Pay-for-performance tanks productivity, creates a risky compliance culture, causes undesirable conflicts among departments, is only useful for tasks involving physical labor (vs. “problem solving”), and harms customer relationships. Those of us who are involved with compensation should “just say no” to this blunt instrument and instead work on building a culture in which people care about the customer & each other. For example, by treating employees with respect and offering excellent training opportunities.
Those are the conclusions from this recent article from management consultant Roger Martin, whose faith in “pay-for-performance” has crumbled over the last 30 years. I usually blow off articles like this as fluff – but this one goes a bit deeper. It ties intuitive points to real-world events & research (which according to Prof. Martin, is more than can be said for pay-for-performance). Here’s more detail on a couple of the problems he points to:
Fourth, the gaming is without limit. Roy’s machine shop is a poignant example. For every worker, half their day was spent doing nothing productive. Tanking a whole year to reset the budget at an easy level. Stuffing the distribution channel to make the quarter. Chopping advertising spending to jack up this year’s profitability. Diluting the ingredients in the termite spray at the end of the year to make budget — yup, freely admitted to me by field staff at a former client. Opening accounts that customers never approved. Recognize that there is no limit!
Fifth, you can’t fool customers. They figure out that they have a big target on their backs. Your incentive compensation ranks far above their satisfaction. They figure out that are merely a means to your end. But of course, they aren’t powerless. They know that you are trying to make budget to get your bonus and they can wrap you around their finger as year-end approaches. Monetary incentive compensation is toxic for customers. And that is even if it is about customer satisfaction scores. With two of my last three car purchases, the salesperson pleaded with me to give him a perfect satisfaction score to help with his compensation — resulting in me never intending to purchase a car from their companies (Lexus and Range Rover) again — great cars, but terrible customer experience thanks to monetary incentive compensation.
It would require a huge amount of bravery to depart from pay-for-performance – from boards, managers, investors, proxy advisors, and consultants. Maybe even lawyers, as it’s just so different than what we’ve become accustomed to documenting and disclosing. The problem is that people at the top do need to communicate in some way what type of performance they want delivered, and it takes a lot of extra work to figure out what motivates each individual to get there – it may even require the investors/directors/managers to loosen their grip on specific metrics or outcomes. Combine that with frequent executive & employee turnover – and difficulty measuring things like culture – and many are left feeling that a “blunt instrument” is the only efficient option.
The thing is, more than a few investors are starting to show signs of disapproval – and even former execs are questioning it. This may be something where at some point, leaders will admit that the experiment isn’t delivering the results that were hoped for – and that adding ESG metrics isn’t a simple solution, either.
‘Tis the season…for updating off-season peer groups. ISS announced yesterday that their peer group submission window will be open from 9 am ET on Tuesday, July 6th until 8 pm ET on Friday, July 16th – for companies that have annual meetings slated to be held between September 16, 2021 and January 31, 2022. Here’s more detail:
As part of ISS’ peer group construction process, on a semi-annual basis, corporations are requested to submit changes they have made to their self-selected peer groups for their next proxy disclosure. ISS considers companies’ self-selected peer groups as an important input as part of its own peer group construction methodology.
Submissions should reflect peer companies used (or to be used) by the submitting company for pay-setting for the fiscal year ending prior to the company’s next upcoming annual meeting.
If you haven’t made any changes to your peer group, or you don’t want to provide the info in advance, you aren’t required to participate. That just means that ISS will automatically factor into its methodology the peers that you disclosed in your last proxy statement.
Meanwhile, Equilar’s peer group submission window is open through tomorrow – Wednesday, June 30th – targeting companies that file their proxy statement between July 15, 2021 and January 14, 2022. Institutional investors’ voting policies often say that they incorporate a third-party analysis to verify company peer groups, and some use Equilar’s research for that. The portal re-opens in December for spring filings (and any changes submitted after June 30th will be incorporated in that update).
Last week, I blogged on TheCorporateCounsel.net that the SEC has issued a record amount of whistleblower awards this year. Companies need to anticipate the possibility of whistleblowers and encourage employees to raise concerns internally – but that doesn’t mean you can prohibit them from going directly to the SEC! Doing so would violate Rule 21F-17 of the Exchange Act.
Last week, the SEC announced that it had settled an enforcement action with a brokerage firm that tried to do just that, by including this provision in its employee manual and related training:
Employees are also strictly prohibited from initiating contact with any Regulator without prior approval from the Legal or Compliance Department. This prohibition applies to any subject matter that might be discussed with a Regulator, including an individual’s registration status with FINRA. Any employee that violates this policy may be subject to disciplinary action by the Firm.
The manual defined “Regulator” to include the SEC. Meanwhile, the Code of Conduct said:
Nothing in this policy or any other Company policy or agreement is intended to prohibit you (with or without prior notice to the Company) from reporting to or participating in an investigation with a government agency or authority about a possible violation of law, or from making other disclosures protected by applicable whistleblower statutes.
