This alignment of CEO to shareholder value, with handsome rewards for top executives, is how the theory is supposed to work. In reality, executive compensation is often laughably disconnected from financial and stock performance. At its worst, the pay model has encouraged heedless risk-taking, accounting fraud and volatility.
This happens especially because of weak corporate governance, despite efforts to improve it. Even with nominally independent directors, the board and CEO are part of the same “club,” in world view, life path, outlook and extreme wealth.
This article from Semler Brossy’s Seymour Burchman is interesting, illustrating how EVA has made a comeback – mainly due to ISS embracing economic value added (EVA) – and providing a historical lookback about how economic value has been used in pay packages over time…
– The SEC All-Stars: A Frank Conversation
– Hedging Disclosures & More
– Section 162(m) Deductibility (Is There Really Any Grandfathering?)
– Comp Issues: How to Handle PR & Employee Fallout
– The Top Compensation Consultants Speak
– Navigating ISS & Glass Lewis
– Clawbacks: #MeToo & More
– Director Pay Disclosures
– Proxy Disclosures: 20 Things You’ve Overlooked
– How to Handle Negative Proxy Advisor Recommendations
– Dealing with the Complexities of Perks
– The SEC All-Stars: The Bleeding Edge
– The Big Kahuna: Your Burning Questions Answered
– Hot Topics: 50 Practical Nuggets in 60 Minutes
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This article from CBS News notes the discrepancy between the overall CEO rate of pay inflation and the pay rate of ‘typical’ worker. I imagine this type of media attention will become more prevalent as word gets out – so at some point, companies may need to address this widening gap in their proxy disclosures. Here’s the bullets that introduce the article:
– The total median pay package for chief executives at S&P 500 companies rose to $12 million last year.
– The number — which includes salary, stock, bonuses and other compensation — is 7% higher than in it was in 2017, for an average pay hike of $800,000 for large-company CEOs.
– The median pay increase for the typical worker at an S&P 500 company grew just 3% last year, or less than half the rate that the top boss enjoyed.
– It would take 158 years for the typical worker at most big companies to make what their CEO did in 2018.
According to this recent Equilar report (available for purchase), CEO pay continues to grow – with median total compensation increasing by 8% since 2017. It also identifies this notable trend:
Since 2014, the percentage of Equilar 500 CEOs receiving performance-based awards has been steadily rising, exceeding both time-based stock and options grants as the most prevalent long-term incentive vehicle. In 2018, 87.8% of Equilar 500 CEOs received performance-based awards.
This ClearBridge memo on annual & long-term incentive plan trends says the proportion of companies using performance awards might be even higher than that Equilar figure. Some people think the pendulum is due to swing back towards salary & time-based awards…stay tuned.
The weighted average cost of capital (WACC) is an important financial precept that is widely used in financial circles to test whether a return on investment can exceed or meet an asset, project, or company’s cost of invested capital (equity + debt). The thesis of this opinion article is that companies can develop more meaningful return performance targets by better understanding the details of its WACC before setting a return performance target.
Simply stated, a company’s return on capital performance target will be more relevant if in fact the return shows that the level of performance to be achieved must equal or exceed the company’s estimated cost of capital. Directors serving on the Board’s compensation committee can use the WACC model to test the validity and reasonableness of an incentive plan’s return performance target by learning whether the return target meets or exceeds the company’s WACC over the performance period.
I’ve blogged that most companies will experience a say-on-pay failure at some point. This PJT Camberview memo says that might be because voting policies have become more complex. Here’s an excerpt:
Feedback from engagement meetings this spring indicated a heightened focus on one-time or supplemental awards and a desire for plan design that is tightly linked to challenging strategic and financial measures. As investors continue to become more sophisticated in their compensation analysis, they have also become more willing to support plans that have moved away from traditional metrics such as TSR and toward those specific to company circumstances and strategy. As a result, compensation plans have generally become more aligned with key performance metrics, with the caveat that unique plan design requires clear disclosure and more in-depth engagements to provide investors with context.
Underlying both voting and engagement trends is the continued search for perceived or actual gaps in pay and performance. Many investors have created proprietary quantitative pay screens to flag potential disconnects that can prompt an engagement request to understand the underlying causes.
Companies that faced investor challenges this spring on compensation can expect further discussion this fall into the rationale behind the compensation committee’s decision-making and how investor feedback has informed potential changes to plan design. 2020 should bring further complexity as investors continue to dig deeper into compensation plans and ISS potentially expands its analysis to include Economic Value Added (EVA) in addition to TSR and other financial metrics.
