Meridian recently published its 2024 Corporate Governance & Incentive Design Survey. The survey contains 56 pages of benchmarking data, pulled from the latest proxy statements of 200 large-cap companies (median revenue of $25 billion and median market cap of $41 billion), on topics including proxy disclosure practices, compensation-related shareholder proposal trends, annual & long-term incentive design practices, corporate governance practices, and more.
Meridian’s analysis confirms datathat we’ve previously shared: most large companies are going “above & beyond” when it comes to clawback policies. Here’s more detail:
All Meridian 200 companies maintain a clawback policy that aligns with the standards outlined by the Dodd-Frank Act. Over three-quarters (78%) of companies also maintain additional clawback policies or provisions that exceed the requirements mandated by Dodd-Frank. Some companies implemented these policies while waiting for the Dodd-Frank mandatory clawback rules to go into effect, while others approved new, additional requirements at the same time as adopting the mandatory Dodd-Frank clawback policy.
Companies expand upon the mandatory Dodd-Frank provisions in different ways, namely:
– Additional triggers (i.e., beyond financial restatement – such as ethical misconduct, violation of restrictive covenants, reputational risk, failure to supervise, or other triggers),
– A broader covered employee group (e.g., all incentive plan participants), or
– More elements of compensation (e.g., time-based equity awards).
For companies with expanded policies, typically the board (or compensation committee) has discretionary authority to recoup compensation. They are not required to recoup pay (as they are with the mandatory Dodd-Frank policy).
Meridian predicts that more companies will consider expanding their approach to clawback policies in 2024-2025. To learn more about what companies are doing, join us for our “Proxy Disclosure & Executive Compensation Conferences” October 14th – 15th, where Compensia’s Mark Borges, Ropes & Gray’s Renata Ferrari, Davis Polk’s Kyoko Takahashi Lin, and Gibson Dunn’s Ron Mueller will be discussing “Living with Clawbacks: What Are We Learning?” Check out the agenda for more details!
This Compensia Thoughtful Pay alert analyzes PvP disclosures by life sciences and technology sector companies during the 2024 proxy season. In sharing the data from its survey, Compensia provides some compliance reminders for the third year of PvP disclosures, which I’ve tried to distill for you below — since it’s (already) about time to start thinking this through for the 2025 proxy season!
– Companies are not permitted to use a broad equity market index for purposes of disclosing the cumulative TSR of their peer group in the table. Compensia continued to observe a number of companies (8.8%) using what appears to be a broad equity market index, rather than the narrower published industry or line-of-business index (or, alternatively, a compensation peer group) required by the rule. (The alert says a few SRCs also disclosed peer group TSR even though it’s not required — although there may be other reasons to do so.)
– Five years of PvP data will now be required for non-SRCs (2020 onward). Compensia noticed a handful of companies included only three years of disclosures, having dropped 2020 information from their second-year table.
– For the relationship description, graphics might be best. Compensia found a vast majority of the technology and life sciences companies used a single graphic to provide the required relationship disclosures. This is consistent with informal statements by SEC Staff in late 2023 that graphical relationship depictions were generally more effective than narrative ones.
– Provide explanations where it looks like your disclosure isn’t fully compliant. Compensia didn’t observe many companies providing explanations when their disclosures didn’t include certain elements due to their SRC status or lack of financial performance metrics, even though many companies were advised to do so. Compensia continues to believe that these statements are helpful to investors and regulators.
– The SEC Staff has clarified that, following a company’s first PvP disclosures, footnote disclosures of the amounts deducted and added to calculate CAP for years other than the most recently completed fiscal year are required only if material to an understanding of the most recently completed fiscal year. In Compensia’s survey, 79% continued to provide a reconciliation for all four years, and only 20.8% opted to streamline the disclosures and only provide one year.
I’m looking forward to hearing Mark Borges, one of the authors of the alert, discuss improvements for third-year PvP disclosures during our “SEC All-Stars: Executive Pay Nuggets” panel at the “2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences” on October 14-15 in San Francisco and virtually. If you haven’t signed up to hear all the “nuggets” our expert speakers will share over two days, you can check out our action-packed agenda and register now by visiting our online store or by calling us at 800-737-1271.
