With ISS’s FAQ update last month, there is now one more reason to review your company’s approach to clawback policies and provisions. A recent Debevoise memo summarizes key voting policies on this topic:
– ISS recently clarified in its FAQs on executive compensation policies that, for purposes of ISS’s say-on-pay vote recommendation, clawback policies must explicitly cover all time-vesting equity awards in order to receive credit for a “robust” clawback policy. This is consistent with the view ISS had already taken for purposes of analyzing equity-based incentive program proposals under its Equity Plan Scorecard (“EPSC”) policy. Under ISS’s FAQs on Equity Compensation Plans, in order to receive EPSC points for the clawback policy factor, an issuer’s clawback policy should authorize recovery upon a financial restatement and cover all or most equity-based compensation for all NEOs, including both time- and performance-vesting equity awards.
– Glass Lewis’s view on clawback policies under its 2025 U.S. Benchmark Policy Guidelines is that effective clawback policies should provide companies with the authority to recoup incentive compensation (whether time-based or performancebased) in the event of a restatement of financial results or similar revision of performance indicators upon which the awards were based. In addition, recovery should be available when there is evidence of problematic decisions or actions, such as material misconduct or a material reputational failure, material risk management failure or material operational failure, the consequences of which have not already been reflected in incentive payments and where recovery is warranted. Glass Lewis expects that this authority to recoup should be provided regardless of whether the employment of the executive officer was terminated with or without cause.
– BlackRock’s view, expressed in its 2024 Proxy Voting Guidelines for U.S. Securities, is that it favors prompt recovery from any senior executive whose compensation was based on faulty financial reporting or deceptive business practices. This includes DoddFrank-compliant policies and broader policies requiring recovery from (or the foregoing of) the grant of any awards by any senior executive whose behavior caused material financial harm to shareholders, material reputational risk to the company or resulted in a criminal investigation, even if such actions did not ultimately result in a material restatement of past results. BlackRock generally supports shareholder proposals on these matters unless the company already has a robust clawback policy in its view.
The memo notes that even for the largest U.S. companies – most of whom already have policies or provisions that go beyond Dodd-Frank requirements (e.g., additional triggers, a broader group of covered employees, etc.) – it’s a good time to take a fresh look at policies. And companies that don’t go beyond what’s mandated may want to discuss whether to change that. In addition to proxy advisor and investor positions, compensation committees should consider the DOJ’s pilot program and company-specific factors. The Debevoise team recommends taking these steps:
1. Where companies have existing discretionary policies, companies should review these policies to confirm whether any standalone clawback policy or related terms set forth in an incentive plan are sufficiently rigorous under proxy advisor or shareholder guidelines. Consider whether any changes are appropriate for the organization.
2. For companies without existing discretionary policies, consider whether the board should have the authority to recoup compensation in other circumstances to comply with proxy advisor guidelines or to otherwise strengthen the company’s corporate governance program. While industry and peer benchmarking can be instructive, companies should design discretionary policies that reflect their own unique risks and organizational and compensation structures.
3. Engage with legal counsel to ensure that all clawback policies are enforceable under state laws and are integrated into agreements where appropriate.
Programming Note: Happy Thanksgiving, everyone! We’ll see you back here next week.
It’s hard to believe we are rolling into Year 3 of pay versus performance disclosures. Glass Lewis already incorporates this data as a supplemental quantitative factor in its executive compensation analysis (pg. 53), but ISS and many investors are still in “wait & see” mode. This Semler Brossy memo predicts that the “Compensation Actually Paid” metric will become a more valuable data point over time. Here’s why we aren’t there yet:
One way to think about full-tenure CAP is that it is the best possible running estimate of what compensation has been and could be delivered. The annual fluctuations in unvested equity values net themselves out over time and end up showing the tallied value of compensation the moment someone could have taken their pay off the table. Even the method for calculating stock options gives credit to the long lifespan of this vehicle. By using a Black Scholes calculation at the time of vest, CAP gives credit to the long life of a stock option, even if it is “underwater” when it vests (but still has economic value). It shows a credible estimate of what could be delivered to the executive the moment it was theirs to take.
