Last week, I blogged about the scrutiny on executive compensation actions. A recent Pearl Meyer blog also urges caution, particularly when thinking about making an equity grant now for purposes of retention and alignment with shareholders. Here’s an excerpt:
Looking ahead three to five years, when the economy has fully recovered and stock prices are again robust, the executives who have been given extra equity grants today will begin cashing in on their gains. Unlike similar studies published in the middle of the last decade, these reports are likely to attract major attention. Investors are likely to hold the directors who gave out those equity grants, and the executives who are still active, accountable.
In terms of how directors should approach decisions about equity grants in today’s environment, the blog lists these questions to ask as a way to help guide any decisions:
– Was our stock price in early March truly reflective of our economic value?
– What is your estimate of how much cash the executive will lose in foregone salary and unearned bonus?
– If you make an equity grant now (whether a regularly scheduled award or a special grant), how much will the executive gain when the stock price gets back to “normal”?
– What else are you doing for the executives in terms of adjustments to incentive award calculations or using discretion in determining awards?
– Is the retention argument compelling in your case?
You’ll likely be hearing more about the SEC’s Enforcement Action against Argo Group International Holdings for failing to disclose certain perquisites. The SEC’s press release and order provide the details but the company paid a price. It settled with the SEC by agreeing to pay a $900,000 civil fee but the order also identifies several remedial actions the company took, which sound like they didn’t come cheap and caused quite a bit of upheaval at the company.
To help guard against this type of action, we have a 97-page chapter on Perks & Other Personal Benefits as part of Lynn, Borges & Romanek’s “Executive Compensation Disclosure Treatise” posted on this site.
We also have a panel about perk disclosures as part of our “Proxy Disclosure” conference – which is coming up in September via Nationwide Video Webcast. This is our big annual conference and it will cover all sorts of disclosure issues. Register now to receive the special Early Bird Rate!
A recent Equilar blog reports that it, together with the AP, has released its annual CEO pay study. The study says total compensation includes information disclosed in company proxy statements and includes CEOs that have served in that role at a S&P 500 company for two years as of fiscal year end 2019. Here’s an excerpt from Equilar’s blog:
Median total compensation for individuals included in the 2020 study totaled $12.3 million, a 4.1% increase from the year prior – a slightly smaller pay increase than in 2019 and 2018
This year’s study saw communication services emerge with the highest median CEO pay package among S&P 500 companies at $27.8 million, topping the healthcare industry, which led the way in each of the last two years. The healthcare industry, which includes traditional healthcare, insurance as well as biopharma companies, had the second-highest median CEO pay package at $16.4 million, followed by consumer defensive at $14.0 million. CEOs within the real estate industry were awarded a median $10.4 million, the lowest of the industries in the study.
Studies like this always get scrutinized and this year will likely attract greater scrutiny as companies grapple with furloughs, layoffs and other compensation changes – and, it didn’t take long, here’s an early media piece about the study that questions where CEO pay will go after the pandemic.
I’ve blogged before about reports we’re seeing of executive and director pay cuts. For companies thinking about potentially making pay cuts or salary reductions for employees, executives and possibly directors, this Simpson Thacher memo provides a thoughtful discussion of key issues companies should consider. The memo reminds companies that existing contractual obligations with employees require careful review as many contain “constructive termination” or “good reason” protections that might be triggered by a reduction in compensation. Here’s an excerpt:
The exact formulation of these provisions will vary, but, in the event the employer reduces pre-agreed elements of the employee’s compensation, they generally permit an employee to resign from employment as a result of “good reason” or “constructive termination” and receive severance payments and/or accelerated vesting. Occasionally, a “good reason” definition may contain an exception for a reduction that’s an across-the-board reduction affecting similarly-situated employees and/or that is not “material.” The uniqueness of COVID-19-related reductions may present challenging interpretation issues. Even if an employment agreement doesn’t contain a specific “constructive termination” or “good reason” protection, an employer’s unilateral decrease in an employee’s compensation levels could constitute a breach of contract (in which case the employee may have general damages claims) and/or violation of state wage laws (which may provide for significant liquidated damages).
