I blogged a few weeks ago that investors are pushing for higher-quality ESG metrics. A new PwC analysis of carbon targets shows they may have good reason to be skeptical. The “TL;DR” is that executives are getting “surprisingly high” bonuses despite the common understanding that we’re making inadequate progress on reducing carbon emissions worldwide. But in both this analysis & the pay plans themselves, the devil’s in the details.
The report assesses carbon targets at 50 of the largest European listed companies – which is the region of the world where linking pay to climate & other ESG targets is most well-developed. It looks at 4 criteria that investors say constitute “robust” targets – namely, that the targets are:
1. Significant – a separate & meaningful percentage of incentives
2. Measurable – objective & quantifiable
3. Transparent – externally clear & prospectively disclosed targets, and
4. Demonstrably linked to long-term carbon reduction goals – clearly disclosed bridge between short-term & long-term
Here are the high-level findings:
While there has been rapid adoption of carbon pay targets in the last couple of years, only one company’s carbon pay measures met every one of our criteria. And payouts on carbon targets disclosed in 2022 averaged 86%, with over half paying out at 100%. This is surprisingly high given the common understanding that we’re making inadequate progress on reducing carbon emissions, which raises the question on whether the carbon targets in pay are working.
The criteria that companies’ carbon measures most commonly failed to meet relate to the weighting (which is frequently quite low), the transparency of targets (which are rarely prospectively disclosed), and their quantitative link to the company’s stated long-term carbon reduction goals (which is often unclear).
Thankfully, the report also notes that many of the current shortcomings are easily addressed – e.g., disclosing prospective targets, adjusting weighting. While executive pay is never going to be the panacea for solving climate change, it can be part of the solution. It sets out 9 questions for boards to consider based on company-specific circumstances (along with examples & recommendations for each). When your comp committee next considers incentive plans, it may be worth diving into these details:
1. Should executive pay carbon targets be based on CO2 or CO2 equivalents?
2. Should executive pay carbon targets be adjusted for transactions?
3. Should offsets count for executive pay purposes?
4. Should executive pay targets use absolute carbon emissions or carbon intensity?
5. Should pay measures include Scope 3 emissions?
6. Are carbon measures relevant for low emitting companies?
7. Should Scope 4 emissions affect targets?
8. Are carbon targets relevant for companies covered by carbon trading scheme?
9. Should executive pay targets focus on new sources of competitive advantage over carbon reductions?
If you’re looking for “gold star” examples & food for thought, the report suggests looking at the companies below – and it also shares a mockup of hypothetical executive compensation disclosure (pg. 19):
A leading example from our analysis of disclosures in 2022 is TotalEnergies, which was the only company to score maximum points on our assessment. They disclose their strategic 2025 GHG reduction target in Mt CO2e, and disclose how their executive pay targets to reduce carbon emissions directly tie into that long-term ambition, by setting a Mt CO2e to hit by 2022, in line with this ambition.
Other positive examples include ABB, AstraZeneca, AXA, Enel, Reckitt and Santander, each of which score seven out of a possible eight points. But in the case of most companies reviewed, there are opportunities for further steps to fully meet investor expectations.
Here’s the latest 131-page guide for compensation committees from Wachtell Lipton. As always, the guide even includes a sample compensation committee charter at the back – with these wise words of caution:
It is not necessary that a company have every guideline and procedure that another company has to be “state of the art” in its governance practices. When taken too far, an overly broad or detailed committee charter can be counterproductive. For example, if a charter explicitly requires the compensation committee to review a particular type of compensation arrangement, meet a stated number of times each year or take other action, and the compensation committee has not taken that action, then the failure may be considered evidence of lack of due care. Therefore, we recommend that each company tailor its compensation committee charter and written procedures to those that are necessary and practical for the particular company.