The problem is that each individual year of disclosure is meaningless in isolation. Most years are overly influenced by the change in value of outstanding equity, not the full tallied value. When there is a big negative CAP value, it’s hard to make sense of it unless you know how much the outstanding equity was initially worth. There isn’t a clear story to tell unless you can compare the full tallied value of SCT and CAP numbers.
But:
Once full-tenure CAP is available, CAP/SCT ratios become powerful because they are apples-to-apples comparisons of everything that was awarded and what it turned into (i.e., the actual compensation outcomes that were delivered) in a manner that allows for comparison across organizations. In the first two years of PVP reporting, only 84 companies in the Russell 3000 had new CEOs join in the window that would provide enough information to look at full-tenure CAP.
By 2025, organizations will be required to report five full years of data. As CEO transitions occur over time, the data set of full-tenure CAP/SCT ratios will get richer and allow for benchmarking. There will also be the opportunity to assess and develop clearer market standards for a reasonable relationship between full-tenure CAP and SCT.
Taking a closer look at the 84 companies that report “full-tenure CAP,” the memo shows how the data can raise questions (or tell a story):
– Agricultural retail company. The CEO’s full-tenure CAP/SCT was higher than relative performance due to a strong leverage profile in its long-term incentive (LTI) structure (25% options and 50% performance stock units [PSUs]) and a 200% payout on PSUs in recent years. This outcome begs the question: Has performance justified the payouts?
– Pharmaceutical company. The organization had low full-tenure CAP/SCT and flat performance due to a 100% stock option design. The CAP values decreased as options neared vesting without price improvement, and the Black Scholes calculations remained low. This scenario raises the question: Is the design working, or are there any retention risks to address?
I’m willing to bet that there are diligent compensation committee members (and advisors) who would intuitively know that something is amiss in these types of scenarios. At some point, full-tenure CAP could give them another data point to help articulate concerns. . . hopefully before an investor brings it to their attention.
We’ve patted everyone on the back a few times about this year’s record-low failure rate for say-on-pay. We also saw much lower rates of ISS opposition. This Pay Governance memo takes a close look at factors that may have contributed to this result, including:
1. Significantly better performance on the ISS Multiple of Median (MOM) test. The MOM test evaluates the ratio of 1-year CEO pay to the median CEO pay of the ISS-selected peer group and has historically been (and continues to be) a meaningful predictor of adverse ISS SOP recommendations. The average MOM outcome was 1.7x in 2024, compared to 2.2x in 2023 and 2.4x in 2022, demonstrating a migration of CEO pay toward peer median levels and fewer outlying pay packages.
2. Improvement in Compensation Committee responsiveness to proxy advisor and shareholder concerns over executive pay. We observed fewer Compensation Committees being criticized by ISS for poor responsiveness to shareholder concerns and fewer cases of significant one-time awards that led to an against SOP recommendation. In addition, the number of companies that received ISS opposition to SOP in two consecutive years declined, demonstrating that companies are getting better at addressing investor feedback.
These findings are worth considering if your say-on-pay resolution has gotten lower support than you’d like in recent years, and the memo goes into much greater detail on both. The notion of “conformity” also appears to align with another study that I blogged about last month.
Calendar year-end companies are gearing up to provide new disclosures under Item 402(x) of Regulation S-K in 2025 proxy statements. The new subsection of Item 402 requires:
– Disclosure of policies and practices related to the timing of awards of options, SARs and/or similar option-like instruments in relation to the disclosure of MNPI, and
– New tabular disclosure to the extent that, during the fiscal year, any stock options, SARs or similar instruments were granted to NEOs during the period beginning four business days before and ending one business day after the filing of a 10-Q, 10-K, or 8-K that discloses MNPI.
