Here is an interesting academic paper that was published this month in the Review of Finance. Four B-School profs looked at TSR and other “relative performance evaluation”-based awards – which in recent years constitute about one-third of the value of total compensation, according to the study. The professors first lay out why peer group selection can be fraught:
In practice, awards are designed by the board of directors often in consultation with the management. Frictions in contracting or lack of board oversight could enable the CEOs and executives to influence peer selection with the intention of increasing expected award payout and reducing award effectiveness thereby leading to a tension between the benefits of RPE from a theoretical perspective and the costs imposed by agency issues.
Boards or executives may also have other incentives to not design the awards exactly as theory predicts. For example, boards may feel, out of a sense of fairness, that executives should face some of the same risk in industry or market swings as investors do (Edmans, Gosling, and Jenter, 2021) and consequently select peers that do not filter out all common shocks to firm performance.
The use of peer groups to set pay levels, that is, competitive benchmarking, could also create inefficiency in RPE peer group selection. There is often significant overlap in firms included in the compensation and RPE peer groups. Firms selected for the compensation benchmark peer group either because they provide information about labor markets or are included to justify higher pay, may not be firms that are the best for filtering out common shocks to performance.
And here’s what their data revealed:
The custom group is significantly more effective than four plausible alternative peer groups at filtering out common shocks, lowering the cost of compensation, and increasing managerial incentives.
For RPE awards using a market index, we find some evidence that firms could have selected a custom set of peers with better filtering properties at a lower cost with similar incentives. For example, firms could have saved around $118,000 in present value terms, on average, for an RPE award had they chosen a custom group comprising their product market peers instead of a market index.
Although $118k is small potatoes in comparison to CEOs’ total compensation, it adds up across executives and over time. The question for companies that have been using a market index peer group is, would a switch be worth the internal & external communication efforts – and all that goes along with that? Check out this blog from last year for practical steps to select the right peer group – as well as the resources in our “Peer Groups” Practice Area.
When it comes to ESG metrics, European investors have so far been more likely to take a stance in favor of the practice. Big global asset managers like BlackRock have disavowed having a strong view on whether executive pay plans incorporate ESG metrics and instead focus on transparent disclosure and structuring compensation programs in a way that incentivizes long-term performance.
Columbia Threadneedle – which still has a large focus on European-based companies, but also holds North American companies and is the asset management business of Ameriprise – is getting more specific. In a 9-page guidance document issued last week, the asset manager gives market stats and examples of companies employing ESG metrics in incentive plans, and lays out its expectations in a more detailed way than many other institutions. While most of the guidance defers to company judgment on how to use ESG metrics, it does take a stance on how important they should be:
We advocate that the total percentage of variable remuneration based on ESG metrics should be no less than 10%, regardless of whether one or a variety of metrics are selected. We believe weighting within a range of 10-20% is sufficient to incentivise executives while not overshadowing other strategic goals. Nevertheless, we believe there are circumstances where remuneration committees in their discretion may appropriately wish to increase that proportion where the business strategy allows or encourages.
And auditing:
In the UK and Europe, metrics must be audited as part of information disclosed in annual reports. In markets where this is not required, we expect metrics to be externally audited or verified. For example, Shell’s climate metric, which part of its executive remuneration is based upon, is audited, while Danone’s climate metric is based on its CDP climate score.
Columbia Threadneedle – which has “responsible investment” ethos – expects to see a growing number of companies adopt ESG-linked executive incentives. It cites statistics that more than half of S&P 500 companies and nearly half of FTSE 100 companies included at least one ESG metric in incentive plans last year.
We’ll also be sharing practical guidance about ESG Metrics at our virtual “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – coming up in only two weeks, October 12th – 14th. There is still time to register! Here’s the agenda – 18 essential sessions over the course of three days. Sign up online (with the “Conference” drop-down, and the “PDEC” options), email sales@ccrcorp.com, or call 1-800-737-1271. Bundle your registration with our “1st Annual Practical ESG Conference” and get a discounted rate!
