Recent research from WTW covering more than 1,000 companies (including the S&P 500, FTSE 100, TSX 60, and major European and Asia Pacific indices) found that 81% of those surveyed include ESG metrics in incentive plans — up from 75% of surveyed companies in 2022. Not surprisingly, the practice is more prevalent in Europe, with 93% of surveyed European companies using ESG metrics, compared to 76% in the U.S. In the U.S. and Canada, use of ESG metrics in LTI plans specifically has more than tripled since 2019.
Human capital metrics are most prevalent, with common metrics including employee engagement, safety, succession & talent management, and management & workforce representation. That said, environmental and climate metrics are becoming increasingly common, with 80% of companies using them in Europe. In the U.S., prevalence has jumped from 12% in 2020 to 44% in 2023.
The announcement notes that companies need to focus on “identifying and measuring individual elements of ESG most impactful to businesses” given institutional investor and regulatory pressure. During our recent webcast, “The Latest: Your Upcoming Proxy Disclosures,” Gibson Dunn’s Ron Mueller noted that we’ve seen some shareholder proposals this proxy season asking companies to eliminate GHG reduction metrics as performance measures. We have yet to see whether this slows, halts or reverses the recent growth in the use of climate metrics.
Meredith blogged yesterday on TheCorporateCounsel.net about the NYSE’s annual letter to listed companies. The letter covers a point on clawback policies that we have also written about on this blog. Here’s what Meredith wrote about the NYSE reminder on this point (visit our “Clawbacks” Practice Area for more on this topic):
In response to listed company inquiries, NYSE’s annual Listed Company Compliance Guidance letter also includes a reminder to debt-only issuers that they, too, are required to adopt a clawback policy. Here’s an excerpt:
In adopting Rule 10D-1, […] the SEC did not provide any such exemption for issuers whose only listed securities are debt securities, including issuers of debt securities guaranteed by a parent company whose common equity securities are typically listed on the Exchange. In response to inquiries from listed companies and their advisors, NYSE Regulation has sought clarification from the SEC regarding the treatment of debt-only issuers under Rule 10D-1 and Section 303A.14.
As a result of those conversations, NYSE Regulation confirms that all debt only issuers listed on the NYSE are required to adopt a Recovery Policy, including, without limitation, those with guarantees from listed parents and those that are exempt from disclosure requirements pursuant to Exchange Act Rule 12h-5. To the extent an issuer has not put in place relevant procedures, it is out of compliance with NYSE rules.
This Davis Polk memo from a few weeks ago has more on this and explains the mechanics (or lack thereof) for some debt-only issuers.
A subsidiary of a public company (including an operating company or finance subsidiary) can itself be the issuer of debt securities or a guarantor of debt securities issued by its parent company. […] Under SEC rules, where the parent guarantees the debt, the subsidiary is exempt from ongoing SEC reporting (in accordance with Rule 12h-5 under the Securities Exchange Act of 1934), and the parent reporting company is not required to provide separate financial statements to the SEC for the subsidiary (in accordance with the exemption under Rule 3-10 of Regulation S-X). […] Subsidiary securities are sometimes listed on an exchange.
Subsidiaries with listed securities should adopt a clawback policy to comply with the listing standards. The good news is that under both NYSE and Nasdaq listing standards, if the subsidiary is not itself subject to SEC financial reporting requirements, there should be no events that would trigger recovery of compensation under the policy.
This is because under the clawback rules, recovery of compensation is only triggered by a financial restatement that the issuer is required to prepare due to the issuer’s (i.e., the subsidiary’s) material noncompliance with financial reporting requirements under the U.S. federal securities laws. If the subsidiary issuer is not subject to such financial reporting requirements, then it should never be required to prepare a restatement due to material noncompliance with such financial reporting requirements.
The memo goes on to say that the clawback policy “could simply state that the parent company’s clawback policy applies to the subsidiary” and even includes a sample resolution that could be adapted for this purpose as an annex. Finally, it clarifies that, for any such subsidiary that does not file an annual report on Form 10-K, Form 20-F or Form 40-F, there would be no need to file the clawback policy as an exhibit.
Vanguard recently released its updated 2024 proxy voting policy. The policy is effective beginning this month and applies to Vanguard-advised funds.
There were no significant substantive changes to the asset manager’s case-by-case approach to compensation-related ballot items (including say-on-pay), but it has reframed the factors that it considers.