Over on the Q&A Forum (Topic # 12418) on TheCorporateCounsel.net, a member recently asked, “Have you seen any examples of disclosures containing insider trading and/or equity award disclosures that will be required for the first time in 2025 for calendar year filers?” I suspect many folks are — or will soon be — on the lookout for sample or precedent disclosures under Item 402(x), so here is my response:
Also take a look at this DLA Piper alert that gives an illustrative example of the tabular disclosure. And keep in mind that, like other sections of Item 402 that require tabular disclosure, Item 402(x)(2)(i) includes a blank table.
Late last week, shortly after releasing the results from its second annual global policy survey, Glass Lewis announced the publication of its 2025 Voting Policy Guidelines (U.S.) and the Shareholder Proposals & ESG-Related Issues Guidelines (global) that apply to shareholder meetings held after January 1. Two updates relate to executive compensation matters. Here is the description from the Summary of Changes for 2025:
Change-In-Control Provisions. We have updated our discussion of change-in-control provisions in the section “The Link Between Compensation and Performance” to define our benchmark policy view that companies that allow for committee discretion over the treatment of unvested awards should commit to providing clear rationale for how such awards are treated in the event a change in control occurs.
Approach to Executive Pay Program. We have provided some clarifying statements to the discussion in the section titled “The Link Between Compensation and Performance” to emphasize Glass Lewis’ holistic approach to analyzing executive compensation programs. There are few program features that, on their own, lead to an unfavorable recommendation from Glass Lewis for a say-on-pay proposal. Our analysis reviews pay programs on a case-by-case basis. We do not utilize a pre-determined scorecard approach when considering individual features such as the allocation of the long-term incentive between performance-based awards and time-based awards. Unfavorable factors in a pay program are reviewed in the context of rationale, overall structure, overall disclosure quality, the program’s ability to align executive pay with performance and the shareholder experience and the trajectory of the pay program resulting from changes introduced by the compensation committee.
Yesterday on TheCorporateCounsel.net, I blogged about the other (non-compensation-related) proposed changes. For more commentary and insight, we’ll be posting memos in our “Proxy Advisors” Practice Area, and Glass Lewis is planning a webinar on December 11 to share additional context.
Yesterday, ISS announced the launch of its open comment period on proposed changes to its benchmark voting policies. During this open comment period, ISS gathers views from stakeholders on its proposed voting policy changes for 2025 (and beyond). The comment period closes at 5:00 p.m. Eastern time on December 2.
It looks like 2025 will be another light year for benchmark policy changes. The main substantive policy updates address poison pills and SPAC extension requests. However, ISS also provided a summary of ongoing considerations related to U.S. executive compensation policy on the use of performance- vs. time-based equity awards, including a planned change in policy application for 2025 (under the current policy). Here’s more:
The current pay-for-performance assessment for executive compensation under ISS U.S. benchmark policy considers a predominance of time-vesting (as opposed to performance-vesting) equity awards to be a significant concern at a company that exhibits a quantitative pay-for-performance misalignment. However, a growing number of investors have expressed changing viewpoints regarding U.S. equity award practices. Some investors highlight concerns with performance equity programs that may be poorly designed and/or disclosed, including concerns about highly complex programs and non-rigorous performance measures, and some consider that well-designed timevesting awards are preferable to performance-vesting awards.
These changing viewpoints were demonstrated by the results of a question in the 2024 Global Benchmark Policy Survey. … Considering the various feedback and arguments put forward, a potential policy update remains under consideration for 2026 (or later) regarding the evaluation of the equity pay mix for regular-cycle equity awards whereby a preponderance of time-vesting equity awards generally would not in itself raise significant concerns in the qualitative review of pay programs.
