The Advisors' Blog

– Liz Dunshee

Beginning in 2019, ISS will recommend a vote against members of the board committee responsible for setting non-employee director pay if the pay has been “excessive” for two or more years and there’s not a “compelling rationale” or other mitigating factors for that arrangement. This Exequity memo charts director pay stats for the S&P 500 and the Russell 3000 so that you can know what amount of compensation will be problematic.

The memo notes that if you come within 10% of the 95th percentile, you should be cautious about director pay increases and your director pay disclosures. It might make sense to clearly explain in the proxy statement why the pay levels are appropriate. I’ve also blogged about factors & program features that could lead to unexpected outcomes in the ISS evaluation…

– Liz Dunshee

I blogged last month about whether you can use the same “median employee” for your second year of pay ratio disclosure. This Pearl Meyer blog lists some other things to think about for Year 2 – but the main takeaway is to keep it simple. Here’s an excerpt:

Should you change your disclosure? After reading those nearly 4,000 other proxies, you may find yourself with a case of pay ratio disclosure envy and want to change the way your disclosure reads or is presented. Again, absent a compelling reason to do so (see our next two considerations), we would recommend retaining the same format and flow from 2018. With the SEC issuing zero comment letters on this disclosure requirement last year, it appears that every registrant has so far made a good faith attempt to comply and did (at least in the eyes of the SEC). Even proxy advisors and institutional investors didn’t complain about the disclosures, and if anything, said there was too much information. Why open yourself up to scrutiny by changing what has already worked?

– Liz Dunshee

We might be seeing the end of the TSR heyday. More and more investors are focused on long-term value creation and the alleged evils of earnings forecasts – and there’s buzz around the idea that return on invested capital is the primary driver of value creation. So it’s no surprise that ROIC is becoming a preferred metric for performance plans.

This Forbes blog (from an ROIC-focused research firm) says that almost a third of companies are now using this performance metric. It provides some case studies – and explains the trend:

ROIC has become a more common word in corporate America over the past three years. In 2016, The Wall Street Journal declared ROIC “The Hottest Metric in Finance.” Proxy advisor Institutional Shareholder Services recently bought EVA Dimensions so that it could offer more than just unscrubbed accounting metrics. JPMorgan Chase (JPM) CEO Jamie Dimon called out ROIC as a key driver of value in his 2018 letter to shareholders. From 2014 to 2016, the percentage of companies that tied executive pay to capital allocation measures rose from 21% to 30%. And a 2016 Rivel Research survey of buy-side investors found that ROIC was their favorite metric to link management pay to company performance.

Companies that focus on hitting quarterly earnings targets instead of driving long-term improvements in shareholder value should not be surprised to find themselves targeted by activist shareholders – like the ones that forced General Motors to adopt ROIC as a key performance metric in 2014.

Despite these improvements, there’s still a large disconnect between CEOs and investors regarding the importance of ROIC. 77% of buy-side investors favor ROIC as a performance metric while only 30% approve of EPS. Meanwhile, 63% of companies link long-term executive compensation to earnings while only 30% link compensation to ROIC.

– Broc Romanek

Recently, Liz blogged about Glass Lewis issuing its 2019 voting policies. Glass Lewis also has issued this 32-page set of shareholder initiatives…

– Broc Romanek

As noted in this Bloomberg article, Rite Aid received a 84% vote ‘against’ on its say-on-pay. I was pretty sure that was a record low…but surprisingly, it’s not even the leader in the clubhouse for 2018! For example, Nuance Communications got only 10% in favor. Some bigger names also got clobbered – Wynn Resorts was at 20%, and Bed, Bath & Beyond was at 21%. We post reports with say-on-pay results for each proxy season in our “Say-on-Pay” Practice Area…

– Broc Romanek

Here’s the annual “Guide to Effective Proxies” from Donnelley Financial, 514 pages of examples from actual proxies…

– Broc Romanek

Here’s the news from this blog by Steve Quinlivan (also see this Bloomberg article):

In Stein v. Blankfein, the Delaware Court of Chancery considered a proposed settlement of litigation against directors of Goldman Sachs. The related complaint contained two counts for derivative relief for breach of fiduciary duties related to the payment of excessive compensation awards to non-employee directors and issuing stock-based awards that were void because of uninformed shareholder votes. The complaint also included two direct claims for breach of fiduciary duties for failure to disclose material information to stockholders when compensation plans were approved and for partial disclosures in proxy statements concerning the tax deductibility of cash-based incentive awards to named executive officers.

