Not long ago, I blogged about EVA metrics and how they may inadvertently reward short-termism. The analysis was qualitative and here’s a memo from Ira Kay and the folks at Pay Governance analyzing EVA metrics from a quantitative perspective. Here, Pay Governance found that EVA may work well for some companies but not all.
The memo’s analysis tested a simple theory: that companies with positive or higher percentage growth in EVA should experience positive or superior levels of TSR. What did they find?
– Of all metrics reviewed, EBITDA growth had the highest correlation with TSR – it was more highly correlated than either EVA growth or EVA momentum
– EVA growth and EVA momentum have similar but not superior correlations to TSR as GAAP metrics such as sales growth, EPS growth and others
– EVA growth and EVA momentum show very low or negative correlation to TSR for companies in certain sectors such as energy and real estate investment trust
The memo says Pay Governance found that it’s possible that EVA metrics may produce a number of “false negatives” – meaning poor EVA results in the ISS test but positive TSR.
A couple of weeks ago, I blogged about an unusual compensation program adopted by one company and this Meridian blog discusses another program – one where the CEO takes $1 in salary along with large equity awards. The blog discusses advantages, challenges and logistics – perhaps during the current cycle it might be something more comp committees consider – and CEOs may like the symbolism. Some of the advantages mentioned in the blog include:
– Sends a clear signal of faith in the future of the company – CEO believes in the company’s long-term value potential
– The program will underscore management’s commitment to managing cash
– Focus is long-term thinking – value realized through innovation and expansion take precedence over short-term margin expansion or efficiency capture
A new poll from Pearl Meyer shows that although most companies haven’t considered how the COVID-19 pandemic will impact executive compensation in 2020 – many have considered the potential impact when setting incentive plan goals for 2020. Among the study’s findings:
– For committees that have discussed the potential impact on their goal setting process, the most prevalent approaches are to revisit 2020 goals later in the year and make necessary adjustments or to exclude the adverse impact of coronavirus when evaluating performance
– Most comp committees haven’t discussed how the coronavirus might impact executive incentive payments from 2020 annual or long-term incentive plans
– More than a third of companies have begun tracking the financial impact of coronavirus
Responses represent close to real-time data – the survey included responses from 233 public company and private company participants over the last week – March 10-16.
Tune in tomorrow for the webcast – “The Top Compensation Consultants Speak” – to hear Semler Brossy’s Blair Jones, Pay Governance’s Ira Kay and Deloitte’s Mike Kesner discuss what compensation committees should be learning about and considering today – importantly including the impact of the COVID-19 pandemic on executive compensation and incentive practices, including goals, timing and incentive plan share usage amid this rapidly changing environment with continued uncertainty. Be sure to tune in!
Tune in tomorrow for the webcast – “The Top Compensation Consultants Speak” – to hear Semler Brossy’s Blair Jones, Pay Governance’s Ira Kay and Deloitte’s Mike Kesner discuss what compensation committees should be learning about and considering today. Discussion will cover the impact of the COVID-19 pandemic on executive compensation and incentive practices, including goals, timing and incentive plan share usage amid this rapidly changing environment with continued uncertainty. Don’t miss it!
Yesterday I blogged about some of the implications COVID-19 is having on compensation plans. Here’s more information from Pearl Meyer’s blog – the first blog discusses equity awards in the wake of the health pandemic and has four approaches for companies that haven’t yet made their annual equity awards. The second blog is a good reminder for all of us not to panic and suggests this will likely be the year to exercise discretion.
COVID-19 is creating plenty of challenges for executive compensation programs. Here are two recent memos, one from Semler Brossy and another from PwC, that discuss some of the implications and approaches companies can take to address the effect of COVID-19 on compensation plans.
– Semler Brossy’s memo notes that the right approach to addressing COVID-19 and executive compensation programs will vary across companies depending on where a company is at in terms of business impact from the virus, incentive plan design and its compensation cycle. The memo then discusses four primary approaches companies have followed to address the effect of COVID-19 on executive compensation programs.
– PwC’s memo provides an overview, focused primarily on possible use of discretion in setting performance targets and when determining incentive awards. The memo provides a list of steps for compensation committees to consider in light of the fast-moving COVID-19 developments. The memo also touches on the issue of possible increased scrutiny if discretion is used and satisfaction of executive stock ownership targets in light of falling share prices.
We’ve blogged before about ISS’ new EVA metrics that are being used in this year’s pay-for-performance analysis. Hopefully comp committees are looking at EVA metrics to understand how or if use of the metrics will affect a company’s P4P analysis. And, this Jones Day blog points out that depending on a company’s strategy, EVA may end up hurting its P4P analysis and may reward short-termism.
Perhaps more importantly, are EVA-based metrics really a better measure of a company’s performance? One problematic aspect is that EVA-based measurements can reward CEOs of turnaround companies even if the expected upswings in the companies’ performance have not yet been achieved. The use of EVA can also penalize companies that are investing heavily in the future but not yet realizing the fruits of those investments. Accordingly, the use of EVA to measure performance could incentivize management to pursue projects with quick returns, rather than the multi-year investments that a company may actually need to make in order to realize long-term, sustainable growth.
For this reason, we believe that ISS’s use of EVA may actually promote short-termism, rather than the long-term outlook necessary for sustainable value creation—and for a focus on the sustainability issues that are critical in the current environment.
The memo says companies should review EVA information that was included in ISS’s 2019 proxy voting report and compute similar metrics for 2020. Based on that analysis, a company should consider whether to prepare any disclosure for inclusion in its 2020 proxy statement in anticipation of ISS’s assessment.
Liz blogged last fall about how executive pay was getting more political as bills were introduced in Congress aiming to get companies with high pay ratios to pay higher taxes. Now, news reports say California lawmakers are considering a similar idea – under California SB 37 companies making over $10 million would pay a higher California tax rate with the actual rate determined based on the ratio of CEO pay to average worker pay.
It doesn’t sound like the California bill is expected to get much traction, it’s currently stuck in California’s Senate Rules Committee. It will be interesting to see if other states or cities start putting similar bills up for consideration.
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.