For 2025 and in advance of any potential wider policy changes for 2026, we intend to implement certain pay-for-performance policy application changes that do not require formal policy changes at this time but are adaptations within the current U.S benchmark policy framework. …
Effective for 2025 (for meetings on or after Feb. 1, 2025), we will introduce adaptations to the qualitative review of performance-vesting equity awards carried out under the current U.S. benchmark policy. Specifically, any design or disclosure concerns regarding performance equity will carry greater weight in the qualitative analysis, and significant concerns in these areas will be more likely to drive an adverse say-on-pay recommendation for a company that exhibits a quantitative pay-for-performance misalignment. Further details on the changes will be provided in an update to ISS’ U.S. Executive Compensation Policies FAQ, expected to be published in mid-December 2024.
They invite additional feedback on the following questions:
– If, in the future, U.S benchmark policy were to no longer view a predominance of time-vesting equity awards as concerning in itself, what criteria would you consider most important for analyzing time-vesting equity awards? (for example, vesting periods, award magnitude, holding period requirements, or any other significant factors)
– If U.S. benchmark policy were to no longer view a predominance of regular-cycle time-vesting equity awards as concerning, do you believe the same standard should be applied to any off-cycle/one-time equity awards?
Over on TheCorporateCounsel.net in late August, I blogged about some things companies need to do — or consider — if they want to be ready to capitalize on any potential IPO window that may open in 2025. This Morgan Lewis blog is focused on the same topic — but specifically with executive compensation considerations in mind. Here are a few tips from the blog:
Cheap Stock: During the period prior to an IPO, private companies often seek to incentivize employees through the grant of stock and stock-based equity awards. While this practice is frequently a successful means of incentivizing key employees and service providers, without sufficient preparation and consideration, the practice can raise the issue of whether pre-IPO awards represent “cheap stock.” …
With equity being a popular form of compensation for many pre-IPO companies, the following are key considerations companies should take prior to the IPO:
– Work with outside advisors well in advance of the IPO process (especially in the 12-month period prior to the IPO) to understand the potential accounting, tax, and disclosure implications of cheap stock grants.
– Obtain frequent independent valuations with respect to the value of shares underlying all equity awards made during the pre-IPO period (with the valuations made contemporaneous to, or close in time to, the grant date of the equity awards).
– Ensure that there is a good corporate record of all grants of equity awards, including formal approvals by the company’s board and its consideration of outside independent valuation.
Triggering Events in Existing Arrangements: In the lead-up to an IPO, a company should consider the impacts that the IPO will have on existing executive arrangements generally and equity compensation considerations specifically. For example, it is common for an IPO not to be treated as a “change in control,” “change of control,” or “liquidity event” under its equity plan and the individual award agreements that govern private company equity awards. Many companies do not have other bonuses or arrangements with key executives that will become automatically payable in connection with an IPO.
It is advisable to review all outstanding equity awards and other executive compensation arrangements to ensure that executives have sufficient incentives to get to the IPO. If no arrangements will be automatically triggered, consider structuring bonuses or other arrangements to reward the executive team for getting the company through a successful IPO. It is not uncommon for members of the executive team to retain their own legal advisors to negotiate these arrangements and advise on market practices from the executives’ perspective. This review tends to be coupled with the proposals and considerations below to ensure that key employees and service providers will be incentivized for post-IPO success.
“Cheap stock” and other IPO-readiness issues will be addressed during an upcoming webcast on TheCorporateCounsel.net. Tune in at 2 pm ET on Thursday, December 12, 2024 to hear White & Case’s Maia Gez, Mayer Brown’s Anna Pinedo, Cooley’s Richard Segal and Gunderson Dettmer’s Andy Thorpe discuss “Capital Markets: The Latest Developments.”
Members of TheCorporateCounsel.net are able to attend this critical webcast at no charge. If you’re not yet a member, subscribe now. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
I blogged earlier this week about share usage trends, which can be a useful data point if you’re submitting an equity plan proposal at your next meeting. As you craft your proposal, an important part of the process involves considering how your practices stack up against those of other companies. This LinkedIn post from Aon’s Laura Wanlass articulates why you might want to use that process, along with consideration of your future needs, to “look inward” – before thinking about proxy advisor policies and parameters:
Before jumping straight to the proxy advisory firm models, it is helpful to understand if you are an outlier regarding your equity usage profile (i.e., dilution and run rate across the numerous methodologies used externally in the market) and whether there are good reasons for why you might be one (i.e., lower total common shares outstanding due to share repurchases, a lot of underwater overhang, broader equity distribution throughout the organization, shares issued in lieu of earned annual cash, etc.). This context becomes incredibly important if you need to engage with shareholders. Also, have you assessed the market competitiveness of your equity granting practices, and determined what you really need to grant a competitive level of equity for the next one to three years?
