This recent 9-page paper from Stanford’s Rock Center for Corporate Governance looks at where practices stand for climate metrics in executive pay programs – and where they might be going. I blogged last month that “ESG” metrics, on the whole, are improving in the midst of pushback. In a similar vein, this paper says that setting climate goals and incorporating them into pay programs is a journey. Here’s an excerpt:
Most companies acknowledge that it takes time to learn how to break down multi-year targets into one-year goals. Through repeated effort, they learn how efficiency programs, sourcing programs, and technology translate into emission reductions. To many, the process is analogous to continuous improvement programs for capital efficiency. It also takes time to get the largest suppliers on board and to educate smaller suppliers on how they can reduce their carbon footprint.
And:
Companies express very different experiences in the implementation of programs and creating buy in. For most, adopting climate targets and tying these to compensation is a multi-year (even decade-long) process. Companies newer to the effort will be faced with shorter timelines but have the benefit of learning from those who have gone before them. Companies phase the implementation, first adopting metrics to test their use and calculation before tying metrics to compensation. They also start at the top, adding climate goals to senior executive bonuses before rolling out to larger populations.
The underlying climate progress that the programs are intended to incentivize also takes time:
While some companies aim to realize straight-line reductions (for example, 3 percent annual decreases in absolute terms), others are on a “hockey-stick” trajectory. Targets for the first five to seven years focus on the transition to renewable energy and gross energy reductions in production and supply. Beyond this, there is general acknowledgement that technological innovation (outside the company) is going to be required for companies to achieve their long-term pledges.
The paper gives practical suggestions on overcoming resistance to pay changes, board committee oversight practices, why this topic matters in the first place, and more. Here are recommended “best practices” for integrating climate goals into compensation:
1. Leadership and organizational commitment. A company’s commitment to decarbonization is most effective when leadership (CEO, senior executive team, and board) genuinely embraces climate goals. This includes prioritizing decarbonization so it is not seen as secondary to strategic and financial objectives but integral to them. Climate-related goals are tied to strategy, embedded in budgets, and ultimately made part of culture. The reasons that the organization has committed to climate goals should be clearly and consistently articulated to divisional leaders and within functional groups to overcome resistance, remove inertia, and convince employees of the financial, organizational, and environmental necessity of decarbonization.
2. Metrics and reporting. Climate objectives should be few in number, low in redundancy, and largely quantifiable. We found that the most successful companies adopt science-based targets because of their demonstrable link to net-zero emission goals. Long-term targets are broken down into clearly achievable milestones, which map to quarterly, annual, and multi-year budgets and are supported by granular plans for capital allocation and procurement. Companies should be prepared to invest up front in systems for raw data collection and analytical processes, and entrust the reporting process to a small team of experts to ensure consistency and accuracy. Continuous improvement generally decreases cost and increase reliability over time. Ultimately, reported metrics should be audited to ensure accuracy and reliability.
3. Compensation. Climate programs are most effective when goals are added to executive and senior-manager compensation contracts to fully align the organization with its commitments. While many companies use the annual bonus program to do so, the most successful companies also embed climate in the longterm incentive program (LTIP) to match the timing of goals and compensation payouts. Annual targets in support of long-term goals are then reinforced through the annual incentive program. The achievement of annual goals gives executives and employees confidence that long-term objectives will be met. The rewards for meeting climate pledges should constitute a material part of at-risk compensation to encourage performance. Transparent reporting of interim and long-term targets allows the board and shareholders to monitor progress and hold the company accountable.
I blogged last week on TheCorporateCounsel.net about changes to “corporate diversity” messaging that some companies are making in the wake of the SCOTUS ruling in Students for Fair Admissions v. Harvard. In our informal “Quick Poll,” people were split on whether companies will soften DEI-related disclosures in proxy statements (feel free to add your two cents).
Over half of S&P 500 companies consider diversity metrics in some way in executive incentive plans, according to this WTW article. The article gives tips for how to respond to the ruling in the context of setting these goals. Here’s an excerpt:
3. Be specific in measurement. There are many ways DEI progress can be measured. While leadership and workforce representation goals may be a common approach, they also arguably present the highest reputational and litigation risk, especially if the company does not have strong documentation on career and pay decisions. Some other impactful ways to measure DEI progress include engagement score gaps for under-represented groups or participation in DEI enablement programs such as employee resource groups. In addition, companies should evaluate the pros and cons of using quantitative vs. qualitative measurement, especially in countries where demographic information is often self-reported and can be inaccurate. Companies that choose to assess DEI performance qualitatively should take note that investors strongly prefer quantitative and outcome-based metrics over activities-based and qualitative metrics.