For example, the policies say that Vanguard considers 3-year TSR as part of its consideration of “alignment of pay & performance.” The policies also expand on what the funds look at for “compensation plan structure” – and they now expressly state that Vanguard considers “governance” as well. Here’s an excerpt:
– Alignment of pay and performance. The funds look for evidence of clear alignment between pay outcomes and company performance. This is mainly assessed through alignment of incentive targets with corporate strategy and analysis of three-year total shareholder return and realized pay over the same period vs. a relevant set of peer companies. If there are concerns that pay and performance are not aligned, a fund may vote against a pay-related proposal.
– Compensation plan structure. Plan structures should be aligned with the company’s stated longterm strategy and should support pay-for-performance alignment. Where a plan includes structural issues which the funds determine have led to, or could in the future lead to, pay-for-performance misalignment, a fund may vote against a pay-related proposal. For compensation structures which are not typical of a market, the Vanguard-advised funds look for specific disclosure demonstrating how the structure supports long-term value creation for shareholders.
– Governance of compensation plans. The funds look for boards to have a clear strategy and philosophy on executive pay, utilize robust processes to evaluate and evolve executive pay plans, and implement executive pay plans responsive to shareholder feedback over time. The funds also look for boards to explain these matters to shareholders via company disclosures. Where pay-related proposals consistently receive low support, the funds look for boards to demonstrate responsiveness to shareholder concerns.
The policy document goes on to list practices that raise high & moderate concern, which are unchanged from last year. But if you find that you are engaged in any of these practices, all is not lost. New this year, the policy also acknowledges:
Where these warning signs exist, elements of strong compensation governance, such as board responsiveness and disclosure that includes data, rationale, and alternatives considered, can sometimes serve to mitigate these concerns.
Keep in mind that there may be other policies at play if your company is in Vanuard’s portfolio. Wellington makes voting decisions for some Vanguard funds and also released its policies (see the full policies and a summary of changes on Wellington’s policy portal). And of course you now also need to keep track of policies that apply when investors are using “proxy voting choice.”
Now that the Delaware Court of Chancery has taken the unusual step of invalidating the compensation package that Tesla’s board of directors awarded to Elon Musk back in 2018, shareholder proponents are saying they see an opening for higher support on traditional corporate governance resolutions – including a proposal urging annual director elections that has been submitted to the company this year. This Reuters article quotes prolific proponent John Chevedden:
“People are going to be looking to rein in what’s going on,” said John Chevedden, an independent activist investor. He has put forward a resolution at Tesla’s upcoming shareholder meeting expected this spring that would replace a requirement for major corporate changes to gain support from two-thirds of all shares outstanding with a simple majority vote.
The article also points out that ISS has in the past recommended votes against certain Tesla directors due to CEO compensation concerns. The question is whether this year, the court’s findings will contribute to a drop in support from significant institutional holders who have previously cast “management friendly” votes.
It was the “moonshot” award that started it all. But last week, as you’ve probably heard, Elon Musk did not get the outcome he was hoping for in the Tornetta v. Musk litigation that has been winding its way through the Delaware Court of Chancery for several years.
The case challenged the record-breaking equity award that was granted to Musk in 2018 and – when the value of the company skyrocketed – came to be worth about $51 billion. Chancellor Kathaleen McCormick issued her 201-page opinion last Tuesday. As Tulane Law Prof Ann Lipton put it, “she took the extraordinary step of holding that Elon Musk’s Tesla pay package from 2018 was not “entirely fair” to Tesla investors, and ordered that it be rescinded.” Mechanically, it looks like the options that the company had granted to Musk will now be cancelled (none of the options had been exercised). Ann’s blog walks through the complex legal standards – & burdens of proof – that led Chancellor McCormick to this outcome. Here’s an excerpt:
Formally, in Tornetta, the court concluded that Elon Musk was a controlling shareholder of Tesla, at least for the purposes of setting his compensation package. The court considered both his 21% percent stake, and his “ability to exercise outsized influence in the board room” due to his close personal ties to the directors and his “superstar CEO” status. She recounted the process by which the pay package was set, noting in particular that Musk proposed it, Musk controlled the timelines of the board’s deliberation, and he received almost no pushback – board members and Tesla’s general counsel seemed to view themselves as participating in a cooperative process to set Musk’s pay, rather than an adversarial one.
