Liz blogged earlier this year about how clawback policies may be turning restatements into a rare species. Recently I came across this memo discussing why, even with a restatement, we don’t seem to read a lot about actual clawbacks when the vast majority of companies in the S&P 500 have adopted clawback policies. Perhaps clawback policies just need more teeth and for a company wanting to strengthen its clawback policy, the memo includes suggestions.
The memo references a study of 242 companies with voluntary clawback policies that later restated earnings and the study found only 3 of the companies disclosed activation of a clawback in their proxy statements. It says one of the reasons is that clawback policies leave a lot of unanswered questions so the question of a clawback is left to the board’s determination. Suggestions for strengthening a clawback policy include:
– List the actual names of the executives covered by the policy in the annual proxy statement
– Identify a specific time period describing how far back in time the company can go to claw back incentive pay from covered executives
– Detail the types of compensation the company can recoup
– Exclude words that give the board of directors discretion to enforce a clawback (for example, don’t use language such as “the board has an option to recoup if an executive is proven to have engaged in misconduct”)
– Specify a meaningful amount (taking the executives’ total compensation into account) that’s subject to clawback
Another factor noted in the memo is that the board should have a deadline to enforce the policy and activate a clawback. The memo includes marked sample clawback policy language to help make a clawback policy stronger.
What was perhaps more eye opening was the memo’s reference to a research paper suggesting companies that voluntarily adopt clawback policies are more likely to issue pessimistic earnings guidance, which leads to lower investment returns for stockholders compared to stockholders of companies without clawback policies.
A recent Harvard Business Review article discusses a new compensation plan design for companies encountering sector or industry disruption – and, it seems like this includes more companies every day. The author, Seymour Burchman of Semler Brossy, says that companies need to look at comp plan design because most “executives are essentially tied to a structure that supports only incremental change versus radical transformation.”
Designing a comp plan to support long-term transformation can be a challenge but the author says it’s not insurmountable.
To do this, the author says you should design your incentive plans around mission, rather than strategy, attaching targets and incentive payouts to those goals in a disciplined way. Your company’s mission offers consistent, yet flexible, guidance for long-term transformation, agile course corrections, and the building, operation, and constant reshaping of stakeholder-rich ecosystems.
It’s up to boards to narrow the focus to two to three mission-based measures that will serve as the basis for a long-term incentive plan, and then to set goals based on those measures. The goals need to be both specific enough to guide actions and measurable enough to show performance improvement. To complement the long-term goals, directors should set annual incentive objectives as intermediate milestones to gauge progress toward long-term outcomes.
With concern about COVID-19, we’ve had questions about what companies are doing when setting performance targets for incentive comp. This blog from Willis Towers Watson discusses implications of COVID-19 for incentive plan goals.
As noted in the blog, many companies have either just set their short-term and long-term incentive goals or they’re trying to figure out how to set the goals in the midst of all the uncertainty. The blog says that as the firm has worked with its clients, some have discussed or decided on the following actions:
– Delaying metric and goal setting until Q2 (this has been the prevailing response so far as it’s viewed as less disruptive to existing incentive plans)
I blogged earlier in the year about how, this year, ESG is one area of focus for comp committees. Depending on your industry and where your company is at with identifying and reporting ESG metrics, the thought of tying ESG to executive comp can seem daunting. That’s why it’s nice to see this Semler Brossy blog discussing “thought starters” for boards when thinking about integrating ESG with executive comp.
The blog discusses approaches for integrating ESG into annual incentive plans as well as long-term incentive plans. As noted in the blog, integrating ESG into a long-term plan can seem most intuitive given the long timeframe of most ESG issues. Given that most companies have several important long-term goals, the blog suggests creating a long-term “scorecard” so that too much value isn’t placed on a single goal. Here’s some of what it had to say about that:
PepsiCo has five 2025 goals related to water use in high-risk water areas; target payout could be tied to achieving all five, with an above-target payout or early vesting if several goals are met early. A long-term “scorecard” could also be devised by setting a different long-term ESG goal each year, eventually focusing executives on achieving two or three material goals at any given point and allowing a natural evolution of long-term goals.
Arrangement for payments upon a change-in-control continue to draw scrutiny from many, including proxy advisors and activist shareholders and if excessive, they often invite public criticism. Here’s a report from Alvarez & Marsal, with commentary from Equilar, that might help boards and comp committees analyze and structure executive change-in-control arrangements to demonstrate accountability.
The report analyzes executive change-in-control arrangements at 200 U.S. publicly-traded companies (top 20 companies based on market cap in 10 different sectors). Among other things, the report provides insight into the prevalence of double-trigger vesting provisions, excise tax gross-ups, change-in-control severance multiples and the breakdown of change-in-control benefit values by industry sector.
With a depressed company stock price, senior officers at AMC Entertainment Holdings recently agreed to a new compensation approach for its executives. The approach involves a reduction in agreed-upon pay in exchange for an equivalent out-of-the-money share grant. AMC’s stock price has been in decline for several years likely at least partially attributable to a decline in movie theater viewership.