Last spring, Liz shared a Bloomberg article describing the more “critical eye” that investors and the media are casting toward ESG incentives, saying, “there’s evidence to suggest the add-on is being used to enable bigger remuneration packages without leading to any meaningful [ESG] improvement.” A recent research paper suggests there’s reason for concern.
Financial targets are nearly always hard targets that are tied to measures such as revenue and profitability. In general, they appear to be set at levels that are not easy to hit, which would explain why executives missed all of their financial targets 22% of the time in our sample.
ESG targets, it appears, get set in a different way. We find that, of the 247 firms that disclose an ESG performance incentive, only 6 of them reported missing every target. That is, 98 percent of them met at least one ESG target. Similarly, we find that 44% of firms met or exceeded all of their financial targets while 76% of firms met or exceeded all of their ESG targets.
They then tried to analyze what’s causing this. Are NEOs just ‘knocking it out of the park’ when it comes to ESG improvement? It’s hard to say for sure, but that seems unlikely.
Using three different measures of ESG performance, we find no statistically significant association between attaining ESG performance goals and improvements in ESG scores. We next examine whether there is an association between whether a company meets or exceeds all of its ESG targets and the level of shareholder support that executives receive during the annual say-on-pay vote. Here we do find a statistically significant negative association.
But what does it all mean? They go on:
This evidence is consistent with the theory that ESG targets are set at levels that reflect weak corporate governance. That is, they may be set at levels that are low to allow executives to reap their rewards even if ESG performance is not particularly strong. …
Motivating better ESG performance benefits from setting award thresholds and the amount of compensation at high levels. But doing so poses the risk that executives will miss the targets, which may indicate to the outside world that managers are not prioritizing ESG values. … [F]irms may have responded to this dilemma by setting ESG incentive targets at levels that are designed to be achieved.
Take note! If companies are setting ‘softball’ ESG goals, this will continue to be a pain point for investors, who will demand better transparency around target metrics and executives’ performance against them.
This spring, Liz shared that the IRS was rolling out an “aircraft audit” initiative to evaluate whether companies have improperly deducted expenses for airplanes that were sometimes being used for personal travel, and whether individuals have properly recognized income relating to personal travel benefits. (See the Large Business and International Division’s list of active compliance campaigns, which now includes the “Business Aircraft Campaign.”)
According to the Baker McKenzie blog, The Compensation Connection, this focus has triggered calls to revisit the manner in which personal use of corporate aircraft is valued for income imputation purposes.
Shortly after the IRS announced this corporate aircraft campaign, six Senate Democrats … wrote to the IRS and the Treasury Department to laud this effort to crack down on executive personal use of corporate aircraft. In addition, the letter urged the IRS and Treasury to use its regulatory authority “to close the … SIFL loophole that allows corporate executives to undervalue, and minimize taxes paid, when they use corporate jets for personal travel.” SIFL stands for the Standard Industry Fare Level valuation method.
In recent informal discussions with the IRS and Treasury, representatives have indicated that they are seriously considering the Senate letter asking them to revisit the SIFL rates and thereby increase the rates at which personal use of the corporate aircraft is imputed into income. Although this would disadvantage employees and executives engaging in personal use of the corporate aircraft, it would have the silver lining of allowing companies to take a deduction for the higher amount included in an executive officer’s income for an entertainment flight.