Laura also points out that a negative proxy advisor recommendation isn’t necessarily the end of the line. If you can see it coming, you can take a few protective steps ahead of time:
However, if you find yourself failing one or more of these proxy advisory firm models, than you likely need to take proactive mitigating actions—such as enhancing the proxy proposal language and potentially engaging with investors. Furthermore, evaluate the policies of your top investors—do they use industry benchmarks, do they have certain dealbreaker thresholds? A holistic review can be crucial for share request proposals depending on which investors own your company.
As Laura notes, it’s helpful to start the process early, and of course consider prior investor feedback as well. Check out our treatise chapter on “Plan Disclosure When Seeking Shareholder Action” for more info about requirements and strategies when you’re submitting an equity plan proposal.
In the latest 13-minute episode of The Pay & Proxy Podcast, Meredith was joined by Ani Huang, CEO of the Center On Executive Compensation (a division of HR Policy Association), which recently released a “CHRO’s guide to governance of environmental and social matters.” Meredith and Ani discussed:
– The impetus for the CHRO guide to governance of E&S
– The guide’s five-step playbook
– How companies approach board oversight of E&S issues, and the pros and cons of the approaches
– How companies approach leadership of E&S issues at the management level, and the pros and cons of the approaches
– Investor perspectives on governance of E&S issues
– Identifying and supplementing experience gaps and resource needs at the board, management and employee levels
Now is a good time to consider whether you’ll need to update your equity plan reserve at your next annual meeting – and if so, how many additional shares to propose. Often, this exercise also leads to questions about how your company’s share usage compares to practices at other companies. To help answer some of those queries, FW Cook recently issued its 2024 aggregate share-based compensation report.
The report reviews share usage trend data covering the three-year period 2021 – 2023 from 300 companies spread across five industry groups. Data analyzed includes:
– Company-wide annual grant rates, measured based on annual share usage as a percentage of weighted average basic common shares outstanding and fair value transfer (FVT) – which is the aggregate grant date fair value of all long-term incentive awards granted during a given year as a percentage of company market cap value at grant and as a percent of revenue
– Potential share dilution,
– Frequency and prevalence of long-term incentive plan share requests
– Allocation of long-term incentive pools to the “top 5” proxy officers.
Here are a few highlights:
– Annual FVT rates as a percentage of market capitalization were slightly lower compared to our prior 2020 study, with the median 3-year average annual rate decreasing from 0.92% in the prior study to 0.87% in the current study.
– Median FVT rates increased slightly for 2022 and 2023 compared to 2021. For 2023, FVT grant value and market capitalization declined slightly compared to 2022, resulting in FVT as a % of market capitalization remaining relatively consistent.
– Potential dilution from outstanding equity awards has trended downward over the last three years, falling from 3.0% at the median in the prior study to 2.7% in the current study. Driven by companies granting a greater proportion of equity awards in the form of restricted and performance shares, which generally use fewer shares than stock options for equivalent grant value and remain outstanding for far shorter periods of time.
– Allocation of long-term incentive pools to the Top 5 proxy-reported officers (including CEO) is closely linked to company size, as small-cap companies grant a significantly higher percentage of the overall pool to their top officers compared to largecap companies, who generally have more long-term incentive participants.
– Over the last three years, 53% of our sample companies sought shareholder approval of a new share authorization under employee stock plans.
– The median size of the requests ranged from 3% to 4% of common shares outstanding, with slight variation based on company size and year of request.