On our page about “Director Compensation Practices,” we regularly share trend reports on the amount and form of director pay. I blogged a couple of months ago that average total compensation for directors in the S&P 500 is around $316k.
This recent Directors & Boards article, written by Jena Abernathy and Don Lowman of Korn Ferry, notes that while you don’t want to pay directors so much that it’s unreasonable or affects their independence, directors are being asked to do more & more. In addition, competitive director compensation not only attracts talented individuals who have in-demand experience & skills, it also reinforces accountability expectations.
The Korn Ferry folks also note that – unlike the annual review of executive compensation – director compensation is more typically reviewed only once every 2 – 4 years. They suggest scheduling regular board compensation reviews in order to verify that what the company is providing is competitive & reasonable, and propose these guidelines:
– Establish a timetable for board compensation review.
– Compare your board compensation program with programs of other peer organizations.
– Choose companies for comparison by size, reputation, growth, products and services, financial performance, employees, customers and investors.
– Develop a rationale or justification for the mix of cash and equity offered to board members.
– Engage an external compensation consultant to review your board compensation program for alignment with company goals, shareholder expectations, public perceptions and regulations.
I’m blogging about this here because it’s a responsibility often handled by the compensation committee and because Item 402 of Reg S-K, which is something we obviously cover on this site, requires disclosure about director compensation (see our Treatise chapter for the details). But as noted in the article, at some companies, this is handled by the nominating/governance committee.
Yesterday, the SEC’s final Dodd-Frank clawback rules were published in the Federal Register. that means the rules will have an effective date of January 27, 2023.
As I blogged when the SEC adopted these rules, the Federal Register publication also starts the 90-day clock for the exchanges to propose listing standards. The effective date for those listing standards can be as late as November 28, 2023. Companies will have 60 days following the listing standard effective date to adopt a compliant recovery policy – which would put us at January 2024.
As this Covington memo details, the threat of a recession is raising new “human capital” and workforce compensation issues for boards to consider. With compensation committees taking on this responsibility at many companies, it may be a topic for your next committee meeting. Here are the 6 questions the memo recommends asking:
1. Should incentive plan performance targets be adjusted?
2. Can we unilaterally reduce compensation or benefits?
3. Will we have enough shares to continue making equity grants?
4. What can be done about underwater stock options?
5. Should employer contributions to 401(k) plans be reduced or suspended?
6. What changes can be made to non-qualified deferred compensation?
Here’s a pretty interesting study from three B-school profs about what actual CEO take-home pay can tell investors, compensation committees, and others that use executive pay info for decision-making. Let’s start with the takeaways – excerpted from this CLS Blue Sky blog:
We find that a firm’s accounting performance during the evaluation period strongly predicts the probability that the CEO will receive a payout, the probability that the payout is at the target level or higher, and the actual payout amount after controlling for firm characteristics, other aspects of CEO pay, CEO power, and corporate governance. We find no evidence that the strong payout-for-performance relation is driven by earnings management. There is also no strong evidence that firms design contacts to award CEOs regardless of performance.
In contrast to the significant relation between the actual plan payout and performance, the disclosed target plan payout, which is often used as a proxy for the estimated fair value of performance plans, is not correlated with firm performance in the evaluation period. The finding suggests that the current practice of extrapolating executives’ payout-for-performance relation from the reported ex-ante expected values could be misleading.
We also find that the actual plan payout contains information about CEO quality. Achieving the target payment level or higher may signal that the CEO is of good quality as she can meet or beat the internal performance expectations set by the board. Confirming that investors infer CEO quality from actual plan payouts, we find that, when the LTAP payout is at or above the target payment level, the stock market reacts positively, shareholders are less likely to vote against executive compensation in subsequent say-on-pay (SOP) voting, and the CEO is less likely to leave the firm over the next two years.
A small subset of our sample LTAPs (8.6 percent of those with actual payouts) has abnormally high payouts that generally exceed the plan’s maximum payment level. These firms do not have better accounting or stock performance over the performance evaluation period than firms with normal payouts and experience significantly lower performance over the next three years. The CEOs who receive abnormal payouts tend to be powerful and work for firms with weak governance, and they are more likely to sell their shares after receiving abnormal payments. After reading the proxy statements, we find that firms granting abnormal LTAP payouts on average provide less detailed disclosure, adopt complex plans with soft payout targets, and allow adjustments to the amount ultimately paid.
