We’ve blogged before about legislative considerations tying corporate tax rates to pay ratios. A recent Baker McKenzie blog says San Francisco is considering such a move. The blog summarizes action taken earlier this summer by the San Francisco Board of Supervisors when it approved what is called the “Overpaid Executive Gross Receipts Tax” for inclusion on November ballots.
The initiative would impose a tax on companies doing business in San Francisco if their highest-paid employee makes more than 100 times the median compensation of the company’s San Francisco-based employees. Businesses with no more than $1 million in annual gross receipts and non-profits would be exempt from the tax, but other businesses with a presence in San Francisco would potentially be subject to the tax.
As discussed in the blog, the ballot initiative is silent on how compensation will be determined, making it difficult for companies to understand the potential impact of the tax. The blog suggests the potential purpose of the tax is less about making policy and more about seeking an additional source of tax revenue.
Although 62% of the Fortune 200 incorporates ESG metrics into incentive plans, a significant portion of those relate to shorter-term “operational” metrics, versus metrics that shareholders have deemed relevant to long-term sustainability and stakeholder objectives. That’s according to this Semler Brossy memo – which categorizes “operational” metrics to include:
The memo notes that “customer satisfaction” is the most common ESG metric, used by about 55 companies in the Fortune 200. Although they may not be exactly what “stakeholder capitalism” proponents are looking for, the rationale for using “operational” metrics seems pretty strong – they’re easier to tie to the top or bottom line.
We’ve blogged a lot about pay adjustments that may be necessary due to unforeseen challenges that the pandemic has presented (here’s the latest – and this 11-page CGLytics memo analyzes adjustments that’ve been announced by 554 companies in the Russell 3000).
But for some companies, the pandemic has meant that business is booming. This Pay Governance memo summarizes pay actions that you might want to take if you’re at either end of the spectrum – noting that even companies that are doing relatively well right now still need to be sensitive to the overall environment that we’re all facing.
Here’s what it says to consider if your company’s performance has been better than expected this year, and you’re tracking to above-target payouts for annual incentives:
Discuss formulaic payouts, based on:
• Reviewing the impact of the pandemic on revenues/profits versus future/sustainable levels
• Considering the team’s response to the pandemic to safely meet increased customer demands while managing supply chain and other operational challenges
• Evaluating if negative discretion is appropriate considering broader context (e.g., pay less than maximum to avoid perceptions of windfalls and demonstrate empathy)
And for long-term incentives that were granted at prices well below the current value, or that are tracking for above-target payouts due to unique 2020 performance, it suggests:
• Reviewing formulaic payouts to ensure payouts are appropriate considering the broader economic and social context
• Evaluating if the estimated payouts from outstanding awards provide sufficient recognition for the performance delivered, which also may be considered in developing next year’s long-term incentive grants
In addition, the memo suggests reviewing NEO pay – including potential realizable pay and a mock-up of next year’s Summary Compensation Table – and the history of incentive payouts compared to TSR over 3, 5 and 10-year periods. While you’re at it, now’s also the time to start assessing whether 2020 events should affect plan design for 2021.
As I recently blogged, ISS is already saying that COVID-related compensation decisions will dominate next year’s proxy season. That means proxy advisors and shareholders will be looking even more closely at your CD&A to understand the rationale for pay decisions – and how they fit into your broader “ESG” story, especially with respect to your “human capital” practices and decisions.
As this Willis Towers Watson memo points out, shareholders “may be less inclined to support companies taking what they perceive to be disproportionate actions to protect executives at the expense of or in contrast with others.” The memo notes that these social and governance factors could attract extra scrutiny this year:
– Furloughs
– Reductions in force
– Reliance on government aid programs
– Broad employee pay-cuts
– Outbreaks at sites or among employee populations
– Customer safety
– Reduced or suspended dividends
– Increased dilution
Willis Towers Watson urges companies to address any “red flags” – such as one-time retention awards, overriding formulaic outcomes through the use of discretion, executive windfall gains, etc. – head-on, through a storytelling approach. And when it comes to ESG, the consulting firm suggests that discussing its role in executive compensation may offer these benefits:
– Preempt investor questions and demonstrate awareness of a topical issue
– Highlight existing practices or documents that may not have been widely known about to date
I blogged a few weeks ago about a framework for executive pay adjustments. This Mercer memo lays out additional considerations specific to “non-performing” performance shares – including available alternatives for this situation, plan provisions, accounting treatment, and disclosure and tax implications. Here’s what it says about accounting treatment:
The accounting treatment of discretionary performance share cancellations, modifications, and replacements differs for awards with nonmarket (e.g., EPS or sales targets) vs. market performance conditions (e.g., TSR). Automatic adjustments that are set out in the plan (“the committee shall adjust for …”) generally have no impact on compensation expense.