The Court described what the Company would give up by settling the claims. The Court noted the claims compromised were allegations that the Company’s directors are liable to the Company for excessively compensating themselves and for issuing stock-based incentive awards in reliance on stock incentive plans that were void at the time of the award. These claims are assets of the Company. The settlement, if confirmed, would release all stockholders’ and the Company’s rights to assert these and related claims going forward.

The Court than analyzed what the Company would obtain by settling the claims. According to the Plaintiff and the Director Defendants, the quid pro quo arose from the settlement of the Plaintiff’s direct claims against the Director Defendants. Those claims were composed of allegations that the Director Defendants breached fiduciary duties in failing to make required disclosures in connection with the Company’s recent stock incentive plans and proxy statements. The Director Defendants also agreed to cause the Company to do certain beneficial things, including making certain disclosures in the future and continuing certain practices, already implemented, with respect to executive compensation for at least three years. The Plaintiff alleged that the disclosures would bring future stock incentive plans into compliance with the Plaintiff’s interpretation of federal law, thus conveying a large but hypothetical monetary benefit on the Company.

However the Court declined to approve the settlement because it did not find the release of the derivative claims fair to the Company. According to the Court, in return for a release of the monetary claims against them, the Director Defendants give up nothing. Instead, the Director Defendants only agreed to cause the Company to take or refrain from certain actions that were largely mandatory given the Director Defendants’ fiduciary duties. Even if the undertaking of the Defendant Directors had merit, they were unrelated to claims for conflicted overpayment that were at the heart of the derivative claims.

– Liz Dunshee

As I blogged today on TheCorporateCounsel.net – and as noted on their blog – Glass Lewis has posted its 2019 Voting Guidelines. As always, page 1 of the Guidelines summarizes the policy changes – and we will be posting memos in our “Proxy Advisors” Practice Area. Changes include:

– Officer & Director Compensation: In its say-on-pay recommendation, Glass Lewis will consider excise tax gross-ups, severance and sign-on arrangements, grants of front-loaded awards, clawback provisions, and CD&A disclosure for smaller reporting companies. And they’ve clarified their approach to peer groups, pay-for-performance, the use of discretion, director compensation and bonus plans.

– Board Gender Diversity: The policy announced last year will take effect in 2019 – Glass Lewis will generally recommend voting against the nominating committee chair of a board that has no female members, but they’ll closely examine the company’s disclosure of its board diversity considerations and other relevant contextual factors.

– Conflicting & Excluded Proposals: The policy lays out how Glass Lewis will evaluate conflicting proposals on special meeting rights – for one thing, they’ll typically recommend against members of the nominating & governance committee when a company excludes a shareholder proposal in favor of a management proposal of an existing special meeting right. And in limited circumstances, Glass Lewis may recommend against members of the governance committee if a company excludes any conflicting proposal based on no-action relief, if Glass Lewis believes the exclusion is detrimental to shareholders. See this blog from Davis Polk’s Ning Chiu.

– Diversity Reporting: Glass Lewis will now generally recommend in favor of shareholder proposals requesting additional disclosure on employee diversity and those requesting additional disclosure on the steps that companies are taking to promote diversity within their workforces.

– Environmental & Social Risk Oversight: Glass Lewis has codified its approach to reviewing how boards are overseeing environmental and social issues – if mismanagement of these risks has threatened or diminished shareholder value, Glass Lewis may recommend against the directors responsible for E&S oversight.

– Auditor Ratification: Glass Lewis will consider additional factors for auditor ratification proposals, including the auditor’s tenure, a pattern of inaccurate audits, and any ongoing litigation
or significant controversies which call into question an auditor’s effectiveness. In limited cases, these factors may contribute to a recommendation against auditor ratification.

– Virtual Shareholder Meetings: The policy announced last year will take effect in 2019. For companies opting to hold their annual meeting by virtual means, and without the option of attending in person, Glass Lewis will examine the company’s disclosure of its virtual meeting procedures and may recommend voting against the members of the governance committee if the disclosure does not ensure that shareholders will be afforded the same rights and opportunities to participate as they would at an in-person meeting.