Pay equity is a topic that we’ve been covering on this site for over a decade (here’s a list of a bunch of blogs that address it). What’s fascinating is that the notion of what “pay equity” means continues to evolve and be driven by different factors. This Perkins Coie blog highlights four recent trends to monitor, which could affect where we go next on this issue:
1. Evolving focus and complexity. Audits are expanding their focus on evaluating racial and ethnic pay differences in light of recent social movements. Moreover, organizational shifts, from acquisitions to job architecture changes, may cause havoc with ensuring fair pay throughout an organization.
2. Changing labor market. The tight labor market makes it important that starting salary and retention pay decisions follow established principles of pay equity.
3. Greater pressure to disclose. Employees have become far less shy about sharing information about their pay, and many states require disclosure of starting salary data. Recently, the EEOC has signaled a renewed interest in obtaining pay data from employers. These efforts trigger intricate issues related to how companies typically disclose information and how long-standing legal privileges are evaluated.
4. Aggressive government enforcement. We are seeing unprecedented coordination among Biden administration officials to investigate and enforce laws related to pay equity. In addition, states like California and Illinois have put into place very robust compliance and enforcement obligations with enhanced penalties for violations of the law.
Visit our “Gender & Racial Pay Equity” Practice Area for checklists and other resources that will help you stay on top of this area of changing regulations and demands.
We’ll also be covering the compensation committee role in overseeing pay equity audits & shareholder proposals at our virtual “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – coming up in only two weeks, October 12th – 14th. There is still time to register! Here’s the agenda – 18 essential sessions over the course of three days. Sign up online (with the “Conference” drop-down, and the “PDEC” options), email sales@ccrcorp.com, or call 1-800-737-1271. Bundle your registration with our “1st Annual Practical ESG Conference” and get a discounted rate!
The SEC’s newly adopted “pay vs. performance” disclosure rules are one of the most significant changes to executive compensation disclosure in the past decade. The new disclosures will require multiple years of information and new calculations for equity awards – and they’re required in 2023 proxy statements!
On Thursday, November 10th from 1-4pm ET, join us for a special session on “Tackling Your Pay Vs. Performance Disclosures” – featuring Compensia’s Mark Borges, Morrison Foerster’s Dave Lynn, WilmerHale’s Meredith Cross, Sidley’s Sonia Barros, SGP’s Rob Main, Fenwick’s Liz Gartland, Gibson Dunn’s Ron Mueller, and more.
This is a 3-part, 3-hour special session that will cover:
1. Navigating Interpretive Issues – we are already getting lots of questions in our Q&A forum about how to apply the new rules, and we know that new issues are arising daily. We’ll be sharing practitioner guidance and any SEC updates that you need to know – including what you’ll need to tell your board and executives.
2. Big Picture Impact – how will the disclosure mandate affect say-on-pay models and shareholder engagements? This session will provide context and pointers for bolstering executive compensation & compensation committee support during proxy season.
3. Key Learnings From Our Sample – attendees of this event will get first access to our sample disclosures, prepared by Mark Borges and Dave Lynn. Hear “lessons learned” from their drafting effort that will guide you through your own process and jumpstart your disclosures.
This event is available at a reduced rate of only $295 for anyone who is already a CompensationStandards.com member or who is signed up to attend our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” on October 12th – 14th – where we’ll be setting the stage with key takeaways from the pay vs. performance rule and the steps that you need to take now to be ready to comply. Register for the “special session” here for the CompensationStandards.com member rate (or, if you are not a CompensationStandards.com member but you are signed up for our “Proxy Disclosure & 19th Annual Executive Compensation Conferences,” contact sales@ccrcorp.com for the special rate).
For non-members, the cost to attend is $595. If you’re not yet a member, try a no-risk trial now. We’ll be continuing to add practical guidance on this topic to CompensationStandards.com as disclosure hurdles & consequences come to light – such as this great podcast that Dave already taped with Gibson Dunn’s Ron Mueller about “first impressions” of the rule, emerging interpretive issues, possible pitfalls, and more.
All that to say, a CompensationStandards.com membership be an essential ongoing resource if you are involved with pay vs. performance. Plus, our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. Register for the “special session” here if you are a non-member and are not attending our Conference.
