For companies with May or June compensation committee meetings, they’ll undoubtedly be discussing company responses to Covid-19 and impacts to compensation. A Pearl Meyer blog suggests three high-level comp committee discussion topics dealing with Covid-19:
– Review disclosed actions to date: there’s value in knowing what other companies are doing but know that disclosures may only be the tip of the iceberg
– Start establishing ground rules regarding 2020 short-term incentives: discuss the impact of COVID-19 on the business and incentive plan metrics, including potentially modeling two or three scenarios of full-year effects to the extent possible. If modeling is not practical, the discussion should turn to establishing ground rules for how performance will be evaluated – for example, defining what “good performance” looks like post COVID-19 and how this might translate to potential bonus payouts
– Tee-up a discussion about long-term incentives/equity: Given that in most cases these awards are for multi-year periods, there is no reason to panic just yet. That said, if the impact of COVID-19 is projected to zero out all performance cycles in play, there may be an argument for discussing the potential need for retention awards, who would be eligible to receive them, the amounts, and the optics of such a move
ISS’s impact on say-on-pay vote results is a frequent topic this time of year. An updated Semler Brossy report shows that the current average say-on-pay vote result for companies receiving an ISS “against” recommendation is 36 percentage points lower than for companies that received an ISS “for” recommendation.
In an earlier look at say-on-pay vote results, the number had stood at 38 percentage points. Even though the number has declined slightly from earlier this proxy season, it’s still higher than the historical average range of 24 to 32 percentage points. This will be interesting to watch whether the number ends up closer to its historical average by the end of the 2020 season and in any event, the reports show ISS vote recommendations continue playing a significant part in final vote results.
A recent report from ClearBridge Compensation Group takes a look at trends in non-employee director compensation. The report examines compensation for non-employee directors among 100 of the S&P 500 from 2009 – 2019 and looks at median compensation levels for board service, committee chair and board leadership fees and compensation mix. The report also looks at non-employee director stock ownership guidelines and here’s some of what it found:
– Stock ownership guidelines have become significantly more prevalent, from 63% of companies in 2009 to 94% in 2019, further increasing the alignment between directors and shareholders
– The specific ownership guideline (as a multiple of the annual board cash retainer) has also increased; while 3x and 5x were common in 2009 (34% and 46%, respectively), 85% had a guideline of at least 5x in 2019
– A majority of companies in 2019 required directors to retain shares of company stock for a specified length of time, either through a holding requirement (15% in 2009 and 21% in 2019) or a mandatory equity deferral feature (24% in 2009 and 32% in 2019)
A recent blog from Dan Ryterband at FW Cook serves as a reminder that the pay cuts we seem to read about daily for senior executives and non-management directors have been concentrated primarily among a smaller group of companies. Here’s an excerpt:
Approximately 10% of the Russell 3000 and less than 15% of the S&P 500 companies have taken action to reduce pay. There are two common threads among these companies, most of which are concentrated in the hardest hit industries:
– A need to preserve cash to enhance liquidity or to meet specific financial targets due to debt covenants or other requirements, and
– A sense of “shared sacrifice” between top leadership and the broad workforce if large numbers of employees have been laid off or placed on unpaid or reduced-pay furloughs
Typical pay mix for S&P 500 CEOs is heavily weighted toward performance-based pay, including multi-year equity awards, which is likely a primary reason we haven’t seen more widespread action to reduce pay.
One observation noted in the blog is the importance of deeper succession planning. Although it’s still early, looking forward, the blog says it’s possible that the gap between CEO and other proxy officers’ pay may narrow as companies recognize more fully that the CEO is part of a team, as opposed to disproportionately creating value on his/her own. Pay parity throughout the entire organization may elevate in importance as companies reevaluate the definition of “essential” within the workforce.
Changes to investor proxy voting policies and guidelines are common and recent changes to J.P. Morgan’s voting policies caught my eye as some changes relate to executive compensation. This Georgeson blog provides a summary of the comp-related changes:
– Say-on-Pay: Under its current policy, JPM withholds votes from compensation committee members for failing to respond adequately to a say-on-pay proposal that received less than 60% shareholder support at the previous year’s shareholder meeting. JPM now also considers withholding votes from select members of the compensation committee in cases of pay-for-performance misalignment or where performance metrics and targets, used to determine executive payouts, are not aligned with long-term shareholder value.
– Clawback Proposals: JPM changed its position from case-by-case evaluation to generally support shareholder proposals seeking to recoup unearned incentive bonuses or other incentive payments made to senior executives where fraud, misconduct or negligence significantly contributed to financial restatements. In its updated policy, JPM also added that it will support shareholder proposals seeking to recoup incentive payments where misconduct or poor performance by an individual prior to the payments contributed in whole or in part to the issuance of such payments.