– Written Consent Shareholder Proposals: In instances where companies have adopted proxy access and a special meeting right of 15% or lower, Glass Lewis will generally recommend against shareholder proposals requesting that companies adopt a shareholder right to action by written consent.

– Clarifying Updates: No changes here, but Glass Lewis has codified its approach to director and officer indemnification, quorum requirements, director recommendations on the basis of company performance, and OTC-listed companies.

– Liz Dunshee

Earlier this week, I blogged about typical terms for incentive plans that are based on relative total shareholder return. This blog from Hunton Andrews Kurth dives into another issue that pops up with these plans: how to handle payouts when relative TSR is good, but absolute TSR is negative. Should management still get a payout? Here’s some ideas:

– Elimination: Eliminate payouts when absolute TSR is negative over the measurement period (consider whether the reverse should apply – trigger a payout when absolute TSR is high but relative TSR is low).

– Cap the Opportunity: Implement a cap to the payout opportunity when absolute TSR is negative over the measurement period (consider whether the reverse should apply – same as above). When absolute TSR is negative, a cap would typically limit the payout at the target level.

– Downward Adjust the Payout: A modifier could be implemented to downward adjust the payout when absolute TSR is negative (consider whether the reverse should apply – trigger an upward adjustment to the payout when absolute TSR is positive).

We might be heading into a down market – and these alternatives can help you avoid the perception that you’re rewarding management for low returns, just because the company didn’t do as poorly as its peer group. But they do shift some general market risk back to executives. Also, keep this in mind:

It is common for compensation committees to initially denominate an executive’s award in dollars (e.g., the executive is awarded a target TSR equal to $300,000 as of the date of grant), and then convert that dollar amount into a number of shares covered by the relative TSR award. A design issue is whether the dollar amount should be converted into shares on the basis of grant date stock price or grant date “fair value” (the latter determined using a Monte Carlo simulation).

If the number of shares issued to your executives is calculated using the grant date fair value of the award, implementing any of the above design considerations will decrease the “fair value” of the award, thus having the direct result of increasing the number of shares subject to the award.

– Liz Dunshee

A recent study from The Conference Board, Gallagher & MyLogIQ shows that full-value stock awards represented almost half of total CEO pay last year – compared to 32% in 2010. That’s not too surprising in light of the market highs we experienced – Broc predicts that everyone will leap back into stock options in a bear market. Here’s more detail from the study:

– Companies continue the trend towards granting two or more types of long-term incentive plans (LTIs): All three major LTI vehicles (appreciation awards, time-based awards, and performance-based awards) have increased in prevalence from 2016 to 2017. There has been a slight uptick in appreciation award usage from 2016 to 2017, with prevalence increasing slightly to 46 percent in 2017.

– Both time & performance-based awards are trending: Time-based awards exploded in 2017, increasing in prevalence to 74 percent after falling from 66 percent in 2014 to 64 percent in 2016. In the same period, the use of performance-based awards, mostly performance shares, rose from 64 percent in 2014 to 77 percent in 2016, and have again grown in usage in 2017 to 80 percent. This continues the impetus of companies to demonstrate to their investors that longer-term incentives are more focused on strict performance measurement. Stock options have come under fire recently, with many commentators viewing performance awards that measure achievement over three years as midterm incentives. Stock options vesting over three to five years, and retained beyond that before exercise in many cases, are more often viewed as longer term. In addition, with retention clauses being added to many different types of equity awards—restricted stock, in particular—these are also viewed as longer term.

– Contrary to popular belief, CEO pay at larger companies is stable or even declining, while smaller firms are playing catch-up with double-digit raises for their chief executives: Companies with revenues less than $100 million saw increases for their CEOs at more than 20.5 percent, while CEOs in the next bracket up, $100 million to $999 million, had increases of 14.4 percent. However, CEOs in the largest companies ($25-49.9 billion and $50 billion plus) received, respectively, a decrease in pay (-7 percent) and a relatively modest raise (1.4 percent). Among financial services firms, several asset value brackets saw total compensation declines, and there was no real pattern to the changes in contrast to the analysis by revenue. In the lowest asset value bracket (less than $500 million) total compensation fell by more than 8 percent, while in the next bracket up ($500-$999 million) total compensation increased by more than 80 percent.