AMC’s press release announcing the new executive comp program says cash salaries of senior officers will be reduced by 15% and their target cash bonus opportunity will also be reduced by 15%. Here’s how the reduction will work:
This compensation decrease will be split into thirds and applied evenly as reductions across each of three categories: one-third lowering combined cash salary & cash bonus, one-third lowering at-market restricted share equivalent grant amounts that time vest and one-third lowering at-market performance share equivalent grant amounts that vest based on performance. Importantly, these sacrifices in lowered cash salary and cash bonus, as well as in lowered restricted share equivalent grant and performance share equivalent grant levels, will continue at the new lower totals in each of the coming three years.
To potentially offset the pay reduction, the officers will receive a one-time grant of AMC share equivalents that, with certain exceptions, has a 3-year time vesting provision and requires AMC’s stock price to rise materially in order for vesting to occur. Initial vesting will not occur until AMC’s stock price rises to 102% of the grant date price and future vesting goes up from there. Here’s how the vesting will work:
This share equivalent grant is split into six equal tranches. Initial vesting will not occur until the AMC share price recovers on a 20-day VWAP basis to $12 per share, a 102% premium to yesterday’s market close. The second tranche will vest only when the AMC share price rises to $16, a 170% premium. The third tranche vests at $20, a 237% premium. The subsequent tranches vest at $24, $28 and $32, premiums of 305%, 372%, and 440% respectively.
The press release says certain officers are excepted from the program, such as officers that are expected to retire prior to the 3-year time vesting requirement. All other officers voluntarily signed-on to the program signaling they believe the company’s stock is undervalued.
Will be interesting to see how this plays out. For companies with an undervalued stock price, I can see how some might find the approach enticing presuming risk mitigation is factored in so that compensation-related risks aren’t inadvertently raised.
Saving the best for last may sound good but when it involves proxy season, it can amplify stress levels. So, if you’re drafting the CD&A as the proxy statement filing date closes in, this blog from Pearl Meyer says focus on three areas will help you pull the CD&A together. Here’s where the blog says it’s best to spend your energy:
– CD&A Executive summary – this is an opportunity to provide overall context for your pay outcomes, reinforce strength of your leadership team, emphasize your commitment to shareholder engagement and underscore compensation governance practices
– Annual incentive plans – break this narrative down into shorter sub-sections organized by each of the key areas of your plan, which will help with navigation of what is generally a long narrative
– Long-term equity incentives – highlight or lead with the role of performance-based equity and provide strong rationale for the metrics and be clear about the timeframe over which performance is measured
Hopefully this can help wrap-up the drafting process and give time for reviewing the overall narrative to make sure it’s clear and complies with rules!
This recent blog from Foley & Lardner lists 10 considerations for management and compensation committees when establishing performance awards. The blog includes considerations to keep in mind when selecting performance goals as well as when adopting or modifying a clawback policy. One consideration to keep in mind is that if you’re agonizing over what the “right” performance goal is, you can select more than one and don’t need to settle on a single goal. Here’s an excerpt:
Typically, long-term incentive compensation programs use more than one performance goal, including at least one earnings metric (such as Net Income, EBITDA, or net operating profit) and one return metric (such as ROIC, EPS, or TSR). Therefore, companies shouldn’t agonize to figure out the “one right goal” or feel like they should have their executive team focused on only a single outcome. If more than one goal is selected, use their weighting (e.g., achievement of goal #1 results in 70% of the award being earned and achievement of goal #2 results in 30% of the award being earned) to reflect their importance to the company’s overall business strategy.
A recent Equilar blog analyzes CEO pay ratios by industry sector. The data is interesting to review but as the blog points out, the usefulness of pay ratio data is questionable since there’s difficulty comparing pay ratios across sectors due to some companies employing more part-time workers and differing employment practices and labor needs. Equilar found sectors with the highest pay ratios included services, consumer goods and health care – noting that both the services and consumer goods sectors employ high numbers of part-time workers.
The blog also includes “extreme” pay ratios and notes the difficulty comparing CEO and worker pay. Here’s an excerpt:
SEC disclosure requirements for calculating pay ratios create concerns about the usefulness of the metric. For example, Tesla CEO Elon Musk’s pay will only become realizable if the company clears very high performance targets. Regardless, the entire pay package must be used in the pay ratio calculation. This can cause extreme ratios that may not accurately reflect realized CEO compensation in a given year.
In this recent paper, three law & business profs ran some stats on “Say-on-Golden-Parachute” votes. Here’s an excerpt from the abstract:
We find that unlike shareholder votes on proposed mergers, there is a significant amount of variation with respect to votes on golden parachutes. Notwithstanding the variation, however, the SOGP voting regime is likely ineffective in controlling golden parachute (“GP”) compensation.
First proxy advisors seem more likely to adopt a one-size-fits-all approach to recommendations on SOGP votes. Second, shareholders are more likely to adhere to advisor recommendations. Finally, the size of golden parachutes appears to be increasing in the years since the adoption of the Dodd-Frank Act in 2010, and the golden parachutes that are amended immediately prior to SOGP votes tend to grow rather than shrink.
These findings contrast with the research that has examined Say on Pay (“SOP”), and we suggest that the differences between the two regimes lie in the absence of second-stage, market-based discipline for SOGP votes. We offer potential avenues for improving SOGP’s ability to shape change-in-control compensation practices, such as making SOGP votes (partially) binding, and making the GP payment and SOGP voting information more readily available to shareholders of corporations where the target directors also serve as directors of acquiring corporations.