This year’s guide also includes updated sections on “Dodd-Frank Act Compensation Clawback Rules” (pg. 46) and “Dodd-Frank Act Pay Versus Performance Rules” (pg. 10). The discussion on clawbacks identifies several questions to ask when crafting a policy that complies with the new rules, and goes on to note:
Over the past several years, prior to the adoption of the final SEC clawback rules, the prevalence of clawback policies increased dramatically, in part because many institutional investors have actively promoted the adoption of clawback policies. According to a recent study, 99% of 200 large publicly traded companies have disclosed that they maintain clawback policies, although most policies are discretionary and not mandatory.66 The study indicated that common clawback triggers include the following: ethical misconduct leading to a financial restatement (42% of policies); a financial restatement without a requirement of ethical misconduct (53%); ethical misconduct without a financial restatement (54%); violation of restrictive covenants, such as noncompetition, nonsolicitation, nondisclosure or nondisparagement obligations (25% of policies); reputational risk (20%); and failure to supervise (7% of policies).
For companies that have already adopted a clawback policy that is broader than the policy required by the final regulations, decisions will need to be made as to how to reconcile the existing policy with the newly mandated policy. Combining the two policies could lead to undesirable complications. In particular, most existing policies provide discretion to the compensation committee or board of directors as to whether to exercise the clawback, while the new regulations generally require the company to apply the clawback on a mandatory basis. Mandatory application is fundamentally inconsistent with the design of a broad discretionary policy, so a decision will need to be made as to whether to narrow the breadth of the existing policy, or, alternatively, to bifurcate the policy so that it includes both the mandatory clawback required by the final SEC rule and the optionality for the compensation committee or board of directors to continue to exercise discretion in determining whether to apply the existing clawback right. Other alternatives include maintaining two policies, or eliminating the existing policy altogether.
There’s a lot of work to be done on this topic before next year – both exchanges proposed listing standards last week which largely track Rule 10D-1.
On Wednesday of this week, the NYSE posted its initial rule filing to implement listing standards under the SEC’s Dodd-Frank clawback rules – and yesterday, Nasdaq followed suit by posting proposed listing standards on its website. Nasdaq is proposing a new Rule 5608. Here are a few key details, which track closely to the SEC’s Rule 10D-1:
– The new rule will require listed companies, in the event of a restatement (“Big R” and “little r”), to recover the amount of incentive-based compensation received by an executive officer that exceeds the amount the executive officer would have received had the incentive-based compensation been determined based on the accounting restatement.
– Companies will be subject to delisting if they don’t adopted a compensation recovery policy that complies with the listing standard, disclose the policy in accordance with SEC rules, or comply with the policy’s recovery provisions.
– Under the proposed listing standard, Nasdaq would determine whether the steps a company is taking constitute compliance – the propsal lists factors that the exchange will consider.
– Companies will be required to adopt the compensation recovery policy no later than 60 days following the effective date of Rule 5608, and to provide the disclosures required by the Rule and in applicable SEC filings on or after the effective date of Rule 5608.
– As proposed, a company will only be required to apply the recovery policy to incentive-based compensation received on or after the effective date of the new listing standard, notwithstanding the lookback requirement in the rule.
There will be an opportunity for comments on the proposal and it will be effective on the date it’s approved by the SEC (under Rule 10D-1, that’s required to happen by November 28th of this year).
Dave blogged more about the proposed listing standard on TheCorporateCounsel.net And, here’s what Dave blogged yesterday about the NYSE’s rule:
Last October, the SEC adopted Rule 10D-1, which directs the national securities exchanges to adopt listing standards that will apply the disclosure and clawback policy requirements of the rule to all listed companies, with only limited exceptions. Under the rule, each listed company will ultimately be required to adopt a clawback policy, comply with that policy and provide the required clawback policy disclosures. A company will be subject to delisting if it does not adopt and comply with a clawback policy that meets the requirements of the listing standards. The SEC indicated that each national securities exchange must file its proposed listing standards with the SEC no later than 90 days following November 28, 2022. The listing standards required by Rule 10D-1 must be effective no later than one year following November 28, 2022.
The NYSE has now posted on its website its initial rule filing with the SEC. The initial rule filing contemplates proposing new Section 303A.14 of the NYSE Listed Company Manual to require issuers to develop and implement a policy providing for the recovery of erroneously awarded incentive-based compensation received by current or former executive officers. The NYSE notes in the filing that proposed Section 303A.14 is designed to conform closely to the applicable language of Rule 10D-1.