Nonmarket conditions. Companies recognize no cost for performance shares that are improbable of vesting or cancelled. Instead, companies must recognize any incremental cost associated with a modified or replacement award. The incremental cost is calculated by comparing the fair value of the award immediately pre- and post-modification. If an award is improbable of vesting or cancelled, the pre-modification fair value is zero and the post-modification value equals the new number of shares expected to vest (typically target) multiplied by the per-share fair value on the modification date. The final cost is trued up for the number of shares that actually vest.
Market conditions. The cost of a performance share with a market condition must be recognized regardless of the outcome or whether the award is cancelled, as long as the employee completes the award’s original service requirement. In addition, companies have to recognize any incremental cost associated with a modified or replacement award. The incremental cost is calculated by comparing the fair value of the award (using a Monte-Carlo simulation incorporating the probability of achievement) immediately pre- and post-modification.
And when it comes to your plan documents, here are a few questions to consider:
– Are there any restrictions on discretionary modifications or replacements?
– Is participant consent required?
– Will cancelling awards or converting stock-settled awards replenish the share reserve?
– Will additional grants exceed the available share reserve or any plan individual limits?
I blogged the other day about a SEC settlement that included repayment of close to $2 million in incentive compensation, and last week, Liz blogged on TheCorporateCounsel.net about another clawback matter, this one involving Steve Easterbrook, the former CEO of McDonald’s. If you’ve been following news reports, you’re likely aware McDonald’s is suing Easterbrook to claw back severance that was paid to him when Easterbrook was dismissed “without cause.” A recent NYT DealBook article suggests that companies and legal advisors may want to revisit pay and severance policies for a closer look at “cause” definitions. Here’s a Fenwick & West blog discussing some of the potential ramifications companies might find themselves up against when pursuing a clawback.
Many companies adopted clawback policies in the time since the SEC proposed rules directing national securities exchanges to establish listing standards relating to clawback policies. A recent Pay Governance memo reminds companies to monitor upcoming SEC action as it’s likely the SEC will propose final rules on clawbacks in the next several months. If so, companies will want to ensure their policies comply with the final rules – some policies may require amendment.
We’ll be discussing the latest on clawbacks and forfeiture provisions, including the trend to broaden those provisions at our “Proxy Disclosure & Executive Pay Conferences” – coming up virtually September 21st – 23rd. Register today to get the latest essential & practical guidance, direct from the experts. Here are the agendas – 15 panels over 3 days, plus interactive roundtables to discuss pressing topics.
We’ve blogged before about reports showing trends in tying ESG metrics to executive compensation and a recent Clermont Partners blog looks at shareholder proposal trends for insight into investor interest in tying ESG to executive compensation. And, it sounds like companies may want to start planning for how to enhance disclosure in next year’s proxy statement about E&S compensation metrics and how executives are compensated against E&S goals.
In analyzing shareholder proposal trends, the blog says investor’s want to see executive compensation tied to ESG metrics. The blog reports that the number of, and support for, ESG executive compensation shareholder proposals have increased and then it walks through some of the factors ESG ratings firms evaluate for executive compensation. Depending on which ratings firms company investors follow, the blog provides a helpful overview of ESG ratings in context of executive compensation. To get started, the blog suggests companies first define key performance indicators used to track and measure company-specific ESG goals and then clearly disclose these KPIs in ongoing investor communications.
In terms of potential E&S executive compensation proposals – within the “E” dimension, the blog says investors have cited poor performance on SASB-defined material ESG issues, requesting boards integrate ESG metrics into executive incentive programs. Within the “S” dimension, investor requests have largely centered around reporting on a company’s global median pay gap across gender, race or ethnicity or requesting compensation committees evaluate pay grades and/or salary ranges of all classifications of employees when setting CEO compensation targets.
Earlier this year, I blogged about disclosure of investor engagement following a failed or low say-on-pay vote result. With a failed or low say-on-pay vote result, most companies will consider a variety of actions and a recent Compensia memo reviewed low say-on-pay vote results at technology companies to help shed light on actions companies took. Each company will make decisions about changes to compensation design or structure based on its own circumstances, although it’s helpful to know what other companies have done if you find yourself dealing with this issue.
A low say-on-pay vote result is described as a vote that failed to win shareholder support or for ISS, a vote receiving less than 70% support, and for Glass Lewis, less than 80% support. Some of the most common actions companies took (the memo delves further into each category of changes) include:
– Long-term incentive design changes – 92%
– Enhanced CD&A/outreach – 76%
– Performance share design changes – 60%
– Short-term incentive design changes – 44%
Compensia also found what it describes as “more dramatic” actions – 52% of the observed companies made a change to the membership of their Compensation Committee in the two years following an unfavorable result, while 36% of the companies subsequently changed their independent compensation consultant. Although the reasons for such changes usually cannot be directly attributed to the say-on-pay vote, it is possible that, in the course of their review, the Board of Directors determined that a fresh point of view might benefit the oversight of the executive compensation program.