This recent 18-page memo from Alliance Advisors recaps major shareholder proposal trends & voting outcomes from annual meetings through August 5th. Beginning on page 11, it summarizes several important compensation-related items that anyone advising on executive pay and human capital issues should be aware of. Here are a few nuggets:
1. Severance Pay: The Chevedden group boosted this year’s count of severance pay proposals to 18 — the most filed in any of the past 10 years when they were largely the purview of organized labor. The resolutions seek shareholder ratification of executive pay packages that provide for severance or termination payments in excess of 2.99 times salary and bonus. The 14 voted averaged 45.6% support and four received majority approval at AbbVie, Alaska Air Group, Fiserv and Spirit AeroSystems. The Association of BellTel Retirees’ long-running campaign at Verizon Communications also tracked up in support to 44.1% from 38.1% last year.
2. Pay Equity: Arjuna Capital and Proxy Impact had greater success this year on gender/racial pay gap reporting, which recorded the highest level of average support (42.6%) since the campaign began in 2015. Two proposals received majority approval at Lowe’s and Walt Disney—the only ones backed by both proxy advisors. Another four were withdrawn at Best Buy, Chipotle Mexican Grill, Home Depot and Target after the companies agreed to annually report their unadjusted gender and racial median pay gaps for all U.S. employees.
3. Performance Metrics: The Investors for Opioid and Pharmaceutical Accountability coalition reintroduced proposals at several drugmakers to exclude legal and compliance costs—particularly opioid-related litigation charges—from incentive compensation metrics. Unlike earlier years when the resolutions garnered less than 20% support, ISS endorsed the 2022 campaigns, which received 47.7% at Johnson & Johnson and 35.5% at AmerisourceBergen.
4. Clawback Policies: Several types of compensation clawback proposals emerged this year as the long-awaited SEC rule undergoes a third round of public comments. In all cases, the resolutions would expand coverage beyond material financial restatements to misconduct that causes financial or reputational harm to the company. Those sponsored by labor funds brought in the highest votes: 46% at Marathon Petroleum, 38.2% at Republic Services and 37% on a repeat proposal at Verizon Communications.
Chevedden’s renewed efforts on this topic—last seen in 2017—fell flat at Citigroup (9.2%) and Wells Fargo (7.3%). They included a requirement that a substantial portion of executive compensation be deferred or forfeited to satisfy legal penalties, irrespective of individual responsibility.
We’ve bloggedseveraltimes that say-on-pay has also taken a hit this year, especially among S&P 500 companies. The memo walks through that too – and highlights that proponents of compensation-related proposals are tending to target companies that have had “exceedingly low” say-on-pay votes in prior years.
The memo also includes in the “compensation” category of shareholder proposals a resolution about Rule 10b5-1 trading plans. I blogged about that on TheCorporateCounsel.net – including how it relates to the SEC’s proposal on that topic – and it’s something that we’ll continue to monitor.
We’ll be hearing practical guidance on these topics from Alliance Advisors’ Reid Pearson and other experts at our virtual “Proxy Disclosure & Executive Compensation Conferences” – which are only 3 weeks away, coming up October 12-14th! Here’s the full agenda for the Conferences – 18 essential sessions over 3 days. Sign up online (via the “Conferences” drop-down), email sales@ccrcorp.com, or call 1-800-737-1271. Hope to “see” you there!
1. The average total compensation for S&P 500 directors is $316,091, an increase of around 3% from $305,808 in 2021.
2. Stock grants represent the largest share of director compensation, at 56% — the same proportion as last year. And these are again followed by cash at 37% of compensation, the same as last year.
3. The composition of equity awards has shifted significantly over the past two decades, with fewer companies granting options and more providing stock awards. This year, 11% of boards disclosed that they award stock options to directors — down from 25% in 2012, and from 77% in 2002.
4. The shift by S&P 500 boards away from paying meeting fees continues. Only 24 boards, or 5%, pay board meeting fees — down from 30 companies (6%) in 2021. A decade ago, 33% paid meeting fees; in 2002, 70% did.