That wasn’t enough to save the company from being tagged in the enforcement action – nor was the finding that no employees were actually prevented from communicating with the SEC about potential violations, or that the company took no action to actually enforce the restriction or prevent communications. Although the company didn’t admit or deny the findings in the SEC order, as part of the settlement they agreed to pay about $210k, revise the manual, alert their employees to the change, and promise not to do it again. See this Stinson blog for more details.
If you haven’t reviewed your employee manual and code of conduct lately, this is a good reminder to do so. If your comp committee is evolving into a “people committee,” they might have a hand in that.
In an unusual twist, last week a company announced voting results from its annual shareholder meeting and said it considered all items of business with the exception of its say-on-pay proposal. Some investor advocates are unhappy with the CEO pay package and the company said shareholders should have more time to consider the say-on-pay vote. Here’s an excerpt from the company’s press release:
Based on requests from shareholders for additional time, the independent members of the Activision Blizzard Board believe it is in the best interest of its shareholders to extend the opportunity for shareholders to vote on this important matter, and therefore recommended an adjournment to allow additional time for shareholders to submit proxies with respect to the [Say-on-Pay] Proposal. The 2021 Annual Meeting will be reconvened on Monday, June 21, 2021 at 9:00 a.m. Pacific Time (the “Reconvened Annual Meeting”). The sole matter of business before the Reconvened Annual Meeting will be the [Say-on-Pay] Proposal.
The company’s press release details certain recent statements about its executive compensation practices that it believes were misleading. The Board members believe that obtaining informed shareholder feedback related to Activision Blizzard’s compensation policies and practices is of fundamental importance, and therefore, allowing additional time for shareholders to meaningfully participate in the vote better represents their interests.
This unusual development ruffled the feathers of some investor advocates and they were speaking out about it. This case might add more fodder to the discussion about whether pay-for-performance is the way to go with compensation because in this case, it doesn’t appear to be pleasing everyone. Activision’s press release says it decreased the CEO’s base salary and cash bonus and made most of the CEO compensation performance based. With that, MarketWatch reports that 54% of shareholders approved Activision’s say-on-pay proposal. Stock awards made up the bulk of the CEO’s compensation and the value of the company’s stock rose and outpaced the S&P 500 last year.
As we cross the high-point of proxy and annual meeting season, Equilar and the NYT recently released their annual look at CEO pay levels for the 200 highest-paid CEOs. Liz blogged about one aspect of the analysis.
It’s also worth visiting Equilar’s interactive chart that analyzes the pay of the 200 CEOs included in the study. It’s sortable by total compensation, change in comp value year over year, the company’s CEO pay ratio and median employee pay, company revenue and change in revenue year over year. Here are some of the findings:
For the first time since 2014, none of the 10 highest-paid CEOs had been in the top 10 in the previous study. Only one of the 10 highest-paid CEOs has been among the top 10 in the past (Regeneron’s CEO). This trend is due chiefly to the fact that there were five newly public companies represented among the top 10, as well as a CEO recently new to his position (DaVita’s CEO).
COVID-19 has had an uneven effect on corporations, often dependent on industry, but the market overall has reached continual highs in the past year. While CEO pay increased due to rising equity values, cash compensation (salary and bonus) was lower in 2020 than the previous year on balance, even among these highest-paid executives. Salary for Equilar 200 CEOs dipped 3.7% at the median from the previous year, while the median cash bonus fell 5.2%.
Meanwhile, median employee pay for the firms included on this year’s list actually increased, albeit modestly, rising 1.9%. While it would be difficult to argue that CEOs suffered as employees benefited in 2020, fixed pay for executives was held to the same standards as that of the median employee across the market in 2020.
Tune in tomorrow for the webcast – “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn analyze this year’s wild say-on-pay results, key 2021 lessons, ongoing pandemic-related issues, ESG metrics, CEO pay ratios, status of SEC rulemaking, and what to start thinking about for next year.
If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submit your state and license number and complete the prompts during the program.
Members of this site are able to attend this critical webcast at no charge. If you’re not yet a member, subscribe now. The webcast cost for non-members is $595. You can renew or sign up online – or by fax or mail via this order form. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
This recent Glass Lewis blog looks at what can go wrong with ESG oversight – and how it can connect to, and impact, executive pay votes. The situation discussed in the blog involves Rio Tinto, a mining company dual listed in both Australia’s ASX 100 and the UK’s FTSE 350. At the company’s 2021 annual meeting, more than 60% of votes cast voted against its remuneration report, which serves as a retrospective, advisory look at the last year’s pay decisions. Here’s an excerpt:
Shareholder concerns centred on the company’s destruction of two ancient rock shelters in the Juukan Gorge, and its subsequent response. The blasting, which caused irreversible damage to a 46,000-year-old Aboriginal cultural heritage site in the Pilibara region of Western Australia, occurred in May 2020 as part of the expansion of an iron-ore mine.
The board review of the matter found certain executives, including the group chief executive, responsible failure to implement an adequate heritage management system. The company then determined that the group chief executive wouldn’t be entitled to receive any bonus awards for FY2020 and also said a reduction would be applied to LTIP awards that were due to vest in 2021. Stakeholders didn’t think the financial penalties were adequate and the executives involved retired, and the board chair announced an intention to retire at the conclusion of the company’s 2022 annual meeting.