Why is that? Well, for those of us who aren’t tax attorneys (that includes me!), the blog has this background/reminder:
SIFL is a method of valuing personal use of corporate aircraft flights that has been in the regulations for decades. Under the fringe benefit regulations, a company can impute income for personal use of a corporate aircraft using charter rates or using the SIFL rates. The SIFL rates are significantly lower than the charter rates and are meant to approximate first class fares or a multiple thereof. If a company uses the SIFL rates, the income required to be imputed to the executive for the trip is almost always lower than the actual expenses incurred by the company. …
There is a disadvantage to the company in using SIFL rates for entertainment flights by executive officers. … [I]n the case of executive officers, under Code section 274(e)(2)(B), if the SIFL rates are used to impute income, only the costs of the aircraft up to the SIFL rates are deductible. Costs incurred in excess of the SIFL rates are nondeductible. …
If the IRS were to change the valuation rules so that higher values had to be imputed into the executive’s income, under the statute as it currently stands, this would allow a higher deduction to the company for an entertainment flight by an executive officer.
In early September, ISS released its 2024 United States Proxy Season Review: Compensation. The summary is public, but the full report is available only to subscribers. This alert describes Gibson Dunn’s key observations and takeaways.
It notes that ISS calls this year’s say-on-pay failure rate the lowest “ever observed.” Average shareholder support for say-on-pay and equity plans improved after decreasing in recent years. But, notably, some other factors — that we’d expect to negatively impact say-on-pay — are also increasing:
– CEO Pay: ISS notes that the record low say-on-pay failure rates combined with the record high S&P CEO median pay level suggest that investors are considering factors beyond pay magnitude in their voting decisions.
– Perks: The ISS report noted that increases in CEO “all other compensation” levels appeared to be primarily driven by larger corporate aircraft perks and security costs.
– Evergreen Provisions & Other Disfavored Plan Provisions: Evergreen provisions in equity plans continued a steady rise and were observed in over 15% of 2024 plans up for approval. Issuers seeking plan approval in 2024 continued to eschew limitations on flexibility to accelerate vesting and set vesting schedules.
The prevalence of evergreen provisions is likely attributable in part to the repeal of Section 162(m) of the Internal Revenue Code in 2017 and an increase in SPAC/de-SPAC transactions since 2021. Favoring the ability to set and adjust vesting schedules is unsurprising as issuers balance the need for flexibility in equity plan administration.
For balanced reporting, I must add that problematic equity plan provisions, like repricings without shareholder approval and liberal change in control vesting, continued to decline overall. But Gibson Dunn attributes the say-on-pay improvements to “continued transparency in compensation program disclosures and increased attention on shareholder engagement efforts.”
Meredith blogged last month about trends in ESG metrics at the 100 largest public companies. A new 16-page analysis from Meridian Compensation Partners confirms that practices are consistent between these largest companies and others in the S&P 500 – and mostly unchanged from last year. Here are a few of the key takeaways from the executive summary:
– In 2024, nearly three-quarters of the S&P 500 linked a portion of incentive compensation to the achievement of ESG metrics – unchanged from 2023. Although there is variation by industry, a majority of companies in all sectors use one or more ESG metrics in their executive incentive arrangements.
– A large majority (73%) of companies using ESG metrics do so in their short-term incentive (STI) plans, unchanged from 2023. Alternatively, ESG in long-term incentives (LTI) remains a distinct minority practice with only 11% (9% in 2023) of the S&P 500 doing so. Only in the Utility sector is the use of ESG in LTI majority practice, (57% and unchanged from 2023).
– Unlike traditional financial and operational metrics, most ESG metrics are not individually measured and weighted. Instead, most companies use either scorecards and/or individual performance assessments.
– Social metrics are the most prevalent ESG metric used in incentive plans. In 2024, 68% (up slightly from 66%) of the S&P 500 used Social metrics, while 39% used Environmental and 30% Governance metrics respectively. An additional 26% included metrics that crossed multiple areas, often to address ESG strategy or measure ESG scoring goals. Prevalence for each of these are up slightly from 2023.
The analysis is based on proxies filed by S&P 500 companies between April 16, 2023 and April 15, 2024. The Meridian team offers these predictions based on changes that they are seeing companies make to compensation programs over the past year or so, which have not yet been reported in proxy statements:
While we have not seen material changes in reported practices we noted trends in our consulting that is likely to emerge in subsequent year’s reporting for DEI-related metrics, specifically:
― Less quantitative;
― More subjective;
― Combining with other criteria; and/or
― Some change in terminology (e.g., talent development).