Last, it’s also worth noting that the memo says although the size of a CEO’s pay package is generally a key factor in the analysis of a say-on-pay proposal, Compensia’s research was inconclusive as to whether a failed vote or low support ultimately resulted in a reduction in CEO pay in a subsequent year. The memo suggests when evaluating a failed or low say-on-pay vote result that companies consider the absolute level of CEO pay as a potential issue and whether a reduction is appropriate in light of shareholder concerns.
Over a year ago, Liz blogged about Hertz’s lawsuit seeking to recover incentive compensation paid to executives. The lawsuit came about after the company had to restate three years of financials. The SEC had investigated the company’s accounting and disclosure, which the company agreed to pay $16 million as part of its settlement of the matter. Now, just last week, the SEC announced it charged Hertz’s former CEO, Mark Frissora, with aiding and abetting the company in filing of its financial statements and disclosures and that Frissora has agreed to settle – with the settlement including repayment of almost $2 million in incentive compensation.
The SEC’s complaint says that, to date, Frissora hadn’t reimbursed Hertz for any portion of his incentive-based compensation received during the 12-month period following the filing of the allegedly materially false financial statements. Here’s an excerpt from the SEC’s press release (also see this Stinson blog):
The SEC’s complaint, filed in federal district court in New Jersey, charges Frissora with aiding and abetting Hertz’s reporting and books and records violations and with violating Section 304 of the Sarbanes-Oxley Act by failing to reimburse Hertz for the requisite amount of incentive-based compensation he received. Without admitting or denying the allegations, Frissora consented to a judgment permanently enjoining him from aiding and abetting any future violations of the applicable federal securities laws, requiring him to reimburse Hertz for $1,982,654 in bonus and other incentive-based compensation and requiring him to pay a $200,000 civil penalty. The settlement is subject to court approval.
The SEC’s press release says that in addition to settling fraud and other charges with the company, late last year, it also settled an order against Hertz’s former controller.
I blogged earlier this week that COVID-related pay decisions will dominate the upcoming proxy season. Unfortunately, the business environment remains uncertain and companies must examine whether previously-adopted metrics remain appropriate. In our “Covid-19″ Practice Area, we’ve posted this chart from Winston & Strawn that catalogues companies that have disclosed changes to annual or long-term incentives due to the pandemic and resulting economic uncertainty. This 9-page Aon memo outlines a framework for deciding whether – and how – to change pay programs. Here’s an excerpt:
Now that we are almost six months into dealing with the pandemic, it’s becoming clear that compensation committees will need to use far more discretion than they have in the past. Given scrutiny over executive compensation is far greater in the era of say-on-pay voting than it was a decade ago, compensation committees will want to review performance objectively and rely more on measured judgement than pure discretion to make compensation decisions.
Relevant internal stakeholders — including compensation committees, executives, HR and rewards leaders — should begin the process by thinking through these types of questions:
▪ How, and how much, should executives and employees be rewarded for results delivered during an unprecedented crisis?
▪ How do we measure performance when performance measures or goals established early in the year don’t translate to the long-term health of the company given the current environment?
▪ How do we help compensation committees move from formulaic to measured judgement?
▪ What should we expect in terms of shareholders’ and proxy advisory firms’ reactions?
To ensure companies are prepared in the coming months to make compensation decisions with measured judgement that withstands intense scrutiny, now is the time to start establishing a process with a solid framework.
Keep in mind that while mid-year adjustments and discretionary awards might be necessary to motivate executives during a challenging time, they also contribute to skepticism of incentive pay programs. This Economist article discusses the growing contingent who are questioning whether “pay-for-performance” is working (a phenomenon I’ve blogged about a few times over the last couple of years). Here’s an excerpt:
In 2017 MSCI, a research firm, published its analysis of realised chief-executive pay between 2007 and 2016 at more than 400 big public American firms. At more than three-fifths of the firms, it showed no correlation with ten-year total returns. Some firms overpaid lousy bosses; others underpaid successful ones. Pay-for-performance “may be broken”, MSCI concluded. A recent paper co-authored by Lucas Davis of the Haas School of Business finds “strong evidence” that bosses of energy firms see clear pay gains when stock valuations rise as a result of an oil-price spike which they have no way to influence.
A fresh analysis by Equilar, commissioned by CalPERS, a big Californian public pension fund, identifies similar trends. It looked at the past five years of realised CEO pay for most firms in the Russell 3000 and compared this with the companies’ total returns. The bosses in the top pay quartile made twelve times what those in the bottom quartile did, but produced financial returns only twice as good. The bosses in the second-lowest pay quartile made nearly three times as much as those in the bottom quartile, even though their firms’ total returns were actually worse. “There is no evidence that boards can tell in advance who is a talented CEO,” sums up Simiso Nzima of CalPERS.