To help avoid ambiguities and questions about whether a contractual provision is implicated, the memo suggests employers thinking about a reduction request each affected employee execute a consent agreeing to such reduction in advance of the reduction. By taking this preemptive step, an employer can obviate later disputes, including any claim for breach of contract.
A consent should expressly acknowledge the original and new compensation levels and specify when compensation will return to the original levels (if known) or that the reduction will continue indefinitely until further notice. The consent also should include a confirmation from the employee that they agree that the reduction doesn’t constitute “good reason” or a “constructive termination” (or term of similar meaning) under any agreement to which the employee is a party or any plan in which the employee participates, including any equity arrangements. The consent should also clarify whether the reduction will affect other compensation amounts that are based on percentages or multiples of base salary, such as 401(k) contributions by the employer or the calculation of annual bonuses and severance amounts.
The memo also covers considerations relating to the scope of changes, deferred compensation arrangements, severance and other retirement benefits, non-U.S. employees and collective bargaining agreements, SEC disclosure, requirements for employee notices, anti-discrimination laws and non-employee director compensation.
Scrutiny of executive compensation continues as articles seem to be proliferating about company actions in response to the Covid-19 pandemic. As much as some companies are making pay adjustments, a recent Reuters review of executive compensation is circulating in the media as it says they found companies are “shielding CEO pay as the pandemic hits employees and investors.” Along with that, a recent Bloomberg article cites Nuveen as saying the pandemic will lead investors to question the existing structure of executive pay and how to incentivize executives to put greater focus on ESG issues.
Companies will take various actions based on particular circumstances but these recent media stories serve as reminders that companies should be cautious in taking action as everything seems to be under a microscope.
When considering whether to modify or substitute equity awards or executive compensation plans in response to economic fallout from the Covid-19 pandemic, this Proskauer blog reminds companies to consider possible plan limitations as well as issues relating to Section 409A of the Internal Revenue Code and potential limitations under Section 162(m) of the Code. Here’s an excerpt about plan limitation considerations:
Prior to taking any actions with respect to their incentive compensation plans, companies should review the terms of the plans to understand the compensation committee’s rights under the plan to amend performance metrics or target compensation levels. Plan provisions that could be problematic include provisions that prohibit amendments to outstanding awards or that do not provide sufficient authority to the compensation committee to exercise discretion in adjusting performance metrics, interpreting performance metrics or determining award payouts. Similarly, plans (or the underlying award agreements) may not provide sufficient discretion for compensation committees to adjust results in order to disregard the effects of COVID-19. However, even if plans permit adjustments, adjustments for COVID-19’s widespread impact may not be determinable or may be so significant that any possible determination of financial results excluding COVID-19 would be impracticable or may not be consistent with other provisions of the plan (e.g., provisions governing minimum vesting). Companies should also consider whether actions that they take could be deemed to reduce or materially and adversely affect award holders, in which case, award holder consent may be required.
I’ve blogged before about the impact of Covid-19 and potential use of discretion in making adjustments to executive compensation. A recent Semler Brossy memo says now is when the board and compensation committees should begin preparing for potential discretionary compensation adjustments at year end. No doubt use of discretion can invite criticism so early planning can be a big help.
The memo provides a framework for tracking the impact from Covid-19 and setting a foundation for any future pay adjustments. Here’s an excerpt about how to begin:
Boards won’t know the full impact of the pandemic on their company’s business results for some time yet. But they can identify metrics where the company is likely to be most vulnerable and see how their performance compares with previous years and with competitors’. At the early stages, it is important to be fairly exhaustive in the exercise, exploring first-, second-, and possibly third-order impacts.
Discretionary adjustments aren’t without scrutiny and the memo says boards will want to take care in setting consistent and transparent expectations in light of the current environment with an eye to concerns of all stakeholders – investors, employees, customers and the community at large.
