop, ownership guidelines denominated in dollars are most likely to cause executives to fail the ownership requirement. Here’s the blog’s message:
Compensation Committees could consider a temporary waiver of the stock ownership requirements, with the idea that the issue will be revisited in the Fall of 2020. But in exchange for such waiver, the executive should be required to hold (i.e., not be able to sell) all shares currently subject to the policy. Such hold requirement should continue until the issue is revisited in the Fall of 2020.
Some companies may already incorporate a “hold until requirement is met” into their guideline, so a consideration for these companies might include whether the policy requires action to temporarily waive the ownership requirement and if so, the length of the waiver.
For companies with May or June compensation committee meetings, they’ll undoubtedly be discussing company responses to Covid-19 and impacts to compensation. A Pearl Meyer blog suggests three high-level comp committee discussion topics dealing with Covid-19:
– Review disclosed actions to date: there’s value in knowing what other companies are doing but know that disclosures may only be the tip of the iceberg
– Start establishing ground rules regarding 2020 short-term incentives: discuss the impact of COVID-19 on the business and incentive plan metrics, including potentially modeling two or three scenarios of full-year effects to the extent possible. If modeling is not practical, the discussion should turn to establishing ground rules for how performance will be evaluated – for example, defining what “good performance” looks like post COVID-19 and how this might translate to potential bonus payouts
– Tee-up a discussion about long-term incentives/equity: Given that in most cases these awards are for multi-year periods, there is no reason to panic just yet. That said, if the impact of COVID-19 is projected to zero out all performance cycles in play, there may be an argument for discussing the potential need for retention awards, who would be eligible to receive them, the amounts, and the optics of such a move
ISS’s impact on say-on-pay vote results is a frequent topic this time of year. An updated Semler Brossy report shows that the current average say-on-pay vote result for companies receiving an ISS “against” recommendation is 36 percentage points lower than for companies that received an ISS “for” recommendation.
In an earlier look at say-on-pay vote results, the number had stood at 38 percentage points. Even though the number has declined slightly from earlier this proxy season, it’s still higher than the historical average range of 24 to 32 percentage points. This will be interesting to watch whether the number ends up closer to its historical average by the end of the 2020 season and in any event, the reports show ISS vote recommendations continue playing a significant part in final vote results.
A recent report from ClearBridge Compensation Group takes a look at trends in non-employee director compensation. The report examines compensation for non-employee directors among 100 of the S&P 500 from 2009 – 2019 and looks at median compensation levels for board service, committee chair and board leadership fees and compensation mix. The report also looks at non-employee director stock ownership guidelines and here’s some of what it found:
– Stock ownership guidelines have become significantly more prevalent, from 63% of companies in 2009 to 94% in 2019, further increasing the alignment between directors and shareholders
– The specific ownership guideline (as a multiple of the annual board cash retainer) has also increased; while 3x and 5x were common in 2009 (34% and 46%, respectively), 85% had a guideline of at least 5x in 2019
– A majority of companies in 2019 required directors to retain shares of company stock for a specified length of time, either through a holding requirement (15% in 2009 and 21% in 2019) or a mandatory equity deferral feature (24% in 2009 and 32% in 2019)
A recent blog from Dan Ryterband at FW Cook serves as a reminder that the pay cuts we seem to read about daily for senior executives and non-management directors have been concentrated primarily among a smaller group of companies. Here’s an excerpt:
Approximately 10% of the Russell 3000 and less than 15% of the S&P 500 companies have taken action to reduce pay. There are two common threads among these companies, most of which are concentrated in the hardest hit industries:
– A need to preserve cash to enhance liquidity or to meet specific financial targets due to debt covenants or other requirements, and
– A sense of “shared sacrifice” between top leadership and the broad workforce if large numbers of employees have been laid off or placed on unpaid or reduced-pay furloughs
Typical pay mix for S&P 500 CEOs is heavily weighted toward performance-based pay, including multi-year equity awards, which is likely a primary reason we haven’t seen more widespread action to reduce pay.
One observation noted in the blog is the importance of deeper succession planning. Although it’s still early, looking forward, the blog says it’s possible that the gap between CEO and other proxy officers’ pay may narrow as companies recognize more fully that the CEO is part of a team, as opposed to disproportionately creating value on his/her own. Pay parity throughout the entire organization may elevate in importance as companies reevaluate the definition of “essential” within the workforce.
Changes to investor proxy voting policies and guidelines are common and recent changes to J.P. Morgan’s voting policies caught my eye as some changes relate to executive compensation. This Georgeson blog provides a summary of the comp-related changes:
– Say-on-Pay: Under its current policy, JPM withholds votes from compensation committee members for failing to respond adequately to a say-on-pay proposal that received less than 60% shareholder support at the previous year’s shareholder meeting. JPM now also considers withholding votes from select members of the compensation committee in cases of pay-for-performance misalignment or where performance metrics and targets, used to determine executive payouts, are not aligned with long-term shareholder value.
– Clawback Proposals: JPM changed its position from case-by-case evaluation to generally support shareholder proposals seeking to recoup unearned incentive bonuses or other incentive payments made to senior executives where fraud, misconduct or negligence significantly contributed to financial restatements. In its updated policy, JPM also added that it will support shareholder proposals seeking to recoup incentive payments where misconduct or poor performance by an individual prior to the payments contributed in whole or in part to the issuance of such payments.
With continued economic volatility, companies also need to think about stock-plan valuation issues. Most companies haven’t had to deal with valuation-related challenges for quite some time but this recent Willis Towers Watson blog discusses considerations, including immediate issues and potential actions for stock options and relative TSR awards.
The discussion of the valuation model for stock options notes that the commonly used Black-Scholes model requires fixed inputs and doesn’t permit flexibility to adjust the volatility and dividend-yield assumptions over time. Here’s an excerpt for a related potential action:
Use of binomial lattice or Monte Carlo models allow for assumption flexibility:
– Volatility can start at today’s elevated levels and revert to long-term historical means
– Dividend yields can start at today’s elevated levels and be adjusted downward over rising share price paths in the model
– Exercises can be assumed to occur sooner in a quick recovery and later in a slow recovery