The headline from this CNBC article caught my eye: “‘Jesus Christ himself isn’t worth 500 times his median worker pay in companies’ — Disney heiress slams CEO pay.” It made me chuckle as I’ve blogged many times about how 99% of our population think CEOs are overpaid. Just jump into a taxi and strike up a conversation about CEO pay. And I love this reaction to the article that I received from a member: “Heiress Discovers Society Favors Rich. Film at 11.”
Meanwhile, Disney itself is a target over its own CEO pay practices – per this Bloomberg article, CalPERS intends to vote against Disney’s sau-on-pay (and two comp committee members) despite the CEO’s pay being reduced…
Here’s a reminder for smaller companies from Skadden Arps:
Most smaller reporting companies held initial shareholder say-on-frequency votes in 2013, when the requirements went into effect. Given that say-on-frequency votes must be submitted at least once every six years, the 2019 proxy season will mark the second time such votes are required for those companies. The proxy cards from those companies must provide shareholders the option to vote for one-, two- or three-year periods between say-on-pay votes or to abstain from voting.
Failure to include a say-on-pay frequency vote once every six calendar years may expose a company to potential SEC enforcement action and other risks, such as a derivative shareholder lawsuit. If a company were to fail to include a required say-on-frequency vote, such a mistake could be corrected by filing a proxy statement amendment or a revised proxy statement on EDGAR and posting the material on the same website where the original proxy materials were posted, which also should be disseminated to shareholders, either by circulating a new Notice of Internet Availability of Proxy Materials or by mailing the supplemental or revised material. The amendment or revised proxy statement can be in the form of a cover page that explains the error and provides the correct information, or it can be a restatement of the entire proxy statement containing the corrected information and an explanatory note regarding the error and corrections made.
This ‘Willis Towers Watson’ note shows how companies in the United Kingdom are handling the new “UK Corporate Governance Code & Reporting Regulations.” Here’s an excerpt:
The CEO pay ratio regulations are more flexible than the Gender Pay Gap statistics, giving companies a choice of which method of calculation is most appropriate for them. Our results indicated very little appetite to publish CEO pay ratio statistics early, as at the time the survey fielded, many companies had not yet determined which methodology they would use. Our survey showed that, so far, only 20% of companies have settled on which calculation methodology they will use, but over two-thirds have calculated or are in the process of calculating ratios to test the various methodologies.
80% of companies are considering voluntarily disclosing additional ratios. Amongst the additional ratios being considered are those which will show base salaries only; exclude LTI vesting; use an average single figure and/or illustrate target pay information.
A member recently sent in a note wondering why some companies were reporting dividends in the “Summary Compensation Table.” She noted that if a company reports the fair market value of an award in the SCT, any subsequent dividends that are paid on the shares (whether prior to – or at – the vesting date) are not reported as compensation expense in the financials (provided the underlying shares vest). And therefore, dividends do not need to be reported in the SCT.
If dividends are paid on a current basis and the shares are subsequently forfeited, those dividends are charged to earnings and would be required to be reported in the SCT. Because paying dividends on unvested shares is considered a bad compensation practice, most companies accrue the dividends and only pay them when the shares vest, thus the reporting of dividends should be rare (if ever). The fact the dividends are treated as taxable income has no bearing on the accounting or proxy disclosure. For support, the member sent this relevant accounting standard:
Paragraph B93 in the Basis of Conclusions of the Financial Accounting Standards Board’s (“FASB”) Statement 123 (revised) – Share-Based Payment states the following:
The fair value of a share of stock in concept equals the present value of the expected future cash flows to the stockholder, which includes dividends. Therefore, additional compensation does not arise from dividends on nonvested shares that eventually vest. Because the measure of compensation cost for those shares is their fair value at the grant date, recognizing dividends on nonvested shares as additional compensation would effectively double count those dividends. For the same reason, if employees do not receive dividends declared on the class of shares granted to them until the shares vest, the grant-date fair value of the award is measured by reducing the share price at that date by the present value of the dividends expected to be paid on the shares during the requisite service period, discounted at the appropriate risk-free interest rate.
