Even though “golden parachute” votes are a one-time advisory vote and arguably inconsequential, shareholders are still taking the opportunity to express displeasure with outsized arrangements – and they’re doing so more often. This memo from Compensation Advisory Partners says there may be a reason for the surviving entity to care about the structure, but we’re still in “wait & see” mode:
Beginning with the 2021 proxy season, Glass Lewis stated that they may recommend against the next say on pay vote or compensation committee members of the acquirer if an excise tax gross-up is introduced. To-date, we have not seen many shareholders vote against say on pay proposals of the surviving entity.
According to recent ISS research, the golden parachute vote failure rate rose to 15.6% in 2022 – a big jump from the failure rate that ranged from 10.3 – 14.5% for the preceding 6 years. The research also shows that the higher failure rate is correlated with higher golden parachute values. Here are a few key takeaways:
– The median CEO golden parachute value also increased significantly, from $7.9 million in 2021 to $12.9 million in 2022.
– Median total golden parachute values for failed proposals were considerably higher than passing proposals.
– Equity values represented a higher proportion of total CEO parachute values for failed golden parachute proposals at 63.4% of total payment in 2022 compared to 52.9% in 2021.
The ISS write-up dives into the numbers, as well as problematic equity acceleration and other problematic practices that could lead to adverse voting recommendations (and may be a contributing factor to the overall higher failure rate). Here’s ISS’s conclusion:
The 2022 spike in the median CEO golden parachute value coincided with an increase in the say-on-golden parachute failure rate. The magnitude of golden parachute payments appears to be a significant factor in many investors’ voting decisions, further highlighted by the stark difference in median golden parachute values between failed and passing proposals.
For failed proposals in 2022, the average value of cash-based payments declined while equity values represented a higher proportion of total CEO parachute payments compared to 2021, and problematic equity acceleration emerged as a more prevalent concern. Concerns identified in 2022 point to potential issues with single trigger acceleration, coupled in some cases with above-target acceleration of performance shares; in other words, the conditions in which CEOs would receive a significant portion of their golden parachute payments – on a single-trigger basis with potentially enhanced amounts – likely played a role in the increase in the say-on-golden parachute failure rate in 2022.
The treatment of equity in severance packages, coupled with increasing magnitude, remains an area of significant concern for many shareholders and that ISS will continue to monitor.
The process for setting director pay has become more fraught in recent years as the result of Delaware case law – leading some companies to adopt annual limits on compensation. In a recent article, Mayer Brown’s Lawrence Cunningham walks through the “inherent conflict” in setting director compensation – and suggests that it’s also important to think carefully about who holds the power to set these arrangements. Here’s an excerpt:
Probing substantive independence may help. Compensation will matter more to some directors than to others, bearing on their independence. All other things being equal, directors will feel less dependent on their board position when they are wealthier, higher paid, own more shares in the company or have many other comparable opportunities.
Reposing decisions over board compensation in those members may improve the integrity of the decision-making process. Indeed, if some directors were willing to accept no pay, they might be the ideal decision makers on what to pay the others.
It is tempting to consider enlisting compensation consultants for recommendations. Such consultants can add value to the process by providing relevant and reliable market research on prevailing practices and fair levels. Again, however, the consultants’ own fees and potential for repeat assignments may incentivize bidding high.
Nor would it help to have the directors delegate their compensation determination to management. That poses a broader conflict of interest since boards’ duties include appointing and overseeing managers.
Directors might consider submitting their compensation plans to a shareholder vote. After all, shareholder approval is the standard step to insulate an interested transaction from scrutiny in favor of business judgment rule deference. A common solution is for boards to propose compensation plans for shareholder approval that establish upper limits on the annual amount per director.
Under recent cases in Delaware, however, the value of shareholder ratification has become more limited. Courts credit such approval only when the approved compensation plan is fixed, not one where directors retain any discretion over it.
At many companies, the compensation committee sets or recommends director pay, so taking a closer look at whether those directors are disinterested and delegating this decision making to a subcommittee would be an extra step – but it may be worth the effort if director pay is higher than at peer companies or the company has another reason to think the decision would be challenged.
Lawrence observes that board pay has increased significantly over the past 20 years – which aligns with the increase to directors’ workloads, the competitive market for qualified board members, and litigation & reputational risks. He also notes that it’s important to benchmark the amount and structure of director compensation arrangements, in addition to having “bulletproof” procedures.