In a perfect world, these findings could be compelling support for the SEC’s new pay versus performance disclosure rule, with its notion of “compensation actually paid.” But we’ll have to file this with our hopes & dreams of “what could have been” – because it doesn’t match up with the final rule that the SEC actually adopted.
The difference is that the the researchers calculated take-home pay by simply using ex-post payouts, rather than using ex-ante estimates of equity awards and other benefits. That’s more in line with how you would think “compensation actually paid” would be defined. But their approach also has some limitations. For example, it may be complicated for plans that have multiple performance metrics.
Speaking of plan complexity and multiple performance metrics, here’s one other interesting finding about plan design:
LTAPs can differ in various contract features, such as performance horizon, relative performance evaluation, or the number of performance contingencies. We find that plans contingent on multiple accounting performance metrics demonstrate a weaker payout-for-performance relation.
We do not find that the payout-for-performance relation depends on the length of the evaluation period, whether the performance hurdles are disclosed ex-ante, or whether the performance is benchmarked to peer firms (i.e., relative performance evaluation). Taken together, the influence of contact design on the payout-for-performance relation appears to be weak.
Programming Note: This blog will be off tomorrow and Friday. Happy Thanksgiving!
Incredibly, we are heading into the 12th year of say-on-pay. With Rule 14a-21(b) requiring a “say-on-frequency” vote no less than once every six years, that means that companies that are not smaller reporting companies will be facing their third go-round on this ballot item during the 2023 proxy season (smaller reporting companies got an extra two years at the front end, so their next say-on-frequency vote won’t be until 2025).
During the second round of say-on-frequency votes in 2017, shareholders at more than 90% of Russell 3000 companies approved “annual” voting. So not surprisingly, that frequency has been the predominant practice since say-on-pay was adopted. In 2017, Compensia found that as of July 2017, 78 out of 79 companies disclosed that shareholders voted for annual say-on-pay votes.
The chapter goes on to list key considerations that affect the say-on-frequency recommendation and provides guidance on ballot wording for this resolution. And, as highlighted in a Faegre webinar last week, don’t forget to have the board actually make the say-on-frequency determination and report the decision on the Item 5.07 Form 8-K (in the initial filing or an amendment).
Late last week, Glass Lewis issued its 2023 policy guidelines for the US and certain other markets – which apply for annual meetings held after January 1st. The biggest change on the executive compensation front is that you may see more “concerns” raised in the coming year for LTI programs, even if they don’t result in negative recommendations. Here’s more detail:
Long-Term Incentives: We revised our threshold for the minimum percentage of the long-term incentive grant that should be performance-based from 33% to 50%, in line with market trends. Beginning in 2023, Glass Lewis will raise concerns in our analysis with executive pay programs that provide less than half of an executive’s long-term incentive awards that are subject to performance-based vesting conditions. As with past year, we may refrain from a negative recommendation in the absence of other significant issues with the program’s design or operation, but a negative trajectory in the allocation amount may lead to an unfavorable recommendation.
In addition, Glass Lewis has made several clarifying amendments that compensation committees should know about – including a couple related to the SEC’s final pay vs. performance and Dodd-Frank clawback rules:
Compensation Committee Performance: We have clarified our approach when certain outsized awards (so called “mega-grants”) have been granted and the awards present concerns such as excessive quantum, lack of sufficient performance conditions, and/or are excessively dilutive, among others. We will generally recommend against the chair of the compensation committee when such outsized awards have been granted and include any of the aforementioned concerns.
Say-on-Pay Responsiveness: With regard to our discussion of company responsiveness, we have clarified that we will also scrutinize high levels of disinterested shareholders when assessing the support levels for previous years’ say-on-pay votes. When evaluating a company’s response to low support levels, we also expanded our discussion of what we consider robust disclosure, including discussion of rationale for not implementing change to pay decisions that drove low support and intentions going forward.
One-Time Awards: We have expanded our discussion regarding what we consider reasonable disclosure in terms of one-time awards. Specifically, we have included that we expect discussion surrounding the determination of quantum and structure for such awards.
Grants of Front-Loaded Awards: Adding to our discussion relating to front-loaded awards, we have included language touching on the topic of the rise in the use of “mega-grants”. Furthermore, we expanded on our concerns regarding the increased restraint placed upon the board to respond to unforeseen factors when front-loaded awards are used. Finally, we provided clarification surrounding situations where front-loaded awards are intended to cover only the time-based or performance-based portion of an executive’s long-term incentive awards.