This Pay Governance memo analyzes the relationship among stock buybacks, long-term growth and executive compensation for companies in the S&P 500. Here’s the conclusion:
Following up on Pay Governance’s original research into the relationship among executive compensation, share buybacks, and shareholder value creation, we found even stronger evidence that certain executive compensation structures (granting stock options and using EPS bonus metrics) are correlated with share buybacks. We also debunked two common myths: that share buybacks damage long-term corporate investment and that there is an excessive trade-off between short-term and long-term shareholder returns.
Taken together, these findings suggest an alternate narrative about the relationships between executive pay, share buybacks, shareholder value, and company growth. The contemporary fact-driven story of share buybacks is not one of managers shirking investment and long-term stewardship of corporate capital but one of disciplined capital allocation. Companies conducting the largest share buybacks are not just rewarding shareholders with higher long-term returns; they also appear to be investing in the long-term through capital expenditures.
Executive compensation programs are an important part of the strategic structure ensuring this efficient capital allocation and long-term corporate financial sustainability. The use of short- and long-term financial metrics and share-based incentives remains a proven approach for focusing executive teams on long-term value drivers and aligning executive pay with shareholder interests.
Some of us have been internally debating what the “latest practicable date” means for purposes of S-4 compensation disclosures. There often are public-public deals with S-4 filings that are updated and amended four or five times before going effective six months after the S-4 is first filed with the SEC. In these S-4s, they start describing all the compensation arrangements as they are back at signing – but six months later, the company is still using some date that is quite a bit earlier (or, in some cases, a future date that is expected to be the closing) to show compensation “as of the latest practicable date.”
Here are various thoughts from folks that I reached out to:
– For a long time, I’ve trying to connect the dots of “latest practicable date” and compensation disclosures and S-4. I can’t find anywhere in S-4 itself that references “latest practicable date” and I only found a few references of it in Item 402 of Regulation S-K – (1) with respect to not being able to calculate salary or bonus and so you would provide it in a Form 8-K, and (2) with respect to golden parachute compensation. I don’t think item (1) would apply for an S-4 as an issuer would theoretically already have get this squared away for its 10-K. As such, I assume we are referring to calculating golden parachute payments where we pick a triggering date as of the latest practicable date and that the payment is based on a price that is not yet determined (such as a stock price).
– My personal approach to “latest practicable date” (a similar term is used in Item 403 for stock ownership tables – “most recent practicable date”) is to update the information so that by the time the registration statement is declared effective, it provides substantively materially accurate information within a reasonable period of time. In other words, as always said by the SEC, “it depends on the facts and circumstances” and don’t make any material misstatement or omissions. My goal would be to set up a calculation so that you can plug in the variable for the answer. This means your comp information could be within 1-3 weeks of going effective (based on filing and amendment and then getting SEC sign-off). If it makes sense, you could also use a variable approach showing payments at different levels based on different assumptions (e.g., high/medium/low).
Generally, executive comp tables must include the last completed fiscal year. Consider CDI Regulation S-K, Ques. 117.05 with regards to updating comp tables in an S-1 or an S-3. Also make sure you are comfortable that there are no material misstatements or omissions. I would also consider providing updates to the extent that there have been changes made in disclosures pursuant the acquisition agreement (e.g., in the disclosure schedules).
– Our view is that (leaving aside how material the volume of comp data really is), we would go with less is more so would leave it until there’s a specific rule or comment to change it. If there’s no SEC comment, we think a lot of S-4 issuers leave well enough alone, so they don’t have to take another cut at comp beyond once for S-4 purposes. Even if perhaps “latest practicable date” means that comp really should be updated to final, that’s easier said than done and sometimes impacts the type of prospectus that can be used and seems more trouble than it’s worth (not to mention the legal costs)).
– If the deal straddles two fiscal years, and forward incorporation by reference is not available, I would probably advise the registrant to roll forward when new annual numbers become available. Otherwise I’ve never thought of the executive compensation tables as ones that had to be updated more frequently than that.
– In most other contexts where “latest practicable date” or “recent practicable date” is used, I’ve had the Corp Fin Staff comment if it wasn’t in the last month or two. I would think the other issue, from a shareholder vote perspective (for deals where there is a vote) is making sure the s/h has all the material information they need to make an informed vote.
– I assume this is talking about the golden parachute comp disclosures, in which case it doesn’t seem like the Staff is too focused on those and my hunch is that companies get away with sticking with the initial date used in the first filing. The few deals I’ve been involved in that have included this disclosure haven’t been updated, but none of those were long registration processes. But I bet if you actually asked the Staff, they’d say it should be updated as time passes.