What about the stockholder vote? That, too, was tainted, because – McCormick concluded – the proxy statement delivered to shareholders contained material misrepresentations and omissions. It described Tesla’s compensation committee as independent when in fact the members had close personal ties to Musk, and it did not accurately describe the manner in which his pay package was set – again, with Musk himself proposing it and the board largely acquiescing. With those findings in hand, McCormick did not rule on the plaintiff’s additional arguments that the proxy statement was misleading for other reasons (namely, it falsely described the payment milestones as “stretches” when in fact the early ones were already expected within Tesla internally.)
Chancellor McCormick said that the process leading to the approval of the compensation plan was “deeply flawed.” Advisors will also find it interesting that she reviewed an early draft of Tesla’s proxy statement and found it to be the “most reliable (indeed, the only) evidence” of the substance of the discussion that established the terms of Musk’s equity grant. Over the course of several drafts, the existence of that conversation was edited out – so, it was not mentioned in the as-filed proxy. The judge also took issue with this statement:
The Proxy disclosed that, when setting the milestones, “the Board carefully considered a variety of factors, including Tesla’s growth trajectory and internal growth plans and the historical performance of other high-growth and high-multiples companies in the technology space that have invested in new businesses and tangible assets.” “Internal growth plans” referred to Tesla’s projections.
According to the court’s findings, the proxy was misleading because it didn’t disclose that the company had projections that would show that the milestones would be achieved. As Ann explained in her blog, the court also took issue with describing compensation committee members as “independent” when – according to the record – they in fact had relationships that gave rise to potential conflicts of interest that should have been disclosed, and a “controlled mindset.” So, Chancellor McCormick concluded:
The record establishes that the Proxy failed to disclose the Compensation Committee members’ potential conflicts and omitted material information concerning the process. Defendants sought to prove otherwise, and they generally contend that the stockholder vote was fully informed because the most important facts about the Grant—the economic terms—were disclosed. But Defendants failed to carry their burden.
The case shows that process, common-sense thinking, and disclosure matter. If you’re involved in the compensation-setting and/or proxy drafting process, you may not win friends if you read everything with a critical eye and ask unwanted questions. It can be hard to find a way to do that tactfully. But now you have a case to point to that shows why it’s important.
Back in October, Liz blogged about a report from non-profit FCLTGlobal making the case for the “simplest” solution to what some investors consider the overcomplication of executive pay programs. That solution is, according to the non-profit, “direct stock ownership by executives, with long-term holding periods.”
The notion of doing away with performance programs isn’t new, especially in Europe, and Liz’s blog identified Norges Bank as one investor that continues to push for simplified pay. But Norges is not alone. In 2019, CII overhauled its executive compensation policy and urged companies to reduce the complexity of their incentive plans.
Although it’s leading to a fair number of against votes by Norges, this can all seem somewhat… theoretical… for many companies. But this report just released by the Center On Executive Compensation (a division of HR Policy Association) addresses practical considerations for pay simplification and gives an example. Here’s an excerpt regarding Unilever:
Under the revised approach to incentives, executives were encouraged to invest up to 100% of their annual incentive payouts in Unilever shares. The company matched the participants’ investment based on the performance of the company. The amount of the company match ranged from 0% to 200% of the participants’ share investment and vested over a 4-year period.
Why do that? The stated rationale for this change was to simplify rewards; increase shareholding levels throughout Unilever’s management population; ensure consistent alignment of performance measures with strategy; and increase the timeframe over which incentives are delivered. Since the time period over which the incentive is earned matched the time period of the reported performance results, it was easier to communicate to executives. Further, a co-investment approach ensures the executive risks his or her own money in company shares, creating real alignment with shareholders. […]
Drawing on research from behavioral economics, one might expect the incentive effect of investing an executive’s own money to be increased effort to create shareholder value and avoid loss. This research suggests that individuals are more highly motivated to avoid losses than to seek gains, suggesting the co-investment model may help create sustained shareholder value while avoiding excessive risk.
The report notes that simplification isn’t for everyone. “[I]t is important that companies engage with investors to understand the extent to which complexity is truly the driver of concerns over the current structure of long-term incentives, if the underlying motivation for simplification is an effort to rein in pay rather than reduce complexity, or whether investors have multiple objections to current executive compensation designs.” It includes a list of key questions the committee should ask when considering simplification and some examples of alternative approaches for committees that want to explore them.