Pay for Performance: We included mention of the new pay versus performance disclosure requirements announced by the U.S. Securities and Exchange Commission (SEC) in August of 2022. In our revised discussion of our Pay-for-Performance methodology, we have made clear that the methodology is not impacted by new rules. There is no change to the methodology for the 2023 Proxy Season. However, we note that the disclosure requirements from the new rule may be reviewed in our evaluation of executive pay programs on a qualitative basis.
Short- & Long-Term Incentives: We have added new discussion to codify our views on certain exercise of compensation committee discretion on incentive payouts. Glass Lewis recognizes the importance of the compensation committee’s judicious and responsible exercise of discretion over incentive pay outcomes to account for significant events that would otherwise be excluded from performance results of selected metrics of incentive programs. We believe that companies should provide thorough discussion of how such events were considered in the committee’s decisions to exercise discretion or refrain from applying discretion over incentive pay outcomes.
Recoupment Provisions: We have revised our discussion on clawback policies to reflect new regulatory developments for exchange-listed companies. On October 26, 2022, the U.S. Securities and Exchange Commission (SEC) approved final rules regarding clawback policies based on which the national exchanges are to create new listing requirements. During period between the announcement of the final rules and the effective date of listing requirements, Glass Lewis will continue to raise concerns for companies that maintain clawback policies that only meet the requirements set forth by Section 304 of the Sarbanes-Oxley Act. However, disclosure from such companies of early effort to meet the standards of the final rules may help to mitigate concerns.
These are just a portion of the updates. I blogged about other key changes this morning on the Proxy Season Blog, over on TheCorporateCounsel.net. Lawrence will be taking a deeper dive into ESG-related topics on the PracticalESG.com blog (which you can subscribe to for free).
As executives and compensation committees plan for 2023, the possibility of a recession and stock price declines continue to be front-of-mind. This Semler Brossy blog offers six approaches to equity grant practices that can help manage “burn rates” – and preserve share authorizations – during volatile times. Here’s an excerpt:
1. Adjusting the Grant Date Fair Value for purposes of determining award sizes by using an average value—such as an annual average stock price—to better reflect the likely prices once the market stabilizes. Note that if this calculation results in a larger number of shares than historical, there will be greater leverage if the market rebounds.
2. Replacing shares with cash awards below the top leadership team—e.g., NEOs. Note that this may not be an option for struggling or cash-strapped firms.
3. Changing the mix of long-term incentive (LTI) vehicles from performance-based to time-based vehicles. Experience has shown that providing greater certainty of awards in volatile times makes executives more willing to accept fewer shares. There is an added benefit: fewer shares need to be reserved for time-based awards because there is no upside.
4. Reducing the eligibility for LTI awards to reflect share constraints while increasing the size of annual incentive opportunities.
5. For early-stage companies, characterizing awards as inducement awards which are not counted against share authorizations. However, these awards do need to be reported to the applicable stock exchange and in a press release. In addition, these awards would be reported as “not approved by shareholders” in the Equity Compensation Plan Information Table.
6. Targeting awards to ensure that higher value-add positions and top performers receive larger awards, especially in tight labor markets.
The blog also offers factors for boards to consider before selecting a course of action – such as how burn rates compare to peers, the date of the last request for an increase in share reserves, and whether the company could switch to cash payouts if necessary.
For additional thoughts on executive compensation trends in a volatile environment, visit the transcript from our August webcast on this exact topic, the May-June issue of The Corporate Executive newsletter, and this blog that Emily shared in May.
Recently, a management professor at the London School of Economics asked 1000 executives whether they care about income inequality and the societal problems it creates. The short answer is “yes.” Yet, the labor market for executives is so inefficient that they are unfairly trapped into being awarded millions of dollars per year.
This article in The Guardian summarizes the research. Here’s an excerpt:
It was evident from the results of our study that many executives take distributive justice very seriously. They engaged with the survey process, telling us about the amount of time they had taken to digest the questions and reflect on their answers. They agreed or strongly agreed with more principles of justice than they disavowed. The narrative comments that many of them provided were consistent with a serious ethical perspective on pay and inequality. We concluded that senior executives are not in the main the self-interested egoists of popular culture – some are, but most are not. Instead, they are the most fortunate beneficiaries of a market failure.