5. Of the 176 S&P 500 boards with independent board chairs, 91% provide the chair with additional compensation (worth an average of $164,205, only $71 less than last year). The value of additional compensation for board chairs ranges from $25,000 to $585,000.
6. Among boards that have a lead or presiding director, 82% pay them additional compensation, averaging $44,314. Lead directors are more likely than presiding directors to receive additional compensation — 86% versus 51% — although the gap has narrowed since last year (87% versus 38%).
The DOJ is adopting its first-ever Department-wide policy to guide prosecutors on considering corporate compensation programs & clawback policies in criminal enforcement decisions, according to a 15-page memo from Deputy AG Lisa Monaco released late last week and described in these remarks at NYU.
The memo says that “although an effective compliance program and ethical corporate culture do not constitute a defense to prosecution of corporate misconduct, they can have a direct and significant impact on the terms of a corporation’s potential resolution with the Department” – and prosecutors will now consider compensation structures as a factor in that evaluation. This excerpt explains the details:
Corporations can best deter misconduct if they make clear that all individuals who engage in or contribute to criminal misconduct will be held personally accountable. In assessing a compliance program, prosecutors should consider whether the corporation’s compensation agreements, arrangements, and packages (the “compensation systems”) incorporate elements such as compensation clawback provisions-that enable penalties to be levied against current or former employees, executives, or directors whose direct or supervisory actions or omissions contributed to criminal conduct. Since misconduct is often discovered after it has occurred, prosecutors should examine whether compensation systems are crafted in a way that allows for retroactive discipline, including through the use of clawback measures, partial escrowing of compensation, or equivalent arrangements.
Similarly, corporations can promote an ethical corporate culture by rewarding those executives and employees who promote compliance within the organization. Prosecutors should therefore also consider whether a corporation’ s compensation systems provide affirmative incentives for compliance-promoting behavior. Affirmative incentives include, for example, the use of compliance metrics and benchmarks in compensation calculations and the use of performance reviews that measure and reward compliance-promoting behavior, both as to the employee and any subordinates whom they supervise. When effectively implemented, such provisions incentivize executives and employees to engage in and promote compliant behavior and emphasize the corporation’s commitment to its compliance programs and its culture.
Prosecutors should look to what has happened in practice at a corporation-not just what is written down. As part of their evaluation of a corporation’s compliance program, prosecutors should review a corporation ‘s policies and practices regarding compensation and determine whether they are followed in practice. If a corporation has included clawback provisions in its compensation agreements, prosecutors should consider whether, following the corporation’s discovery of misconduct, a corporation has, to the extent possible, taken affirmative steps to execute on such agreements and clawback compensation previously paid to current or former executives whose actions or omissions resulted in, or contributed to, the criminal conduct at issue.
Finally, prosecutors should consider whether a corporation uses or has used non-disclosure or non-disparagement provisions in compensation agreements, severance agreements, or other financial arrangements so as to inhibit the public disclosure of criminal misconduct by the corporation or its employees.
As a whole, the memo outlines a wide-ranging overhaul to DOJ policies that will affect cooperation credit and enforcement decisions. It’s the culmination of a year-long review by the “Corporate Crime Advisory Group” – with input from experts including audit committee members, in-house attorneys, compliance & ethics practitioners and more. The memo’s bottom-line theme is that the DOJ wants to hold executives and other involved individuals responsible for corporate misconduct.
Deputy AG Monaco has directed the Criminal Division to develop further guidance by the end of the year on how to reward corporations that develop and apply compensation clawback policies, including how to shift the burden of corporate financial penalties away from shareholders – who in many cases do not have a role in misconduct – onto those more directly responsible.
Companies should consider the elements listed in this memo and the forthcoming guidance as they take a closer look at their clawback policies, compensation programs, and related employment agreements & policies. You should already have some time reserved on your calendar and board agendas to review those items, since we’re expecting final Dodd-Frank clawback rules from the SEC any time now, and the Commission’s Enforcement Division has said that executives should be “on notice” that it is committed to using using SOX 304 clawbacks to incentive a culture of compliance. The DOJ’s new stance makes it all the more important.
