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…
Recently, I blogged about how some say ‘proceed with caution’ when preparing to integrate ESG with incentive plans. Here’s a helpful Sullivan & Cromwell memo that discusses legal and business issues associated with introducing ESG metrics into executive compensation determinations.
Calls for linking ESG targets with executive compensation aren’t new and they’re not slowing down. Despite citing examples of companies that have taken steps to link ESG metrics with executive compensation as including, among others, Royal Dutch Shell, Clorox, Intel and PepsiCo, the memo says doing so is far from mainstream.
If you’re considering linking ESG metrics to executive compensation, it’s helpful to be aware of some of the challenges discussed in the memo:
– Deciding which metrics to benchmark is difficult – internal measures are hard to compare against peers and third-party standards might not be calibrated appropriately for specific industries
– Doing so will include deciding the frequency of disclosing ESG performance to the market and the related feasibility and cost of internal reporting processes
– Care must be taken to avoid unintended consequences – for example, pursuing certain ESG metrics could create conflicts between various stakeholders
Here’s BDO’s latest study on middle-market CEO & CFO compensation – data was collected pre-Covid-19 and was from last year’s proxy season. The study found that total CEO and CFO compensation for middle market companies rose 3.6% and 3.7% respectively. Other findings include:
– Most of the CEO and CFO compensation increases were in the form of bonuses and annual incentives and long-term incentives
– Incumbent CEOs saw more significant pay increases, with average salary increasing 7% and total direct compensation increasing 12%
– Incumbent CFOs also saw more significant pay increases, with average salary increasing 3% and total direct compensation increasing 13%
For additional thoughts on what to do about incentive compensation during the pandemic – with continued economic uncertainly – a Mercer memo provides examples. Here’s a few involving adjustments to the equity grant formulas:
Consider use of a collar: Continue to base the number of shares on the stock price (value-based guideline) or number of shares (fixed-share guideline), but set a floor and maximum for the number of shares that can be awarded — for example, + or – 20% of the estimated pre-stock price drop (or prior year’s) number of shares or share value.
For value-based grant guidelines, consider basing the number of shares on an average stock price over a longer period of time (for example, the prior 90 days) to smooth out recent volatility. (This could also be done to assess compliance with stock ownership guidelines.)
For fixed-share grant guidelines, consider whether a temporary increase is warranted to keep compensation competitive with peers and retain executives.
Not too long ago, I blogged about repricing options & exchange programs and noted there may be renewed discussion about them due to market volatility and depressed stock prices. There’s definitely more discussion, although it’s hard to say how many companies will move forward with a repricing or exchange program. For those wanting to get up to speed on considerations if they elect to go down this path, here’s a recent K&L Gates blog that touches on ISS, Exchange Act, Securities Act and Nasdaq/NYSE issues.