Preparation ahead of time will result in a thoughtful CD&A, grounded in a clear rationale, which in turn will make investors less likely to disagree with the committee’s judgment. Employees and the public will be more likely to see exceptions as logical and justified.
Not to overload the compensation committee, but another item that companies may want to add to the committee’s agenda, if they haven’t already, is a review of their compensation peer group to determine whether changes should be made. As the economic fallout from Covid-19 continues, companies may find that it no longer makes sense for certain companies to be in their compensation peer group.
Each company has its own methodology for selecting peers and the process to make changes varies. The ISS identified peer companies often overlap with a company’s peers but may not line up exactly and recently, ISS issued a memo with suggested peer group strategies for companies to consider. The memo notes that shareholders are quick to scrutinize executive compensation and 2020 pay decisions, including the peer group used, will be no different.
ISS lists common selection criteria for identifying compensation peers, company size being one. Due to recent swings in the market, the memo suggests some companies may want to look at data using a longer time horizon to help smooth out comparisons. Here’s an excerpt:
– Market Capitalization: Rather than using spot-price market cap values, utilize a market cap based on the 200-day average price for a more reliable and less volatile measure of company size.
– Revenue: For revenue or other measures of company size, rather than using the most recently disclosed quarterly or yearly values, look at revenue data over a longer-term period such as 2-year or 3-year averages for a helpful approach to approximate the company’s size under normal conditions. Additionally, analyst estimates of future financials, when available, can help shed additional light on where certain peers are headed and whether they will remain valid comparisons in the coming year.
– M&A, Spinoff, Bankruptcy Activity: Some existing peers may no longer be in operation due to merger, acquisition, or spinoff activity, or are at risk of no longer being viable standalone companies, in which case those could be considered candidates for removal; and these factors can be added as peer screening criteria.
Recently, Vanguard issued its insight about executive pay during Covid-19. Vanguard’s general message is that directors should be guided by good judgment on critical matters such as financial survival and workforce safety as well as longer-term factors that align with a company’s purpose and strategy. The asset manager provided the following pay-related considerations for boards:
– Variable pay: the asset manager may support plans in which variable compensation makes up the majority of executives’ total pay and is measured with a long-term focus beyond the next quarter or year.
– Performance target adjustments: Vanguard doesn’t believe it’s appropriate for compensation committees to adjust or create “easier” performance targets – it wants at-risk pay to remain at-risk.
– Relative performance metrics: Vanguard views these as crucial amid market downturns. In volatile markets, comparing relative performance metrics with those of a relevant set of peers helps guard against outsized payments for market recovery versus true long-term company outperformance.
– Social perspective: the asset manager encourages boards to apply both a financial and, increasingly, a social lens when considering how executive pay, human capital, or capital allocation decisions factor into the overall context and public perception of a company’s practices.
– Use of discretion: Vanguard welcomes adjustments to timing or amount of payouts to better align with the experiences of shareholders and stakeholders. When applying discretion, the asset manager will be looking for disclosure about the decision process and rationale.
Back in February, I blogged about recent trends in stock ownership requirements. Obviously, a lot has happened since then and a recent Hunton Andrews Kurth blog serves as a reminder that, depending on how companies structure stock ownership guidelines, some companies might want to consider granting a temporary waiver of stock ownership requirements. With volatile markets and many companies having experienced a stock drop, ownership guidelines denominated in dollars are most likely to cause executives to fail the ownership requirement. Here’s the blog’s message:
Compensation Committees could consider a temporary waiver of the stock ownership requirements, with the idea that the issue will be revisited in the Fall of 2020. But in exchange for such waiver, the executive should be required to hold (i.e., not be able to sell) all shares currently subject to the policy. Such hold requirement should continue until the issue is revisited in the Fall of 2020.
Some companies may already incorporate a “hold until requirement is met” into their guideline, so a consideration for these companies might include whether the policy requires action to temporarily waive the ownership requirement and if so, the length of the waiver.