We’ll be sharing critical guidance on how to prepare for the new clawback rules and navigate the current enforcement environment at our “Proxy Disclosure & 19th Annual Executive Compensation Conference” this October. In particular, our session on “Clawbacks: Preparing for Final SEC Rules” – with Davis Polk’s Kyoko Takahashi Lin, CompensationStandards.com’s Mike Melbinger, Gibson Dunn’s Ron Mueller, and Hogan Lovells’ Martha Steinman – will give you practical action steps to take now. Here’s the full agenda for the Conferences – 18 essential sessions over 3 days. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271. We’re also posting other resources and practical guidance in our “Clawbacks” Practice Area for members.
As I’ve reiterated time & time again, the Reg Flex Agenda that the SEC publishes reflects the priorities of the Chair and isn’t a commitment to a particular rulemaking schedule. However! The Commission sure does seem to be on a pretty fast clip – and SEC Chair Gary Gensler seems to be committed to tying up loose “Dodd-Frank” ends. With pay versus performance rules adopted in August, there’s reason to believe that clawback rules are also coming soon. Both of those rules were slated for being finalized by October in the most recent Reg Flex Agenda – and it’s now *checks calendar* … mid-September. Clawbacks are complicated. There may be some component of a “little r” restatement in the final rule, once the SEC acts and the exchanges get around to following through with their own rules.
A blog this week from Jun Frank and Paul Hodgson at ISS Corporate Solutions summarizes comments on the reoopened proposal, current market practices, and an ISS policy clarification from earlier this year. Here’s an excerpt:
Earlier this year, Institutional Shareholder Services announced a clarification of its position on clawback policies. In order to receive credit for having a clawback policy under ISS methodology on equity plan evaluation, the policy “should authorize recovering upon a financial restatement and cover all or most equity-based compensation for all NEOs.” The policy notes that no credit will be given if the clawback covers only the limited requirements under the Sarbanes-Oxley Act nor if a company says it will wait until the SEC’s proposed rule is finalized before introducing a policy.
The SEC aims to release the final regulations by October, which may finally result in companies being required to adopt a clawback policy. While a number of businesses plan to adopt a clawback policy only after the rules are finalized, the majority already have such a policy in place.
The scope of clawback policies has also evolved over the years, with more and more boards expanding their reach to enable the recovery of compensation for actions that materially harm the company and its shareholders. The final rules may give companies an opportunity to re-examine their policies to see whether their scope is reasonable considering the firm’s operations, incentive structures and peer practices.
It makes sense that most companies already have some form of clawback policy, due to Sarbanes-Oxley provisions and market norms around non-competes, misconduct and other employment-related issues. But companies will need to pay close attention to what the new rules require and revisit their policies and agreements to make sure they conform. Plus, the SEC’s Enforcement Division is already on a tear to recover incentives under SOX 304, so it’s worth reminding executives of those ins & outs, too (the bottom line: file accurate financials…or else.)
Make sure you’re ready for this complex requirement. There are sure to be tons of questions from your higher-ups if you have to make any changes that could remotely affect their arrangements – so you’ll want to have a very clear understanding of exactly what’s required and the consequences for not complying. Register for our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – to get the crash course on “Clawbacks: Preparing for Final SEC Rules” with Davis Polk’s Kyoko Takahashi Lin, Gibson Dunn’s Ron Mueller, Hogan Lovells’ Martha Steinman, and Mike Melbinger. Plus, 17 other panels, including an interview with Corp Fin Director Renee Jones. The Conference is being held virtually over 3 days – October 12th – 14th. Sign up online (via the “conference” drop-down and “PDEC” options), email sales@ccrcorp.com, or call 1-800-737-1271.
One aspect of this is centered on capping severance payouts: we’ve blogged about recent shareholder proposals which led at least one prominent company to cap the cash component of those arrangements. (And we’ll be discussing what other companies should do about that at our upcoming “19th Annual Executive Compensation Conference.”)