Proposed Section 303A.14(b) would establish the timeframe within which listed companies must comply with proposed Section 303A.14, as follows:
– Each listed issuer must adopt the clawback policy required by proposed Section 303A.14 no later than 60 days from the adoption of the proposed listing.
– Each listed issuer must comply with its clawback policy for all incentive-based compensation received (as such term is defined in proposed Section 303A.14(e) as set forth below) by executive officers on or after the effective date that results from attainment of a financial reporting measure based on or derived from financial information for any fiscal period ending on or after the effective date.
– Each listed issuer must provide the required disclosures in the applicable SEC filings required on or after the effective date.
The NYSE also proposes to adopt new Section 802.01F, which would provide that in any case where the exchange determines that a listed issuer has not recovered erroneously-awarded compensation as required by its clawback policy reasonably promptly after such obligation is incurred, trading in all listed securities of such listed issuer would be immediately suspended and the exchange would immediately commence delisting procedures with respect to all such listed securities. While Rule 10D-1 does not specify the time by which the issuer must complete the recovery of excess incentive-based compensation, NYSE would determine whether the steps an issuer is taking constitute compliance with its clawback policy. A listed issuer would not be eligible to follow the procedures outlined in Sections 802.02 and 802.03 with respect to such a delisting determination, and any such listed issuer would be subject to delisting procedures as set forth in Section 804.
The SEC will next publish the Notice of Filing of Proposed Rule Change to Adopt New Section 303A.14 of the NYSE Listed Company Manual on its website. Comments will be due 21 days from publication of the Notice in the Federal Register.
In a study earlier this year, Willis Towers Watson found that 77% of large companies in Europe & North America are now including ESG metrics in executive compensation plans. Last week, global asset manager AXA IM reinforced its commitment to “net zero as a business & investor by 2050” – by announcing new decarbonization metrics for 400 senior executives. Here’s more detail:
– The weighted average carbon intensity (WACI) to reach the target of 25% reduction in carbon intensity for corporate portfolio by 2025: for the ESG part of the deferred compensation, this metric accounts for 75% for AXA IM Core and 37.5% for transversal functions employees in scope.
– An assets under management (AUM) target for 50% of the real estate portfolio to be aligned to the CRREM1 trajectories by 2025: for the ESG part of the deferred compensation, this metric accounts for 75% for AXA IM Alts and 37.5% of transversal functions employees in scope.
– The reduction of the corporate operational CO2 footprint, to reach the interim target to reduce it by 26% by 2025: for the ESG part of the deferred compensation, this metric accounts for 25% for all AXA IM Core, AXA IM Alts and transversal functions employees in scope.
AXA is a “responsible” asset manager that invests for the long-term – and has a “3 strikes & your out” escalation policy for climate laggards in its investment portfolios. So, this step makes sense for their business. AXA announced the new metrics at the same time it unveiled a new “AXA IM for Progress Monitor” that will show the firm’s progress on certain ESG targets.
The thing that caught my eye here is that AXA’s metrics are tied to specific portfolio company reductions and will be measurable in only two years. This could provide a roadmap for other investors – as well as companies – to integrate emission reduction goals into executive incentive plans. If it becomes more common for asset manager executives to tie their own pay to portfolio company emissions reductions in a meaningful way, they could eventually lose patience with portfolio companies who don’t do the same.
For now, though, it seems like most organizations are still carefully evaluating details – before making sudden moves towards specific, quantifiable metrics – and that’s probably how it should be, to avoid unintended consequences. It’s also worth noting that this type of plan would be much more difficult for index investors like BlackRock or Vanguard, who aren’t able to freely divest “climate laggards” & who are walking a fine line in US politics with climate-related policies.
If you work with REITs, make sure to check out this updated guide to executive compensation – provided by Morrison Foerster & Ferguson Partners. The 2023 edition includes 68 pages of guidance – it addresses:
– The various components of REIT executive compensation;
– Key compensation trends in the REIT industry;
– The respective roles of the board of directors, the compensation committee, management and outside advisors;
– Governance matters relating to executive compensation, including best practices and provisions viewed as problematic by investors and proxy advisory firms;
– Increasing expectations for accountability and transparency by linking ESG priorities and executive compensation; and
– SEC reporting and other obligations relating to executive compensation, including the SEC’s new rules relating to pay-versus-performance disclosures.