The dilemma for directors, however, is determining what aspects of sustainability, or ESG performance, should have priority — and should be linked to pay incentives. The UN, for example, has outlined 17 broad Sustainable Development Goals for 2030. Progress is measured with 169 targets. The goals include eliminating poverty, offering affordable and clean energy, achieving gender equality, protecting ecosystems, increasing responsible consumption and production, and much more. Meanwhile, a number of business organizations have created their own sustainability measures, including the Sustainability Accounting Standards Board, Sustainalytics, Bloomberg, and MSCI. And at many companies, sustainability efforts are measured with well over 10 internal metrics.
Compensation committees often start by tying bonuses and long-term incentives to goals related to compliance and risk management. That approach pleases some stakeholders, but it may put the focus on issues far removed from the company’s core mission. For example, measures of regulatory fines gauge only a company’s environmental “hygiene,” which may reduce risk but doesn’t incentivize executives to increase the company’s broader environmental impact.
What’s a better approach? Have bonuses depend largely, or solely, on executives’ success in tapping big strategic opportunities related to sustainability. By pushing the top team to go on the offense strategically, this change brings the work of advancing sustainability from the periphery of the business to its heart.
Though not all businesses today are in a position to implement big strategic initiatives based on sustainable thinking, the opportunities to pursue them are growing fast. According to a survey by the UN and Accenture, 63% of executives believe that sustainability will cause major changes in their businesses in the next five years. And if that shift ends up determining which companies thrive in the future, then it’s likely that incentive goals must apply to bold business opportunities.
A couple weeks ago, the Delaware Court of Chancery dismissed a derivative suit that alleged the directors of United Airlines breached their fiduciary duties by not clawing back severance paid to a former CEO who was under federal investigation for participating in a bribery scheme. The suit was filed almost two years ago and related to severance paid in 2015 – which at this moment feels like a different era in terms of public tolerance of CEO misconduct. I wrote at the time:
United’s board says clawing back severance would hinder its ability to recruit executives & cause competitive harm. Some people think the board was initially reluctant to claw back severance because it wanted the departed executives to cooperate in the related DOJ investigation. Either way, it begs the question of how far a CEO would have to go before they’re denied severance or it’s clawed back.
So with the dismissal, that question will remain unresolved in this particular case. This Goodwin memo (scroll down) explains that the suit was dismissed because the plaintiff failed to show any conflicts of interest among the members of the special committee that considered & responded to the clawback demand.
Companies typically aren’t able to exclude from their proxies shareholder proposals that address matters of executive & director compensation – see the Battle Mountain Gold Company no-action letter and Release No. 34-30851, both from way back in 1992. And frequently, shareholder proponents tie executive & director compensation into proposals that would otherwise be excludable under the Rule 14a-8 “ordinary business” & “micro-management” exceptions, in hopes that the pay component will trump any basis for exclusion. Last fall, Corp Fin issued Staff Legal Bulletin No. 14J to clarify how it would review no-action requests for these types of proposals – we blogged about it on TheCorporateCounsel.net and also did a webcast with Corp Fin’s Matt McNair.
