I’ve blogged a few times about the downsides of adding ESG metrics to incentive plans – here’s a write-up of why long-term shares might be a better mechanism for motivating ESG behavior, and here’s a post about how ESG metrics can be particularly dangerous when it comes to things like employee safety. Now, Harvard Law profs Lucian Bebchuck & Roberto Tallarita are out with this empirical analysis to highlight flaws of ESG-linked compensation. They identify these two primary limitations:
1. ESG metrics commonly attempt to tie CEO pay to limited dimensions of the welfare of a limited subset of stakeholders. Therefore, even if these pay arrangements were to provide a meaningful incentive to improve the given dimensions, the economics of multitasking indicates that the use of these metrics could well ultimately hurt, not serve, aggregate stakeholder welfare. They risk distorting CEO incentives.
2. ESG compensation poses the danger of creating vague, opaque, and easy-to-manipulate compensation components, which can be exploited by self-interested CEOs to inflate their payoffs, with little or no accountability for actual performance.
The professors are skeptical that ESG pay programs could evolve enough to overcome these problems, even if designed with an eye towards being clear, objective, comprehensive, transparent and standardized. Their current conclusion is that:
Shareholders and those who care about stakeholder welfare should not support maintaining or expanding current practices for using ESG metrics. Existing practices and their expansion should not be regarded as a positive development for those who are concerned about stakeholder protection. They serve the interests of executives but not those of shareholders or stakeholders.
Companies that are resisting the push to incorporate ESG metrics in pay programs may want to add some of these talking points to their engagements and proxy statements.
Companies that have or are planning to add ESG metrics should consider how to overcome these objections – e.g., by improving transparency and limiting discretion. Comp committees and advisors should also thoroughly consider and remain on the lookout for “unforeseen consequences” of these incentives. A lot of investors are on the ESG bandwagon right now, but they’ll be at your doorstep complaining if things go south.
Shareholders just raised the stakes for pay equity proposals. Although fewer resolutions made it onto ballots last year, that simply means that some companies recognized that it’s a gamble to put these to a vote – not necessarily that proponents are slowing down. Arjuna Capital scored a notable win last week at The Walt Disney Co., garnering approval from 59.6% of voting shareholders according to the company’s Form 8-K. That outcome was despite the company’s opposition in the proxy statement and additional soliciting material. Here’s the resolution in full:
Shareholders request Disney report on both median and adjusted pay gaps across race and gender, including associated policy, reputational, competitive, and operational risks, and risks related to recruiting and retaining diverse talent. The report should be prepared at reasonable cost, omitting proprietary information, litigation strategy and legal compliance information.
Racial/gender pay gaps are defined as the difference between non-minority and minority/male and female median earnings expressed as a percentage of non-minority/male earnings (Wikipedia/OECD, respectively).
According to this article, this is one of the first shareholder proposals to pass at Disney in several years. The entertainment giant publishes EEO-1 data, but that was not enough here. The proponent noted that the company does not currently report its unadjusted or adjusted pay gaps – and that an increasing number of companies are doing so. If your company is considering a pay equity audit, we have a checklist for that.
Comments on the SEC’s reopened “Pay versus Performance” proposal were due March 4. The SEC has continued to welcome submissions after that deadline, and letters have continued to roll in as recently as this week. You can view all of the comments submitted – from 2015 to present – on the SEC’s website. Here are a few notable ones:
Many recent comment letters re-hashed concerns previously raised in response to the 2015 proposal. Generally, the investors leaned in favor of additional pay disclosure, but the issuer-side found them overly prescriptive, irrelevant in certain cases, and burdensome. Several of the recent letters brought up discussion points on how ESG metrics may fit in with the proposed rules – AllianceBernstein suggested that companies using ESG metrics should describe the metric’s relationship to the long-term business strategy and other financial metrics to avoid a “check-the-box approach” to ESG metrics in exec compensation; CalSTRS suggested directing companies using ESG metrics to “select metrics from a suitable standard” like SASB. Some of the comments also cut in favor of including a GAAP reconciliation for non-GAAP pay targets.
As was the case in 2015, the Staff has a lot to consider – and companies may want to consider how the proposed rule would impact their compensation programs & disclosures, if adopted. We will be tracking developments!
Transitioning from a private to public company is a huge leap – and it takes a lot of careful thought and dialogue between the company management, its board of directors and its advisors to make sure the company is set up for success. One particular area of pre-IPO focus relates to equity compensation strategies and balancing peer and industry data with the company’s specific compensation philosophy.
To help companies benchmark and assess what works for them, Pay Governance reviewed 368 IPOs from January 1 – December 31, 2021 to analyze equity program practices at IPO. Here’s an excerpt of some key findings:
– Dilution at IPO: Founders and investors use dilution to understand how equity awards to employees could dilute the value of their ownership. Our research shows the median dilution from outstanding equity among IPO companies equaled 5.4%.