Economists have known for a long time that labour markets are different from other commodity markets. This is particularly true of the market for the people the French economist Thomas Piketty described in his book Capital in the Twenty-first Century as “super-managers”. An efficient market requires many buyers and sellers, homogeneous products or at least good substitutes, free market entry and exit, plentiful information and little economic friction. The problem with the market for top executives is that practically none of these conditions hold good.
The article concludes that companies are in an “arms race” for top talent – with everyone paying more than they need to in order to attract “super managers” and avoid the worst executives who could crater the company. Shareholders have supported compensation arrangements through advisory votes and other approvals (so, seemingly, they are happy with how things are going). But a lot of people think it’s not working out very well for society as a whole.
While special retention awards continue to be frowned upon by proxy advisors and investors, they do tend to serve their stated purpose of retaining executives during times of uncertainty – and companies are starting to address investor concerns by adding a long-term performance component to these types of grants. That’s according to a recent analysis by Willis Towers Watson of retention awards in the S&P 1500 from 2017-2021. Here’s more detail:
– 37% of S&P 1500 companies have granted a retention award at least once in the past 5 years.
– 33% of retention grant packages in 2021 included a long-term performance award, the most in any year in our study and a +10 percentage point increase from the prior year. Time-vested restricted stock remained the primary vehicle, being included in 58% of retention packages.
– 76% of executives who received a retention award during 2017 – 2019 remained with the company through the duration of the retention period.
– 11% of of the companies that granted a retention award during the study period saw the award flagged as part of an “Against” say-on-pay ISS recommendation.
The notion of including a performance component in retention awards is something that Rachel Hedrick of ISS also shed light on at our recent “Proxy Disclosure & 19th Annual Executive Compensation Conferences.” Here’s an excerpt from the transcript of our “Navigating ISS & Glass Lewis” panel – with Rachel, Glass Lewis’s Maria Vu, and Davis Polk’s Ning Chiu:
As Maria alluded to, our clients want to see the structure of these awards, particularly, special awards, be more rigorous than the long-term incentive program because if the long-term incentive program is there to incent performance and behavior over the say three year performance period, then the hope is that an additional retention or special award is going to go beyond that and require additional strong performance or some sort of special performance factors in order to be earned.
This session – and the rest of the Conference – was full of useful nuggets. If you attended, make sure to bookmark the archive so that you can refer back to it as you head into proxy season. If you weren’t able to attend the live event, you can still get access to the archived videos & transcripts by emailing sales@ccrcorp.com.
Today, trial begins in the derivative suit against Elon Musk & Tesla – in which former thrasher band drummer and Tesla shareholder Richard Tornetta is alleging that 2018 mega-grant to Musk unfairly awarded him with corporate assets and harmed shareholders. Here’s the complaint. In the more detailed 142-page pretrial brief, the plaintiff argues that the grant should be invalidated because it was:
– Unfair to Tesla because it was excessively large, paid to a “part-time executive,” and based on the company’s already-baked performance trajectory,
– Approved by a conflicted committee (requiring “entire fairness” review), and
– Inadequately “cleansed” due to defective proxy statement disclosure.
Deference under the business judgment rule says that compensation of executive officers is precisely the kind of thing that (in an ordinary situation) deserves to be handled with the lightest touch by the court. As then-Vice Chancellor Slights said in an earlier opinion in this case: “A board of directors’ decision to fix the compensation of the company’s executive officers is about as work-a-day as board decisions get. It is a decision entitled to great judicial deference,” citing See Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000) (“[A] board’s decision on executive compensation is entitled to great deference. It is the essence of business judgment for a board to determine if a particular individual warrant[s] large amounts of money. . .”).
It’s too early to predict takeaways for other companies, but it is worth noting the plaintiff’s disclosure-related arguments, which could be areas to bolster in proxy statements that describe significant compensation awards. Chancery Daily summarizes the plaintiff’s “inadequate disclosure” claims as:
– Failure to disclose committee members’ potential conflicts
– Failure to accurately disclose the grant milestones’ achievability
– Failure to accurately disclose the grant process
– Failure to disclose Musk’s competing interests
The control arguments are more unique to the facts of this case, but also worth watching. Even though Musk didn’t own a majority of Tesla stock at the time of the grant, the plaintiff is arguing that Musk exercised control over the company and the compensation committee, and that at least half of the directors who approved the grant were conflicted. If the judge agrees, then the “entire fairness” standard of review will apply.