With continued economic volatility, companies also need to think about stock-plan valuation issues. Most companies haven’t had to deal with valuation-related challenges for quite some time but this recent Willis Towers Watson blog discusses considerations, including immediate issues and potential actions for stock options and relative TSR awards.
The discussion of the valuation model for stock options notes that the commonly used Black-Scholes model requires fixed inputs and doesn’t permit flexibility to adjust the volatility and dividend-yield assumptions over time. Here’s an excerpt for a related potential action:
Use of binomial lattice or Monte Carlo models allow for assumption flexibility:
– Volatility can start at today’s elevated levels and revert to long-term historical means
– Dividend yields can start at today’s elevated levels and be adjusted downward over rising share price paths in the model
– Exercises can be assumed to occur sooner in a quick recovery and later in a slow recovery
With the current market downturn, I’ve blogged a few times about option repricing and exchange programs as companies take these programs into consideration. As I’ve said before, it’s hard to say how many companies will decide to do so because of, among other things, considerations about proxy advisor and institutional investor views. For a nuts & bolts understanding about how these programs work, Pay Governance issued a helpful memo.
The memo steps through an example of a voluntary exchange of underwater options for new option grants. In addition to explaining the mechanics of calculating the number of options to exchange for underwater options, the memo discusses disclosure implications, views of proxy advisors and institutional investors and then provides analysis to help answer the question of how far underwater options should be to consider the viability of a stock option exchange program.
Ultimately, the firm says that there are no definitive answers that apply in all situations but also explains there is a meaningful relationship between the percentage stock price decline, remaining option term, and the likelihood of options finishing the term “in the money.” The threshold for considering an exchange depends on the likelihood of finishing in the money without intervention.
Earlier this year, shareholder proponent As You Sow issued its sixth annual “100 Most Overpaid CEOs” report, it’s available for download from their website – here’s an excerpt about the methodology used to identify the companies listed in the report:
Each year we evaluate CEO pay at all S&P 500 companies using data provided by ISS. We also use data provided by HIP Investor that uses a statistical regression model to compute what the pay of the CEO would be, assuming such pay is related to cumulative TSR over the previous five years. This provides a formula to calculate the amount of excess pay a CEO receives. To this we add data that ranks companies by what percent of company shares were voted against the CEO pay package. Finally, we rank companies by the pay ratio between CEO’s pay, and the pay of the median company employee.
One of the “findings” mentioned in the report is that there were 30 asset managers that increased their votes “against” executive compensation programs by more than 10% from 2018 to 2019. Of course votes on executive compensation can be driven by more than pay-for-performance concerns, a year-to-year adjustment to comp voting policies can also impact actual voting decisions.
Among other findings, the report says when company performance is considered, the most overpaid CEOs are disproportionately overpaid and that the list of the 100 Most Overpaid CEOs contains many repeat offenders. It might be more interesting to see the report a year from now after a turbulent economic year.
Recently, I blogged about a survey of Russell 3000 companies and the impact Covid-19 has had on executive and director pay. When making changes to director pay, cash retainer cuts seem to be the most common. For those wondering what companies do when reducing director equity awards, this Pay Governance memo takes a look at some of the considerations. Here’s an excerpt:
While the magnitude of stock price declines varies by industry and company, a very likely possibility for many companies – due to director awards being made at the time of election or re-election to the board at annual shareholder meetings – is that the stock prices used to determine non-employee director equity awards will be 20% to 50% lower, if not more, as compared to the stock prices used to determine executive equity awards made earlier this year.
Simply due to timing of awards, using the current stock price would result in significantly more shares to non-employee directors: this would put directors in a much different economic position than company executives and other equity award participants. In some cases, director award share limits may be exceeded, or an unusually large amount of the director share reserve may be used. Additionally, companies may have external implications in possible shareholder and proxy advisor reactions.
Companies may approach this issue several ways, depending on their facts and circumstances. For companies that have already approved a reduction to their cash retainer, they may consider a similar reduction to their stock retainer. Another simple and effective approach that companies may consider is determining the share grants by using the same stock price that was used to determine executive awards earlier in the year. This will harmonize the executive and non-employee director grants and ensure that the circumstances and timing of COVID-19 do not create significant differences between cadres of grant recipients driven solely by the timing of the award.
Importantly, any reduction to the director compensation program should be clearly disclosed in next year’s proxy statement.
Here’s a 137-page guide for compensation committees from Wachtell Lipton – which includes sample compensation committee charters for NYSE and Nasdaq companies at the back…