Going even further is this 16-page position paper (available for download) from European impact investor Triodos. The asset manager first outlines these “best practice” elements of executive pay:
1. Disclosure, Transparency & Responsiveness: consisting of disclosure & intelligibility; transparency & power; and responsiveness
2. Risk-Taking: including a cap on variable pay; clawback policy; and performance targets & thresholds
3. Pay-for-Performance: relating to performance-based payouts; performance metrics & TSR; and company value
4. Sustainability & Alignment with Long-Term Success: including carefully-designed ESG metrics, alignment with long-term success, and appropriate severance agreements
But the more “extreme” part of Triodos’ policy, is how it votes against “the extremes.” Here’s what that means:
1. CEO pay cap of EUR 2.5 million, adjusted for company size (e.g., the largest companies could pay up to 8x that)
2. CEO pay ratio cap of 100:1, not size-corrected
3. Qualitative analysis that allows for tolerance of excessive pay levels if the compensation structure & policies are significantly aligned with long-term value creation and ESG impact
Triodos says that if a company hasn’t already adopted some best practices and/or isn’t open for dialogue, it is excluded from their investment universe.
Triodos isn’t the first investor to float this concept, and it won’t be the last. While these calls tend to come out of European-based investors and asset managers, they are a reaction to global pay levels – and Triodos has engaged with companies including Adobe, Cisco, Disney, Nike, Paypal, Prologis and Starbucks, according to this Responsible Investor article.
These discussions come at a time when CEO pay reached new heights (again) in 2021. I’ve blogged that this wealth accumulation is due in large part to the shift to stock awards. And in the past few years, the embrace of “moonshot” awards has only accelerated the trend. Dave Lynn is covering what you need to know about moonshot awards in the forthcoming issue of The Corporate Executive – so I won’t steal his thunder, but I will reiterate that investors generally don’t like mega-grants or special retention awards.
Compensation committees have a lot to think about these days, and calibrating the amount of CEO pay isn’t easy during this time of market volatility and retention sensitivity. But with continued focus on overall human capital management, directors should be aware that investors and other stakeholders are signaling that tempering payout levels and mega-grants must continue to be part of the conversation.
If you don’t already have access to The Corporate Executive, email sales@ccrcorp.com to check it out. The newsletter is published 5 times per year and Dave ensures that it is always full of valuable information.
Way back in 2019, we blogged that a shareholder went to court to challenge the $56 billion compensation award that was awarded to Elon Musk in 2018. The Delaware Court of Chancery determined that the case could proceed under an “entire fairness” standard because Musk was a controlling shareholder, even though it had been approved by shareholders. Nearly three years later – now that the Tesla moonshot award has paved the way for similar deals at other companies – the compensation case is going before Chancellor Kathaleen McCormick on the merits in late October.
In case you missed it, Chancellor McCormick is also presiding over the litigation that will determine whether Musk can walk away from his merger agreement with Twitter (John’s been blogging about that case on DealLawyers.com, and if you want the blow-by-blow, follow The Chancery Daily on Twitter. Yesterday, the WSJ reported that Twitter’s shareholders are poised to approve the deal – Musk hasn’t voted).
The lawsuit alleges that the compensation decision was a breach of fiduciary duty because the board failed to ensure Elon Musk’s full-time devotion to his role as CEO of Tesla. His other endeavors include chairing SpaceX, founding The Boring Company, owning Neuralink, and joking that he’ll buy public companies. This Reuters article gives more detail:
The lawsuit in Delaware’s Court of Chancery by shareholder Richard Tornetta alleges the package was unnecessary, since Musk at the time owned 22% of Tesla, giving him plenty of incentive to make the company a success.
Tornetta seeks to cancel the plan, including stock options already granted.
Musk is using his Tesla stock as collateral for loans to buy Twitter.
Musk and Tesla’s directors argued in court filings that the pay package did what it set out to do — align Musk’s incentives with shareholders and create value.
On Twitter, Ann Lipton pointed out that some of the arguments being made int he Twitter litigation could also affect the compensation trial. This compensation case has been overshadowed by other Musk drama, but we’ll be watching for the outcome – and the impact that it could have on CEO arrangements, backing up compensation committee decisions, and drafting proxy disclosures for shareholder votes.