Yesterday, the SEC posted notice – for the NYSE, Nasdaq and other SROs – that it would designate a longer period for taking action on proposed listing standards to implement Dodd-Frank clawback rules. This action follows comment letters that were submitted earlier this month to urge a longer lead-time – and it’s welcome news to anyone trying to keep up with the demands of recent SEC rulemaking.
That said, don’t get too excited. For each exchange, the Commission has designated June 11th as the date by which it will either approve or disapprove – or institute proceedings to determine whether to disapprove – the proposed rule change. Under Section 19(b)(2) of the Exchange Act, that’s the outside date of 90 days from the date the notices of these proposals were published in the Federal Register. If the Commission hadn’t designated this longer period, it would have had to act by April 27th.
The lingering issue presented by this June date is that the original proposals from the exchanges said that they’d be effective on the date approved by the SEC (see pg. 31 of the NYSE’s proposal and pg. 31 of Nasdaq’s proposal). So, unless the exchanges amend that portion of their proposed listing standards, if the SEC approves them in June, that’s when they’ll go effective. That will start the 60-day clock for listed companies to adopt a compliant clawback policy – putting the deadline in early August. That’s still a lot earlier than many folks originally expected, and means you can’t delay work on your clawback policy.
We’ll continue to cross our fingers that this plays out more in line with the originally expected timeframe of a November effective date for the exchange listing standards and a January 2024 compliance date. Keep following this blog for updates & practical guidance as the date nears (one way or the other) – and make sure to use the resources available in our “Clawbacks” Practice Area (including a sample policy). And, mark your calendars for our “Proxy Season Post Mortem” webcast – 2pm ET on Tuesday, June 27th, as we’ll touch on this as a “hot topic.” As always, an archive replay and transcript will be available to members following the live program.
If you aren’t already a CompensationStandards.com member with access to these resources, start a no-risk trial today! 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. If you have any questions, email sales@ccrcorp.com – or call us at 800.737.1271.
Although large company stocks performed pretty well during the first quarter of this year, the impact of the bumpy market might be affecting executives’ decisions on whether to find greener pastures – and boards’ decisions on how far to go to retain them. In a recent memo, Semler Brossy points out that retention awards are increasing:
Tighter and more competitive candidate pools have led to higher executive pay. Meanwhile, poor market conditions have eroded much of the equity hold companies rely on to retain their existing talent. We analyzed S&P 500 companies from 2019 to 2021 and found that retention awards are increasing, notably since the start of COVID. Additionally, current board concerns over retention could mean the practice increases in 2023 and beyond.
The Semler Brossy team acknowledges that special retention awards come with a high risk of investor criticism – but says that risk can be worth it if the awards are done right. The memo shares three important considerations – here are a few excerpts from each section:
1. Is now the right time? It is essential for boards to step back and ask what makes this particular time or situation unique, and how special awards might make a real difference. Do investors find the criticality of the individual executive’s role apparent and worthy of a special award? Have the company’s communications supported this narrative to help investors understand the unique situation?
2. Does the existing compensation program have enough holding power to retain the executive(s)? Sometimes, a poor performance year makes a management team question whether the plan works. We advise clients to review performance/payouts over a multiyear period before fearing the worst. . . . Often, making potential opportunities more transparent and rallying executives around achieving these goals is enough to strengthen their commitment.
3. How will the company structure the special award (i.e., performance and vesting)? A special award’s structure will often dictate its external reception. Investors and proxy advisors evaluate four design features in special awards: magnitude, performance requirements, vesting and forfeiture provisions. The memo includes a chart that shows guardrails for these design features, and commentary from S&P 500 analysis.
At the end of the day, the frequency with which the company makes these types of awards is one of the most important considerations. It’s difficult to call something a “special award” if you’re doing it regularly, which the Semler Brossy folks also point out:
Boards should also exhaust all regular compensation actions and consider the internal and external operating environment before undertaking a special award. Lastly, special awards should be kept isolated, making them truly “special” rather than a perpetual practice.