I’ve blogged a few times about the Tornetta v. Musk litigation – in which the plaintiff is arguing that Tesla’s directors (& Elon Musk, as an allegedly controlling stockholder) breached their fiduciary duties when they approved Musk’s 2018 “moonshot” award. This case may have disclosure & governance implications for other companies.
Last month, Charles Elson – who is the founding Director of the Weinberg Center for Corporate Governance at the University of Delaware – filed an amicus brief in support of the plaintiff, which can be found along with other trial-related documents on this docket page. Professor Elson argues that Musk’s award was unfair to stockholders & that the defendants ignored the purpose of equity-linked compensation in crafting it. Here’s an excerpt:
When the challenged award was made, Musk owned 21.9% of Tesla’s outstanding common stock.32 Thus, for every $50 billion dollars that Tesla’s market capitalization increased, Musk would personally see a $10.95 billion benefit based solely on his existing holdings. In this critical respect, Musk could not be more dissimilar from the professional managers whom modern equity compensation packages were designed to motivate. As a founder-owner-manager, Musk is more like Gates, Bezos, Zuckerberg, Brin and Page. And like them, Musk’s pre-existing holdings should have been a more-than-adequate incentive for him to do whatever it took to help Tesla grow.
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For Musk’s award to be justified, Defendants must somehow show that the marginal benefit to Musk—i.e., above and beyond the benefits he would obtain from the increase in value of his significant existing holdings — would meaningfully affect his motivations. They make no serious effort to do so.
Professor Elson also suggests the court consider the effect that Musk’s award has had beyond Tesla – the “Lake Wobegan” dynamic of executive compensation – which I blogged about last year.
Chancery Daily will be live-“tooting” on Mastadon during post-trial arguments today. Here’s their recap of the current procedural status:
The Tornetta v. Musk trial was held back on November 14th through 18th, 2022. Remember those days? To be honest, it’s all a bit of a blur, but at least for the moment, sufficient failover systems still in place mean that most days, Twitter remembers. (At the end of this email, you’ll find links to all of the live Twitter coverage from the trial, as well as to the previous Substack summary of the case.)
But why are we talking about a trial from November, and what was the outcome anyway? Well, that’s kind of the point! Here’s why you should you care, especially now. Because there hasn’t been a verdict yet. These are bench trials, baby! And they are the best. And bench trials have pre- and post-trial briefing and post-trial argument, and this one happens on Tuesday, February 21st at 1:30pm Eastern, and you and me, kid, we can dial-in and listen.
Growing up in the shoe biz, I can empathize with retailers right now. Ongoing disruptions to business models & the economy have created long-term uncertainty for growth – which casts doubt on whether typical incentive plan metrics & goals are still workable. What’s a compensation committee to do? A recent Semler Brossy blog shares recommendations for goal-setting in light of these issues. Here are the key takeaways:
– 2023 goal setting uncertainty. Particularly in the retail industry, recent economic and market uncertainty are expected to impact fiscal year 2022 incentive plan outcomes and create goal setting challenges in 2023 and beyond.
– Approaches to address risks. Establish wider performance and/or payout curves, introduce strategic or operational metrics, separate or shorten performance periods, and consider using more relative metrics.
– Ensure future durability. In contrast with the temporary actions taken to immediately respond to the pandemic, retailers should consider the long-term durability of any incentive plan changes in response to a more prolonged period of uncertainty.
On that last point, the pandemic showed that shareholders and proxy advisors don’t look fondly upon reactionary adjustments that end up creating perceived windfalls for executives. With last month’s consumer spending data being surprisingly favorable for retailers, durability is key – don’t overcorrect.