4. Bolster the supporting infrastructure. It is important to acknowledge that litigation risks with DEI programs have existed since before the SFFA decision, and many other corporate programs and policies are exposed to similar litigation risks. It is unrealistic to expect elimination of all risks associated with DEI programs, and companies should know that the benefits of DEI programs far outweigh the potential risks. A more reasonable approach is to proactively assess, quantify, and manage these risks. Companies should review practices in recruiting, career development, training and development, managerial enablement and performance management to ensure robust governance and documentation for how decisions are made and communicated.
I’ll add my own tip, too: in addition to working with DEI practitioners, always consult an employment lawyer on this stuff!
For at least the past few years, investors have been pushing for more transparency around non-GAAP adjustments that are made to performance metrics in order to calculate incentive payouts. ISS even included a question about this in the policy survey for this year’s voting policies – and even though there weren’t any formal policy changes on this point, the proxy advisor did update an FAQ to encourage detailed disclosure of adjustments. Glass Lewis also made a relevant clarification. So, the issue isn’t going away.
One question that often arises on the company side is, “What’s the big deal? The reconciliation is only a click away.” From the investor perspective, though, not only is it annoying to have to pull up a separate document, but there is also a recognition that the adjustments may not be exactly the same. This Pay Governance memo gives 5 reasons why there might be discrepancies between financial reporting & incentive adjustments:
1. Threshold amounts that seek to limit the number of adjustments to only those that are materially above a certain dollar amount (i.e., expenses or benefits above $5.0 million)
2. Expenses or benefits that are included in the annual business plan used to establish incentive targets (further adjusting actual performance would result in double counting)
3. Expenses or benefits that may be non-recurring and excluded for financial reporting purposes but still deemed within the control of management for incentive purposes
4. Optics and materiality where omitting a significantly large expense could lead to a severe misalignment due to an above target incentive payout and poor share price performance
5. Matter of importance — for example, foreign currency exchange rates that are used to adjust earnings for year-over-year comparability purposes but are not as important for incentive purposes
The memo goes on to share best practices & potential pitfalls to consider when making non-GAAP adjustments to payout calculations. Pay Governance will be following up with “Part 2” to this memo that will cover more complex issues with M&A-related adjustments as well as other issues.
Here’s a paraphrased recap of the equity compensation plan updates:
– Adjusting the Equity Plan Scorecard Framework (Question 30): Among these adjustments, weighting of the SVT – A+B+C Shares factor decreased for both the S&P 500 and Russell 3000 models. Weighting of the Grant Practices pillar for the S&P 500, Russell 3000, and non-Russell 3000 models decreased, while the weighting of the Plan Features pillar for the same models increased.
– Updates to the pillars and pillar scores for the EPSC frameworks (Question 32): Increasing the “maximum pillar score” for the plan cost, plan features, and grant practices pillars for most categories of issuers. The threshold passing scores are unchanged.
ISS also made a few updates to the value-adjusted burn rate benchmarks – in the index to the equity plan FAQs. For the “compensation policies” FAQs, updates are:
– Pay-for-performance quantitative screens (Question 17): There are no changes to the three primary screens (RDA, MOM and PTA) for 2024. The secondary FPA screen’s “Eligible for FPA Adjustment” thresholds are calculated on an annual basis, and slight changes have been made for 2024. For detailed information on the quantitative screens, see ISS’ Pay-for-Performance Mechanics white paper.
– Consideration of company-responses to pay-related concerns (Question 34): If a company has taken recent actions following the publication of ISS’ research report to address pay-related concerns, any such actions must be disclosed in a public filing in order to be considered by ISS. Based on the additional public disclosure, ISS may issue a “proxy alert” to update the analysis and, if warranted, change a vote recommendation. ISS is generally unable to change vote recommendations if the additional public filing is made in close proximity to the meeting date (specifically, less than five business days before the meeting date). ISS may change its vote recommendation in the proxy alert if the company’s actions sufficiently remedy the concerns driving the adverse vote recommendation. The mitigating weight placed on such actions depends on the specificity of disclosure.
– Disclosure of adjustments to metric results, including non-GAAP adjustments (Question 41): Non-GAAP metrics are commonly utilized in incentive pay programs, and the performance results (and consequently the payouts) can be significantly changed by adjustments approved by the board. If such adjustments materially increase incentive payouts, companies should provide clear disclosure in the proxy explaining the nature of the adjustment, its impact (dollar or percentage) on payouts, and the board’s rationale. Disclosure in the proxy of line-item reconciliation to GAAP results, when possible, is considered a best practice. The absence of these disclosures would be viewed negatively, as would adjustments that appear to insulate executives from performance failures – particularly for companies that exhibit a quantitative pay-for-performance misalignment.