Compensation committees have been struggling to set appropriate performance hurdles, especially for long-term awards, in these challenging markets. Equilar recently released a publication (available for download) analyzing trends in plan design, and—not surprisingly—long-time favorite, relative TSR, is only increasing in popularity as a performance metric. Here is Equilar’s summary of their key findings:
Relative TSR reigns supreme. The use of the metric grew in prevalence among Equilar 500 CEO LTIPs by nearly 13 percentage points from 52.8% in 2017 to 65.7% in 2021.
Return on capital loses momentum. ROC was the only Equilar 500 NEO performance metric to decrease in prevalence in 2021, declining from 40.1% in 2020 to 39% in 2021.
Three is the magic number. Three-year performance periods are by far the most common time horizon set for Equilar 500 executive LTIPs, increasing from 86.7% in 2017 to 90.6% in 2021.
CEO LTIPs call for higher performance ranges. Award payouts for Equilar 500 CEO LTIPs were most commonly triggered when performance hit 80%, and capped when performance hit 120% of target, with 84 of the 119 metrics falling within this range.
Max payouts are most commonly double the target. A maximum payout range of 200% the target was the most prevalent across the Equilar 100, with 88 metrics including that parameter as the high mark for CEO LTIP performance awards in 2021.
I recently blogged about Part 1 and Part 2 of a three-part series on clawback policies by WTW. In Part 3, WTW focuses on whether and how companies should prepare in advance to ensure they have the ability to clawback compensation from officers if the need arises.
First, the article notes that companies should not expect to be able to rely on the rule’s “impractical” exception as shareholders, proxy advisors and the press will expect companies to have a mechanism in place to ensure that earned compensation is within reach in the event of a future restatement. This is easier for current officers, of course, for whom future pay provides a ready source of funds but, to move quickly in the event of a restatement, WTW suggests companies consider adopting a policy identifying compensation sources to be pursued first in the event of a clawback—such as shares held pursuant to stock ownership guidelines.
Former officers present the greater challenge. Here’s an excerpt from the article:
Once an officer departs, the company often does not have access to a ready source of funds to effectuate a clawback within its direct reach. There are exceptions: When options remain outstanding, full-value shares are not settled until a later date (e.g., the end of a performance period) or when existing deferral arrangements delay payment until some future date. But we expect that most companies will have to confront the obvious question about whether they should defer a portion of officer compensation for a period sufficient to facilitate a clawback in the event the officer terminates employment.
Companies wishing to adopt this approach must resolve certain issues first. The predominant one is that current officers can become former officers very quickly, and often no compensation is available to defer once they leave. For example, if annual bonuses have a “must be present to win” provision so that payment happens only for a current employee, no funds will be available for a departing officer who leaves before that date or if that office leaves on that date when the bonus is paid. Similar rules apply for most, but not all, long-term incentive plans.
The article goes on to identify other challenges presented by a mandatory deferral, including 409A and how to compute an appropriate deferral amount. Many companies may choose not to implement a policy ranking compensation or a mandatory deferral program, but, at a minimum, compensation committees should be considering these options and weighing in on how far the company should go to ensure compensation can be clawed back.
This Glass Lewis blog highlights a potential use case for CEO pay ratio disclosure—to gauge a company’s human capital management practices. Since it allows companies to use various methodologies to identify the median employee, the rule’s flexibility has resulted in limited comparability of the data across companies, but Glass Lewis has identified helpful takeaways by considering year-over-year changes. As an example, the blog cites one company whose NEO base salaries increased by 50%—for which the company cited a challenging recruiting environment and inflationary pressures—while compensation for rank-and-file employees, which was evident in the pay ratio disclosure, only increased 6%.
This is a good reminder that CEO pay ratio can’t be a fill-in-the-blanks exercise every year, even though it has largely failed to be the controversial, headline grabbing disclosure some expected years ago. Think about how your numbers have changed year-over-year and how investors will react to this year’s data. If there are any anomalies or surprises, make sure to address them with contextual disclosure.