These changes we believe are reflective of recent Supreme Court decisions, that while not immediately applicable to for-profit commercial organizations, nevertheless have been undertaken as adjustments to minimize any similar longer-term risks.
Meredith blogged last month about media coverage of “the unlucky first few” companies that had to mark the new clawback checkbox(es) on their Form 10-K due to a correction of a financial statement error. At last week’s ABA meeting, Corp Fin Director Erik Gerding (again) confirmed that the circumstances are rare in which a company would check the first checkbox about error correction but not the second checkbox about the recovery analysis. He also provided a few other reminders. Here are the key takeaways (also see my earlier blog):
1. The second check box must be checked for all non-voluntary restatements (whether “Big R” or “little r”), since an analysis always must be performed in those situations. This is the case even if very little analysis needs to be done to confirm no recovery is needed.
2. The extent of that recovery analysis will vary based on the facts & circumstances, but even where no amount is recovered, the rules still require a brief discussion of why no amount was recoverable. In other words, the rule calls not just for disclosing your conclusion, but an explanation of why you reached that conclusion.
3. Don’t forget XBRL block-tags for your disclosure about the recovery analysis. The Staff is using tagging to check for compliance with the substance of the rule as well as the tagging requirements, and the tags are also important to investors.
Since 2010, Item 402(s) has required companies to disclose their policies & practices for managing compensation-related risks, to the extent that risks arising from their compensation programs & policies are reasonably likely to have a material adverse effect on the company. Disclosure under Item 402(s) isn’t limited to executive compensation arrangements. It also applies in addition to CD&A requirements to discuss management’s exposure to downside performance risk.
Although Corp Fin issued comments shortly after this rule went into effect, this line item is something that is often handled internally. It often doesn’t result in disclosure – because many companies conclude that the risks of their compensation programs aren’t reasonably likely to have a material adverse effect. The problem, though, is that “hindsight is 20/20.” In the wake of scandals, compensation risks become more apparent.
A new Semler Brossy memo analyzes a few recent mishaps to show the role that compensation-related lapses might have played. The memo also suggests improvements to compensation risk reviews that can help keep your company (and compensation committee members and executives) out of the spotlight. Here’s an excerpt:
The most effective risk reviews don’t just focus on compensation programs alone. They also help to pinpoint areas where compensation could worsen business risks. Therefore, effective processes go beyond just examining compensation structures. They also assess operational risks, critical business areas and organizational governance mechanisms. To achieve this, consider adding the following practices to your risk review:
– A comprehensive inventory of incentive programs. Document all incentive programs, detailing the number of participants, design features that could pose risks and any built-in risk mitigants.An overview of program administration. Summarize how goals are set, performance is measured, payouts are approved, while also verifying the existence and application of clawback mechanisms.
– A governance and oversight review. Evaluate the processes for reviewing incentives for risk outcomes, identify responsible parties and understand how risk-related events are escalated. Understand what data is collected, who has access to it and how it is utilized.
– Historical event analysis. Track and analyze events that prompted further review, including responses and long-term trends in the number and nature of these cases.
– Cultural indicators. Assess key cultural markers, such as trends in engagement survey scores, whistleblower hotline reports and exit interview patterns.
Directors will want to understand existing processes and ensure sound risk management practices, even though not all the elements above need to be addressed at the board level. Although these measures may require additional effort, compensation committees that treat risk management as a strategic priority rather than merely a regulatory requirement will be better positioned to safeguard employees and stakeholders, avoid reputational harm and achieve long-term success.