– Distinguishing between problematic CIC severance arrangements and incentive awards that are payable upon a CIC transaction (Question 51): a new or materially amended executive agreement that provides for CIC severance without requiring a qualifying termination (i.e., single or modified single trigger) is considered a problematic pay practice. However, this is distinguishable from a bona fide incentive award that becomes payable upon a CIC transaction. . . . In order to make the distinction between problematic CIC severance and a single trigger CIC incentive award, ISS will review the company’s disclosure of the incentive award structure and award rationale, and whether separate non-problematic severance entitlements are in place.
For the pay-for-performance mechanics, ISS adjusted the quantitative concern thresholds. For the peer group methodology, ISS didn’t indicate any significant updates.
In prior blogs about the FTC’s proposed ban on the use of non-competes and the many state-level developments in this space, we shared information about legislation in New York that contemplated a very broad ban and was awaiting the Governor’s signature. On December 22, Governor Kathy Hochul vetoed the legislation. This Mintz alert describes the lobbying campaign by groups that opposed the bill and the Governor’s concerns:
The Governor had previously indicated that while she supported a more moderate ban on non-competition provisions that would prohibit mobility restrictions for lower and medium income earners, the Governor wanted to see the incorporation of both a salary threshold for the use of non-competes (i.e., such that higher earners could still be subject to non-compete provisions) and an exception for sale-of-business situations. The bill’s legislative sponsors balked at the “low” $250,000 salary threshold proposed by the Governor and negotiations stalled over not only the amount of the salary threshold but how it would be calculated (e.g., whether and how the threshold amount would include bonuses and commissions earned by New York employees). Ultimately, after negotiations with bill sponsors deteriorated over the past week, the Governor vetoed the legislation, expressing that she had “attempted to work with the Legislature in good faith on a reasonable compromise [while] allowing New York’s businesses to retain highly compensated talent.”
The alert says that we all need to continue to monitor non-compete regulatory developments in other states, at the national level and in New York as well since state legislators have noted a plan to reintroduce a bill in the next legislative session.
As you look ahead to garnering support for your 2024 compensation-related proposals, this new 17-minute episode of “The Pay & Proxy Podcast” will help set you up for success. I spoke with Brian Myers & Heather Marshall of WTW’s Executive Compensation and Board Advisory practice about the meaning behind 2023 voting trends and what you should be doing right now to avoid negative (and possibly embarrassing) results. They cover:
– Trends and process & disclosure improvements impacting say-on-pay results in the 2023 season
– The importance of telling your compensation story
– The most common reasons for say-on-pay opposition
– Heightened scrutiny of equity plan share requests
– Why you need to be thoughtful about managing burn rate
– The year-round process for success: Prepare, engage & disclose
In late December, Dave shared a holiday miracle on TheCorporateCounsel.net blog: ISS Governance announced its 2024 Benchmark Policy Updates effective for meetings on or after February 1, 2024, and no updates are contemplated for the U.S. Benchmark Proxy Voting Guidelines. There’s only one clarification to the U.S. policy shown in Appendix B to this summary:
[The clarification] codifies the case-by-case approach when analyzing shareholder proposals requiring that executive severance arrangements or payments be submitted for shareholder ratification. The updated policy (i) harmonizes the factors used to analyze both regular termination severance as well as change-in-control related severance (golden parachutes) and (ii) clarifies the key factors considered in such case-by-case analysis.
The edits resulting from this codification are detailed on page 3 of this document describing Benchmark Policy Changes for the Americas for 2024. The policy in effect for 2023 annual meetings stated that ISS would recommend voting for shareholder proposals requiring that golden parachutes or executive severance agreements be submitted for shareholder ratification unless they would require approval before entering into employment contracts. Then ISS would apply a case-by-case approach to the proposals to ratify or cancel golden parachutes. It also listed terms that an acceptable parachute should include.
The new policy reads as follows:
Vote case-by-case on shareholder proposals requiring that executive severance (including change-in-control related) arrangements or payments be submitted for shareholder ratification.
Factors that will be considered include, but are not limited to:
– The company’s severance or change-in-control agreements in place, and the presence of problematic features (such as excessive severance entitlements, single triggers, excise tax gross-ups, etc.);
– Any existing limits on cash severance payouts or policies which require shareholder ratification of severance payments exceeding a certain level;
– Any recent severance-related controversies; and
– Whether the proposal is overly prescriptive, such as requiring shareholder approval of severance that does not exceed market norms.