If you’re putting the finishing touches on your HCM disclosures, it’s worth taking a look at this recent Gibson Dunn survey. The 11-page memo covers “human capital” disclosure trends among the S&P 100 – reflecting practices now that companies have been through two reporting cycles since the SEC adopted “principles-based” rules in 2020. Here’s an excerpt with key takeaways:
The overall takeaway from our survey, which categorized disclosures into 17 topic areas, was that companies are generally expanding the length of their disclosures, covering more topics, and including slightly more quantitative information in some areas. We note the following trends regarding the S&P 100 companies’ disclosures compared to the previous year:- Seventy-nine companies increased the length of their disclosures, though the increases were generally modest.
– Sixty-six companies increased the number of topics covered.
– The prevalence of 16 topics increased and one remained the same.
– The most significant year-over-year increases in frequency involved the following topics: talent attraction and retention (67% to 91%), employee compensation (68% to 85%), quantitative diversity statistics on race/ethnicity (43% to 59%) and gender (47% to 61%), workplace health and safety (51% to 65%), and pay equity (30% to 41%).
– The only topic that did not see an increase in frequency was succession planning, which remained at 17%.
– Eight-five companies included more qualitative details in their disclosures compared to the previous year, including information relating to diversity, equity, and inclusion (“DEI”) initiatives and programs and the board’s role in overseeing human capital initiatives, although the depth of the additional detail provided varied greatly between companies.
– In this most recent year, DEI was discussed by 96% of companies (89% in the previous year), and 37% of companies (22% in the previous year) went beyond qualitative DEI information and disclosed quantitative data regarding the breakdown of DEI statistics by job type or level (executive level, etc.).
– Disclosure regarding the role of the board (or a human capital-focused committee) in overseeing human capital jumped to 44% of companies this most recent year from 26% the previous year.
– The topics most commonly discussed this most recent year generally remained consistent with the previous year. For example, DEI, talent development, talent attraction and retention, COVID-19, and employee compensation and benefits remained the five most frequently discussed topics, while succession planning, full-time/part-time employee split, quantitative pay gaps, culture initiatives, and quantitative workforce turnover rates continued to be the five least frequently covered topics.
– Within each industry, the trends that we saw in the previous year regarding the frequency of topics disclosed generally remained the same.
The memo looks at the prevalence of common disclosure topics, trends by industry, and disclosure formats – as well as Corp Fin comment letter correspondence. It notes that SEC Chair Gary Gensler has signaled a plan to propose more prescriptive HCM disclosure rules sometime this year – which will undoubtedly draw a lot of commentary if & when it happens. The Gibson Dunn team suggests these steps for the current reporting season:
– Confirming (or reconfirming) that the company’s disclosure controls and procedures support the statements made in human capital disclosures and that the human capital disclosures included in the Form 10-K remain appropriate and relevant. In this regard, companies may want to compare their own disclosures against what their industry peers did these past two years, including specifically any notable additional disclosures made in the past year.
– Setting expectations internally that these disclosures likely will evolve. As shown by the measurable increase in disclosure in the second year of reporting, companies should expect to develop their disclosure over the course of the next couple of annual reports in response to peer practices, regulatory changes, and investor expectations, as appropriate. The types of disclosures that are material to each company may also change in response to current events.
– Addressing in the upcoming disclosure, if not already disclosed, the progress that management has made with respect to any significant objectives it has set regarding its human capital resources as investors are likely to focus on year-over-year changes and the company’s performance versus stated goals.
– Addressing significant areas of focus highlighted in engagement meetings with investors and other stakeholders. In a 2021 survey, 64% of institutional investors surveyed cited human capital management as a key issue when engaging with boards (second only to climate change at 85%).
– Revalidating the methodology for calculating quantitative metrics and assessing consistency with the prior year. Former Chairman Clayton commented that he would expect companies to “maintain metric definitions constant from period to period or to disclose prominently any changes to the metrics.”
The annual “Corporate Governance & Executive Compensation Survey” of the 100 largest companies from Shearman & Sterling is out! This is always a “hot ticket” item, perhaps because it’s one of the oldest. Last year, I blogged about data on clawbacks – which is covered on page 83 of this year’s survey.
We’ve posted this year’s survey in our “Sustainability Metrics” Practice Area due to the comprehensive article that begins on page 28 about whether investors will ever be satisfied. It notes that there are signs of discontent with the level & quality of ESG metrics.