Compensation Advisory Partners recently analyzed director compensation practices at the 100 largest public companies, based on 2024 proxy statements. Here are the key takeaways:
– Median total board compensation was flat year-over-year ($325K)
– Similarly, compensation provided for service in board and committee leadership roles was also flat versus prior year at median
– Meeting fees and use of stock options continue to be uncommon, with only 6% of companies paying board meeting fees and only 2% granting stock options to their directors
CAP also shares these predictions:
– During the next year, we expect a modest increase to median pay levels for standard board service
– We also expect to see continued focus on the additional retainers provided to Lead Directors and Committee Chairs
Sullivan & Cromwell is out with Part 2 of its 2024 Proxy Season Review covering compensation-related matters, and it contains a helpful deep dive into ISS’s qualitative say-on-pay analyses in 2024. The report lists the following issues regularly cited by ISS in its qualitative assessments this year:
Insufficient disclosure of performance goals. Similar to prior years, the inclusion of limited, opaque, or undisclosed performance goals was a significant qualitative factor in say-on-pay recommendations for S&P 500 companies in 2024. ISS specifically cited this concern for 19 of the 34 companies that received negative recommendations (vs. 24 of 42 in H1 2023). The continued significance of this qualitative factor is consistent with ISS’s focus on pay-for-performance alignment in the quantitative assessments.
Discretion in bonus plans. In addition, ISS was more focused on the use of subjective criteria for determining bonuses, or the use of discretion to increase an executive’s compensation, than it had been in prior years. ISS identified this as a qualitative factor for 17 of the 34 S&P 500 companies that received a negative recommendation in H1 2024 (vs. 16 of 42 in H1 2023). In some cases, companies used discretion to limit the impact of poor performance on outstanding equity awards, which ISS considers to be problematic.
Sizeable compensation. ISS cited the broad provision of outsized compensation, including through large base salaries and one-time, special cash or equity awards, for 17 of the 34 S&P 500 companies (vs. 18 of 42 in H1 2023). Certain companies were also criticized for granting multiple incentive awards that utilized identical performance metrics, resulting in high compensation for the same performance.
Large perquisites. Thirteen of the 34 S&P 500 companies were criticized by ISS for providing excessive perquisites (vs. 19 of 42 in H1 2023). ISS specifically mentioned security services and aircraft use in seven and six of these cases, respectively. Other frequently mentioned perquisites include car services and tax gross-ups.
The use of time-based incentive awards rather than performance-based incentive awards. ISS identified this concern at 12 of the 34 S&P 500 companies (vs. 13 of 42 companies in H1 2023). The failure by ISS to consider time-based vesting awards to be a robust measure of performance has been the subject of criticism because time-based equity awards can give holders a stake in the performance of the company and align the interests of executives with those of shareholders. However, awards granted subject to performance-based conditions are considered to be a matter of good governance by many stakeholders.
The use of above-median peer group benchmarking practices. ISS criticized eight of the 34 S&P 500 companies for using above-median peer group benchmarking practices (vs. 19 of 42 in H1 2023). Specifically, ISS criticized the provision of compensation above the median level of the company’s identified peer group and the selection of a peer group with a greater average revenue than the company. In 2024, ISS also criticized three companies for granting long-term incentive awards to their CEO with a value exceeding the total pay for CEOs at the median company in ISS’s and/or the company’s selected peer group.
Interestingly, ISS’s reports referenced “above target payouts” more than any other “pay practice” in its qualitative assessments for companies receiving negative say-on-pay recommendations, but the reports weren’t always critical of payout levels. They only went one step further to say performance conditions were not sufficiently rigorous in about half of those reports. S&C suggests that other factors, including the above, may have a larger impact on the decision to recommend against say-on-pay.
The qualitative evaluation in ISS’s pay-for-performance screen often gets less attention than the quantitative piece but shouldn’t be overlooked! The following is from ISS’s December 2023 updated Pay-for-Performance Mechanics document that provides technical info & guidance on its say-on-pay methodology:
ISS conducts an in-depth qualitative evaluation for all companies that exhibit a quantitative pay-for-performance misalignment, and for some companies that do not, depending on the circumstances. … It is the outcome of the qualitative evaluation that determines the vote recommendation for the say-on-pay proposal (or, in some cases, for the election of directors when there is no say-on-pay proposal on the ballot). The qualitative evaluation … identifies whether the pay-and-performance misalignment is mitigated or otherwise reinforced.