– New Share Requests: The median share request for newly funded equity plans equaled 8.2% of fully diluted shares outstanding.
– Evergreen Provisions: Among companies that went public in 2021, 73.4% included an evergreen provision in their long-term incentive plan document. They are especially common among Tech, Bio-Tech/Pharma, and Retail companies with approximately 85.0% prevalence (on average)… Over half (74%) of evergreen provisions were established for 10 years, the maximum allowed period under the stock exchange listing requirements.
– Overhang: … [M]edian overhang at IPO equaled 14.4% across all industries. Tech companies had the highest median overhang at 17.2%, while Financial Services had the lowest at 8.8%.
Last week, Liz blogged on TheCorporateCounsel.net about BlackRock’s 2022 engagement priorities. BlackRock Investment Stewardship also published their approach to engaging with companies on compensation that would help maximize long-term shareholder value. BIS noted that “appropriate and transparent compensation policies are a focus in many of BIS’ engagements,” and they want to see companies clearly connect the dots between compensation and long-term financial performance. This includes disclosing how short- and long-term incentive plans work together to lead to long-term value.
BIS also observed that sustainability-related criteria continue to rise in popularity in incentive plans – here’s an excerpt of what they want to see & what they anticipate seeing:
BIS does not have a strong view on the use of sustainability-related performance criteria, but believes that where companies choose to include them, they are best aligned with shareholders’ interests when they: 1) address issues that are material to a company’s business model; 2) are aligned with long-term strategic priorities; and 3) incorporate the same rigor as with other financial or operational targets. It is helpful when companies integrating sustainability-related criteria in their incentive plans clearly explain the connection between what is being measured and rewarded and the company’s strategic priorities. Not doing so may leave companies vulnerable to reputational risks and/or undermine their sustainability efforts…
As companies navigate the global energy transition, we anticipate more incentive plans will include relevant greenhouse gas emissions reduction targets or transition-related metrics. Appropriate use of financial and other metrics aligned with long-term climate risk management – as well as investment in clean energy and product innovation – are increasingly important as companies look to position their business models to transition over time to a net zero economy.
In their memo, BIS also stated a preference for engaging with the relevant directors regarding compensation policies or outcomes – so companies should take that into account during the engagement planning stage. In addition, BIS prefers to engage on proposed compensation policies and plans “in final, or near final, stages” – backed by rationale on how the plans tie to long-term value creation, so companies should consider putting BlackRock later in their engagement schedule.
Countries & companies alike have been taking action against Russia, including with sanctions and pausing sales. Russia has also been taking its own actions – including blocking Facebook – which reinforces the point that companies need to be cognizant both of their actions and the Russian government’s actions. To that end, a member recently posted this question in our Q&A Forum (Topic #1403):
I saw a note that as of March 2, 2022, US companies can no longer engage in share transactions with Russian residents, unless expressly allowed by the Russian Government, which is unlikely to give permission. This encompasses both the issuance of shares for consideration and without consideration.
The implication is that any ESPP purchases, option exercises and RSU vestings should be suspended as of March 2, 2022.
I’m not able to find much more about this. Do you know whether it’s correct and where it is coming from?
Liz responded:
From what I hear, this is accurate. The issuance of foreign shares to Russian residents is prohibited by the new exchange control restrictions in Russia without Central Bank approval (Decrees No. 79 & 81). So, this restriction came from the Russian government. The risk is a fine to employees receiving those shares.
Companies should look at the plan documents to determine whether they allow for suspension of share issues / ESPP participation when not in compliance with applicable laws. Because there are a lot of restrictions on all types of financial transactions right now, cash settlement can be an alternative but would need to be carefully handled and properly accounted for.
Shareholder proponent As You Sow recently issued its 8th annual “100 Most Overpaid CEOs” report, which is available for download on their website. Here’s how they identify “overpaid” CEOs:
To identify the 100 Most Overpaid CEOs, we evaluate the CEO pay at S&P 500 companies using data provided by Institutional Shareholder Services (ISS). Further data and analysis provided by HIP Investor computes what the pay of the CEO would be, assuming such pay is related to cumulative Total Shareholder Return (TSR) over the previous five years, using a statistical regression model. This provides a formula to calculate the amount of excess pay each CEO receives. We then add data that ranks companies by what percent of company shares voted against the CEO pay package.
A newer calculation of shareholder votes by Insightia uses only the votes of institutional investors (those required to file SEC Form 13F) in both the numerator (shares voted against) and denominator (total shares voted) to calculate percentage opposition. This calculation gives a more accurate indication of institutional investors’ level of dissatisfaction, most obviously in cases where insiders own a particularly large portion of stock or there are dual class shares. More information on this and a comparison between reported votes and what we are calling “institutional votes” can be found in Appendix B. Finally, we rank companies by the ratio of the CEO’s pay to the pay of the median company employee.