Even with all this, investors weren’t happy and ultimately voted against the company’s renumeration report. The terms of the group chief executive’s departure apparently made the situation worse because as a good leaver, all of his outstanding awards will vest as scheduled, subject to pro-rating for the time worked and achievement of applicable performance conditions.
This case shows the importance of ESG oversight and that investors may look beyond the initial matter and consider related compensation decisions too. For executives involved in perceived ESG missteps, this case shows the potential of a wide-reaching effect.
This recent Pay Governance Survey of 30 big UK & EU companies shows that nearly all of them have included ESG metrics in their incentive plans – compared to about 20% of US companies that were surveyed earlier this year. The European companies also had a much higher rate of ESG inclusion in long-term incentive plans (41%). These practices are worth a look, because they could foreshadow investor expectations here in coming years. Here are some predictions:
• The prevalence of ESG metrics in incentive plans is much higher in the UK and EU compared to the US, and it is likely the US will close the gap within the next 2-3 years based on past trends (for example, Say on Pay was first adopted in the UK and EU) as well as potential enhanced regulatory requirements (current S.E.C. review of 2010 interpretative release) and investor and societal pressures to prioritize ESG;
• Both UK/EU and US companies will increase the inclusion of ESG metrics in their respective long-term incentive plans as investors and regulators focus on how companies intend on achieving their long-term sustainability goals;
• The types of ESG metrics and plan designs used by both UK/EU and US companies are largely the same,including the use of scorecards, quantitative and qualitative goals,and relatively modest weightings; and
• Once adopted, it will be difficult to turn back,and many US companies are conducting their materiality assessments to select the metrics and goals that will have the greatest impact on the company’s long-term performance. Thus, as noted in our previous Viewpoint, we continue to believe “many [US] companies will use 2021 as a ‘launching pad’ for finalizing and rolling out ESG metrics” in 2022 incentive plans.
The survey says that with respect to Environmental metrics, reduced carbon emissions/greenhouse gas was the number one metric selected by UK/EU companies followed by waste reduction. Among US companies,energy efficiency/renewable energy was the top metric followed by reduced carbon emissions/greenhouse gas.
Diversity was the top Social metric among UK/EU and US companies. US companies also selected a companion metric – inclusion and belonging – at a much higher rate (43% compared to 19%).
This NYT article analyzes whether execs are receiving outsized stock awards that end up widening the gap between CEOs and ordinary workers. It focuses on the 200 highest-paid CEOs – 8 of whom earned more than $100 million in total compensation last year. Here’s an excerpt:
CEOs in the survey received 274 times the pay of the median employee at their companies, compared with 245 times in the previous year. And CEO pay jumped 14.1 percent last year compared with 2019, while median workers got only a 1.9 percent raise.
Last year’s colossal awards sprouted from a well-developed corporate compensation culture, in which boards, consultants and executives preach the gospel of “pay for performance,” which typically links CEO compensation to the company’s stock price. But this approach can lead to enormous payouts if stocks go up. The S&P 500 returned nearly 18 percent in 2020, including dividends, and CEOs reaped handsome rewards. But the question is, how much do they really deserve?
“They are emphasizing performance equity awards so much and ignoring how big they are,” said Michael Varner, director of executive compensation research at CtW Investment Group. “This is one of the chief culprits of the continuing rise in executive pay over the decades.”
The article spends quite a few paragraphs focusing on big payouts that CEOs can achieve if the stock price performs over a long period. You can feel the companies’ frustration in having to respond to some of these media inquiries – explaining repeatedly that the execs don’t actually get the payout until they achieve the milestones, or pointing to SEC filings that say that. But at the end of the day, if activists and others have decided that the company is contributing to inequality, it’s very difficult to communicate a $5 billion award in an appeasing way.
An online fashion retailer out of the UK is linking executive pay to improvements in supply chain workers’ rights – in response to government pressure to do so. Although it’s hard to imagine regulators here requiring particular metrics, it’s not a stretch that investors would carry that mantle.
In this case, allegations of mistreatment sparked a £1bn hit to the company’s share price and resulted in one of the company’s largest shareholders divesting its holdings. Here’s more detail on the comp plan that’s being submitted for shareholder approval this week (see pgs. 71 & 81 of the annual report):
– Vesting of 15% of executive awards depends on the company successfully implementing its “Agenda for Change” program to fix supply chain issues (the “Agenda for Change” includes 6 steps to enhance the company’s supplier audit & compliance procedures, including publishing a full list of its UK suppliers)
– 3-year performance period
– Payout is also tied to stock price performance (could pay up to £150m in total if shares rise by 66% over three years from June 2020)
– Payout decisions will be made by independent compensation committee
Meanwhile, according to the Glass Lewis Controversy Alert, the proxy advisor remains concerned about the company’s ability to mitigate its risk of “modern slavery” issues and is concerned that the board was aware of issues in 2019 and failed to take adequate action prior to this issue emerging in the media in mid-2020. In light of those concerns, it’s recommending against reelection of the company’s co-founder and executive director. ESG issues could have a real impact at this meeting.