BlackRock recently released this investment stewardship announcement, which complements its global incentives commentary by outlining factors that US companies may (should?!) consider when designing executive compensation programs. Directors and others who set compensation will appreciate the high level approach BlackRock has taken here. The announcement specifically avoids providing prescriptive guidance on executive compensation construction, which BlackRock believes boards are in the best position to design. Instead, BlackRock encourages compensation committees of US companies to consider the following factors:
– How the balance between retentive and motivational components in compensation program design promotes long-term performance
– How the compensation program rewards long-term financial value creation, sustained across the duration of the program’s performance period
– How pay underpins strategy, with clear disclosure of the rationale for the selected performance metrics
– How resilient the pay program may be across dynamic market environments and the business cycle
– How the committee might responsibly use discretion to reinforce alignment of pay program outcomes with long-term shareholders’ interests
– How to provide sufficient disclosure in unusual situations such as executive transitions and newly public companies
In this uncertain environment, BlackRock expresses concerns about the resilience of executive compensation programs and suggests that companies may have overly relied on performance awards since 2020. Here is an excerpt:
We believe over-indexing executive pay to performance-levered awards increases the potential for a perceived need for special awards and award modifications, especially in tumultuous business environments. Since 2020, the business environment has been challenging for many companies and as a result, many performance awards have not paid out under the formulas within the plan design. Similarly, many options grants are underwater. We have noted that some boards have used discretion, special awards, and/or award modifications to increase the compensation likely to be realized by executives. In essence, these committees seem to be, at least in part, rewarding executives for expended effort rather than for realized results aligned with returns to long-term shareholders.
We ask that companies consider and explain how their executive compensation program is resilient and, thus, will deliver reasonable pay outcomes across a broad range of business outcomes and market environments. In this context, resilient means that programs will provide sufficient retentive impact without intervention when market conditions are difficult, motivate appropriate risk behaviors by executives, reward performance when conditions are more favorable, and adequately reflect the financial performance that shareholders are experiencing.
CalPERS, which due to its position as the largest public pension fund in the US is an influential investor at many public companies, articulated priorities for the current proxy season as part of a recent Investment Committee meeting. Executive pay remains a priority for this proxy season. Specifically, CalPERS will focus on engagement on relative underperformers with continual higher relative pay. The pension fund will continue to withhold votes from directors at companies with poor pay practices. The “Proxy Voting & Corporate Engagement Update” presented at last month’s Investment Committee meeting shares these results on executive pay votes over the past two years:
– Voted “against” 49% of management say-on-pay proposals versus 55% “against” in 2021
– Voted “against” 1,289 Compensation Committee members in 2022 versus 3,079 in 2021
Although that’s still a lot of “against” votes, at least there was as year-over-year improvement, from the corporate perspective.
Meanwhile, BlackRock – the world’s largest asset manager – has said in its Investment Stewardship team’s engagement priorities that it will want to talk with compensation committee member(s) if it identifies “apparent misalignments” between executive pay & performance or has other concerns about a company’s compensation policies. BlackRock will also vote against both say-on-pay and compensation committee members if say-on-pay is on the ballot and it concludes a company has failed to align pay with performance. That’s consistent with the voting guidelines announced in December.
From the folks who brought you the say-on-pay tracker and other tools, the team at Farient Advisors has now announced the launch of “PVP Tracker” – which can help you stay on top of how S&P 500 competitors and peers are sharing data. Here’s more detail:
Included in our newly launched PvP Tracker™ is coverage of both qualitative and quantitative elements. On the qualitative side, the PvP Tracker™ summarizes trends in peer group selection, the “most important” performance measures, and the formats employed when describing the relationships between CAP and measures of financial performance, among other elements.
Here are a couple of early findings that the real-time data reveals:
– When companies reference the relationship between CAP and performance measures, they most commonly (55% of S&P 500 companies) disclose those relationships in a graphic format only. Another 34% of companies use a combination of graphs and narrative. A slim minority (11%) of S&P 500 companies disclose these relationships in a strictly narrative format. Thus, a visual representation is the preferred approach either because it helps to better show the connection between pay and performance, or because no additional narrative is needed to satisfy SEC reporting requirements.
– In terms of the “most important” company-selected metric (CSM), Farient’s PvP Tracker™ finds that a majority (54%) of companies are choosing an earnings metric, such as operating profit or EPS, followed by returns (15%) and cash flow (13%). Of course, CSM trends vary by industry—for instance, 37% of companies in the financial sector select a returns measure as their CSM.
You can sort the data by industry to show comparisons of CAP to SCT compensation and to explore disclosure trends. It’s a very handy tool for anyone tasked with benchmarking – or just curious about how these disclosures are shaping up.