The rankings of companies by excess CEO pay and by shareholder votes on CEO pay are each weighted at 40 percent. The final ranking based on CEO-to-worker pay ratio is weighted at 20 percent. The complete list of the 100 Most Overpaid CEOs using this methodology is found in Appendix A. The regression analysis of predicted and excess pay calculated by HIP Investor is found in Appendix C, and its methodology is explained further there.
Here’s an interesting nugget from page 7 about the correlation between proxy advisor recommendations and CEOs on the list:
In 2021, ISS recommended voting against 11 percent of the CEO pay packages at S&P 500 companies and against 45 percent of the 100 Most Overpaid CEOs. These percentages are based on the ISS “standard” policy. ISS also offers voting recommendations based on other policies (e.g., a Socially Responsible Investor (SRI) policy, a public pension fund policy, and a Taft-Hartley policy). Differences between the standard and SRI policy are minimal on compensation issues…
The ISS Taft-Hartley policy was designed to appeal to Labor Union pension funds. This season, the Taft-Hartley policy recommended voting against 65 percent of the 100 Most Overpaid CEO pay packages. The most significant difference between the Taft-Hartley policy and the standard policy seems to be a sentence in that policy that says votes against can be triggered when “the board has failed to demonstrate good stewardship of investors’ interests regarding executive compensation practices.” The public pension fund policy closely tracks the Taft-Hartley policy on compensation.
Glass Lewis uses a model comparing CEO pay in relation to company peers and company performance compared to peers. It awards letter grades between “A” and “F.” An “A” means that the percentile rank for compensation is significantly less than its percentile rank for company performance. In 2021, Glass Lewis recommended shareholders vote against 12.4 percent of CEO pay packages at S&P 500 companies and against 50 percent on the 100 Most Overpaid CEOs list. This is a 14 percent increase in vote against recommendations for the 100 Most Overpaid CEOs. These percentages are based on the Glass Lewis “standard” policy. Glass Lewis also offers ESG and Taft-Hartley policies. The ESG policy voted against 57 percent of the 100 Most Overpaid CEOs list and the Taft-Hartley policy voted against 52 percent.
So, if your CEO is on this list, it’s a signal that you should pay extra attention to your proxy statement communications – including how you’re justifying the pay package and disclosing the actual and potential payouts. We have a lot of resources on this site to help you with that. Check out the “Say-on-Pay Solicitation Strategies” and “Say-on-Pay Disclosure Issues” chapters of Lynn & Borges’s “Executive Compensation Disclosure Treatise”. Visit our “Determining How Much Pay is Appropriate” Practice Area for guidance on pay decisions.
I blogged yesterday about the “against” recommendation that ISS is making for Apple’s say-on-pay resolution. While you don’t have to be making $82 million grants to get dinged for a lack of performance criteria or disclosure, mega grants do tend to draw extra scrutiny.
Problematic pay practices that lead to low say-on-pay support are also “blood in the water” for activists. GE received this letter from SOC Investment Group (formerly CtW) urging a refreshment of the company’s compensation committee in light of their 2020 decision to lower performance hurdles associated with a previously granted award, which they did by granting a replacement award that year (valued at $60 million at target). The letter reiterates concern that the activist expressed last year, which preceded a failed say-on-pay vote and several committee members receiving less than 80% support in the director election. Now, SOC says that the company hasn’t demonstrated responsiveness.
Recently, the Financial Times reported that proxy advisor ISS would recommend an “against” vote for Apple’s say-on-pay resolution this Friday – due to concern with the $82 million in stock awards that CEO Tim Cook received last year. According to this CNN article, ISS took issue with a lack of performance criteria for a portion of the award & what it views as inadequate disclosure on whether future awards will be granted. ISS also dislikes the size of this mega grant, even though it’s the first award that Cook has received since 2011.
Over the weekend, Norges Bank – which operates Norway’s $1.3 trillion sovereign wealth fund and has a policy to publish voting instructions 5 days before a portfolio company’s shareholder meeting – also said that it would vote against the pay package (and support 4 of 6 shareholder proposals). Regarding say-on-pay, Norges says:
A substantial proportion of annual remuneration should be provided as shares that are locked in for five to ten years, regardless of resignation or retirement. The board should provide transparency on total remuneration to avoid unacceptable outcomes. The board should ensure that all benefits have a clear business rationale. Pensionable income should constitute a minor part of total remuneration.
Apple’s management is getting love from some notable shareholders, though. I blogged yesterday on TheCorporateCounsel.net that Warren Buffett is in favor of rewarding Mr. Cook for the tech company’s performance. Berkshire Hathaway owns 5.56% of Apple’s outstanding shares – more than the Norwegian sovereign wealth fund.