Now that we’re into proxy season, we’re able to get even more insight into the Staff’s no-action analysis for “executive pay” proposals that arguably also relate to ordinary business matters or attempt to micro-manage the company. This Cooley blog summarizes the company & proponent arguments – and Staff conclusions – in these recent no-action letters:
1. AT&T: Staff agreed that a proposal could be excluded, because it focused on ordinary business matter of existing debt
2. Verizon: Staff disagreed with the company that a proposal for cybersecurity metrics that might apply to 300 employees was focused on the general workforce, and denied no-action relief
3. Verizon: Staff denied no-action relief for a golden parachute proposal, because it was a significant compensation matter for senior executives
4. AbbVie and Johnson & Johnson: Staff agreed that a proposal that sought to prohibit performance metric adjustments for legal & compliance costs amounted to “micro-management,” and granted no-action relief
Just in time to double check your proxy statements before sending them to print, this Wachtell memo summarizes frequently overlooked disclosure requirements, including:
1. Non-GAAP Reconciliations: Required for all non-GAAP measures that are disclosed outside of the CD&A or aren’t for the purpose of explaining performance targets
2. NEOs’ Direct or Indirect Personal Benefits: Unless they’re “integrally & directly” related to the executive’s duties, or available on a non-discriminatory basis to all employees, these items need to be disclosed as perquisites
3. Deferred Equity Awards
4. Outstanding Performance-Based Shares: Calculate using target (or higher) performance
5. Above-Market Preferential Earnings
6. Directors’ Outstanding Awards: Include footnote disclosure, whether vested or unvested
7. Item 10 of Schedule 14A: Make sure that you’ve included all line items if you’re seeking approval for a compensation plan – e.g. number of persons in each class of eligible participants and market value of company stock
This Aon memo looks at why companies might be moving away from TSR as a central performance metric – and suggests alternatives for three tech industries:
– E-Commerce Companies: Internet-related businesses have historically focused on top-line growth as the primary measure of success, but since growth can be rapid and unpredictable, we recommend e-commerce firms consider using measures like revenue, operating income and EBITDA. This focuses executives’ attention on key goals and reduces the importance of precise goal-setting that is typically required for bottom line or return metrics. Smaller e-commerce companies might want to focus on volume-based metrics (e.g., number of customers or transactions), revenue growth and market share as these will be key measures of success for firms not yet reporting a profit.
– Software companies: This high-growth, high-profit industry should focus on metrics that are balanced across various operating and financial measurements. Indeed, our research finds software companies are moving toward a combination of market and operating metrics — from 28% that reported using both in 2015 to 33% in 2016 (based on 2016 and 2017 proxy statements ). The most common operating metrics include revenue growth followed by operating income and earnings per share, according to the 2017 Radford Performance-Based Equity Report for Software Companies (available for $750).
– Semiconductor companies: The semiconductor industry is unique in that it is inherently more cyclical because the business is more directly related to consumer spending. As such, we find there are two common approaches companies take to designing incentive plans. The first is designing performance plans with aggressive metrics that pay out big when business is booming, while the alternative approach is more conservative, developing consistent payouts at, or slightly below, target most years. When deciding which approach is best for your organization, we recommend semiconductor companies think about what approach aligns best with their compensation philosophy, culture and what their employees value.
At about a quarter of S&P 500 companies, CEO incentives are tied (at least in part) to qualitative criteria. There’s a chance that figure will rise now that a company’s tax deductions aren’t tied to whether pay is “performance-based” – but probably not, since proxy advisors and shareholders disfavor plans that give a lot of discretion to the comp committee. This recent study finds that those misgivings might be warranted – company performance is negatively associated with the use of qualitative or subjective metrics in CEO bonus contracts.
As summarized in this CFO.com article, that’s because of these three shortcomings (meanwhile, this 2017 Pay Governance blog gives some ideas for overcoming these hurdles):
1. Qualitative performance criteria are ill-defined, providing the CEO with limited guidance regarding what exactly needs to be achieved going forward. For instance, the 2017 annual bonus of David Zaslav, CEO of Discovery, was based 50% on the accomplishment of six qualitative goals – e.g. “further develop and integrate [the company’s] overall digital and ‘over the top’ strategy” and “develop robust succession plans for key operational roles, while continuing to attract, retain, mentor, and reward exceptional talent.” Although those qualitative goals relate to important aspects of business (e.g., developing human capital), they involve a great deal of ambiguity.
2. Qualitative criteria and related performance targets are likely to be selected arbitrarily. No systematic supporting evidence can be collected and presented by compensation consultants and committees because of the idiosyncratic nature of the criteria under examination. In contrast, relevant data can be collected and tested regarding various quantitative criteria used in CEO bonus contracts.
3. Whereas assessments based on the same quantitative data always lead to the same outcome, this does not hold true in the case of qualitative assessments. The subjective nature of such assessments may induce bias into performance evaluations, possibly reducing the effectiveness of the CEO’s incentive plan in driving better firm performance.