The survey also has data on equity plans, say-on-pay, perquisites, golden parachutes & more. Check it out!
On Friday – after much anticipation & nail-biting – Corp Fin issued 15 “Regulation S-K” CDIs to address common questions under new Item 402(v), which is the “pay versus performance” disclosure rule that was adopted in late August and for which disclosure will be required in proxy statements filed this spring. Dave Lynn is going to be covering these interpretations in-depth in the next issue of The Corporate Executive – if you aren’t already subscribed to that essential newsletter, email sales@ccrcorp.com and arm yourself with expert analysis to tackle these disclosures.
To help you see which CDIs are relevant to you, I’ve paraphrased each of them below – and thanks to the direct links that Corp Fin provided, you can also use this list to easily read your favorites in full:
1. Question 128D.01 – Item 402(v) information is not required in Form 10-K, and will not be deemed incorporated by reference, except to the extent that the registrant specifically does so.
2. Question 128D.02 – When calculating Compensation Actually Paid, companies need to include the change in value of a first-time NEO’s awards during the executive’s tenure as a NEO – even if the NEO received those awards as an employee, before being an NEO.
3. Question 128D.03 – Footnote disclosure of each of the amounts deducted and added pursuant to Item 402(v)(2)(iii) – for years other than the most recent fiscal year included in the Pay Versus Performance table – would be required only if it is material to an investor’s understanding of the information reported in the Pay Versus Performance table for the most recent fiscal year, or of the relationship disclosure provided under Item 402(v)(5). However, in the registrant’s first Pay Versus Performance table under the new rules, the registrant should provide footnote disclosure for each of the periods presented in the table.
4. Question 128D.04 – Aggregation of pension value adjustments and equity award adjustments isn’t permitted in the required footnotes.
5. Question 128D.05 – For purposes of pay versus performance disclosure, companies can use a “peer group” disclosed in CD&A, even if it is not used for “benchmarking” in the CD&A.
6. Question 128D.06 – If the class of securities was registered under Section 12 of the Exchange Act during the earliest year included in the “Pay Versus Performance” table, the “measurement point” for purposes of calculating TSR and peer group TSR should begin on such registration date.
7. Question 128D.07 – Companies need to present the peer group total shareholder return for each year in the table using the peer group disclosed in the CD&A for such year, including if the CD&A peer group changed from 2021 to 2022.
8. Question 128D.08 – GAAP “net income” is required in the Item 402(v) table.
9. Question 128D.09 – The Company-Selected Measure can be any financial performance measure that differs from the financial performance measures otherwise required to be disclosed in the Item 402(v) table, including a measure that is derived from, a component of, or similar to those required measures.
10. Question 128D.10 – It’s appropriate to use stock price as Company-Selected Measure only if it directly links compensation actually paid to company performance – e.g., as a market condition applicable to an incentive plan award – not if it just has a significant impact through affecting the fair value of a time-based share award.
11. Question 128D.11 – The Company-Selected Measure cannot be a multi-year measure – it must relate to the most recently completed fiscal year.
12. Question 128D.12 – In a “bonus pool” where payouts depend on achievement of a financial performance measure along with discretion, companies must identify that financial measure in the Tabular List and provide the required disclosure about the Company-Selected Measure and the related relationship disclosure.
13. Question 128D.13 – Companies can aggregate the compensation of multiple PEOs for purposes of the narrative, graphical or combined comparison between CAP & TSR, net income, and the Company-Selected Measure – to the extent the presentation will not be misleading to investors. Remember that separate columns for each PEO are required in the table.
14. Question 228D.01 – If a company changes its fiscal year during the time period covered by the Item 402(v) Pay Versus Performance table, provide the disclosure required by Item 402(v) for the “stub period,” and do not annualize or restate compensation.
15. Question 228D.02 – For purposes of the requirement in Item 402(v)(2)(iv), a company that has emerged from bankruptcy and issued a new class of stock under the bankruptcy plan may provide its cumulative total shareholder return and peer group cumulative total shareholder return using a measurement period that begins when the post-bankruptcy class of stock began trading.