We don’t often blog about issues specific to private companies – or hard-core tax stuff (thankfully we leave that to “The Corporate Executive” newsletter – and the NASPP). But it’s worth mentioning new Section 83(i) of the Internal Revenue Code, which was added by the Tax Cuts & Jobs Act. Section 83(i) allows private company employees to defer taxes for up to five years from the exercise of a stock option or settlement of a restricted stock unit.
This new Section is intended to benefit smaller & start-up companies, but whether it will actually be helpful remains to be seen. First, a 5-year deferral might not align with a liquidity event. And there are a lot of caveats – including that the company’s written equity plan must grant stock options or RSUs to at least 80% of all employees who provide services to the company in the U.S.
Not only that, Section 83(i) comes with some obligations & risks for companies – there’s a requirement to notify employees (or face penalties) if any of the outstanding awards are eligible for this tax deferral. This Wilson Sonsini memo dives into all of the conditions & requirements. It concludes:
Employers should begin assessing whether they have an obligation to comply with Section 83(i)’s notice requirements to avoid incurring penalties. Under a transition rule, until the IRS issues guidance implementing the employer notice and 80 percent test provisions, employers may comply with those requirements under a reasonable good faith interpretation of the statute. Employers wishing to enable their employees to take advantage of the Section 83(i) deferral opportunity should evaluate whether they wish to design their equity program to permit employees to make Section 83(i) elections in the future and begin planning early.
Section 83(i) provides a favorable, tax-deferral opportunity for rank-and-file employees. However, it likely will involve considerable administrative burden for employers to track eligibility, comply with the notice requirement, and properly report and withhold on deferred taxable income. Given the administrative complexities associated with Section 83(i), some employers may desire to avoid qualifying for Section 83(i) elections either by plan design or operation of the equity compensation program.
This “Proxy Insight” newsletter is full of interesting voting data. On page 4, it reports that 67 of this year’s say-on-pay votes failed to win majority approval. That’s a record number – and a big jump from last year’s 38. This is particularly surprising given the skyrocketing stock market. Wonder what’ll happen when the market falls back to earth…
Yesterday, ISS opened its “Annual Policy Survey.” Like last year, it consists of two parts. The first is a “Governance Principles Survey” – which consists of 10 questions on high-profile topics including auditor independence & quality, audit committee evaluations, board gender diversity and the “one-share, one-vote” principle. This blog from Mike Melbinger highlights that one of the high-profile topics has a relationship to executive compensation:
If ISS assesses that an individual director has failed in his or her oversight responsibilities at one company and this has resulted in a negative ISS vote recommendation, do you consider it appropriate and useful for shareholders for ISS to note this in the proxy research of other companies where that director serves on the board? . . . What types of oversight shortfalls would you consider to be relevant to the assessment in such a situation,” e.g., pattern of poor stewardship of compensation practices, risk oversight failures relating to fraud, or other forms of corporate malfeasance, risk oversight failures related to business operations (such as cyber security), and/or oversight failures regarding protection of shareholder rights or shareholder value.
The second part is a “Policy Application Survey” that allows respondents to drill down on key issues by region. This Weil blog says that the key issues for the Americas region include excessive non-executive director compensation & pay-for-performance metrics.
As always, this is the first step for ISS as it formulates its 2019 voting policies. In addition to the two-part survey, ISS will gather input via regionally-based, topic-specific roundtables & calls and a comment period on the final proposed changes to the policies.
Not only is Cap’n Cashbags real, he has proteges embedded in boardrooms. This blog from Pearl Meyer’s Jim Heim gives specific examples of how they make the argument for “more, more, MORE!” – and some ideas for inoculating boards against greed. Here are some red flags:
1. Move the goalposts. Your greedy executive may point to success with respect to top-line growth when your investors (and your incentive plans) are focused on margin expansion. Or question why revenue is given greater weighting than operating income when selecting peers for benchmarking purposes. Or raise any of a thousand other objections which all boil down to: “Measure me on the areas where I perform well, not the areas you deem important.”
2. Benchmark by anecdote. Your greedy executive may bring you a proxy filing of a competitor who pays their own similarly-titled executive more, without doing the homework to understand which is the anomaly—your greedy executive’s pay or the pay of this supposed peer. Questions arising from this type of behavior are a weekly occurrence in my work. But I have never heard of an executive asking for explanation as to why a competitor is paid less than s/he.
3. Pay me twice. Following a multi-year period of strong performance, the greedy executive asks whether some form of supplemental award is in order. In almost all cases, there is sufficient leverage in the incentive plans such that the executive has already reaped several years of above-target payouts with respect to both cash bonuses and performance shares earned, and equity-denominated vehicles are now much more valuable than what was expected on date of grant (due to accompanying run up in stock price). The executive has already been paid for the performance.
4. I’d like the reward, you can keep the risk. The greedy executive is eager to sign up for a program that will provide extraordinary rewards for extraordinary performance, but questions the fairness of having similar downside risk in the program. “If we meet these aggressive goals, it is most likely evidence that the management team has executed flawlessly against a well-conceived strategic plan…but if we fail, it’s most likely due to exogenous factors. Since those factors are out of our control, we ought not be held accountable for failure to perform.” Or, more succinctly: “Heads I win, tails you lose.”
5. I didn’t like Mom’s answer, so I’ll go ask Dad. The greedy executive attempts to circumvent his/her CEO and go directly to a board member with concerns over his/her pay. This may be exacerbated by a weak CEO inadvertently (one would hope) encouraging this behavior with a “my hands are tied” aroach to communicating a pay decision.
This “Chief Executive” article highlights the pay gap between public & private executives. It makes sense for public company CEOs to earn more than their private-company counterparts, due to their additional responsibilities and risks. Also, we’re in a rising market and a significant portion of their pay is equity-based. But the pay difference is pretty striking. Here’s how the numbers shake out at companies that have similar revenue:
While CEOs of private companies with $100 million to $249.9 million in revenue earned a median total pay package worth $524,500 in 2014, CEOs of public companies in the same revenue range earned 2.8 times that amount – and the compensation gap between public & private companies grew wider with the size of the company.
We received this note recently from an anonymous member:
I have learned that ISS is aware of the issues with the timing differences caused by proxy filing dates within a peer group – e.g. even if a company and ISS use identical peer groups, only outdated data is available to ISS for the later filers in the group – and that data has no relevance to the most recent performance year. This impacts all of the relative measures that ISS uses in its quantitative pay-for-performance evaluation: Multiple of the Median, Relative Degree of Alignment and Financial Performance Assessment. Because ISS understands that the most recent CEO compensation data isn’t available for all members of a peer group, ISS will rely on its judgment in making a say on pay vote recommendation – which is why only about half of the companies with “high concern” receive an against recommendation.
In any event, this illustrates the difficulty ISS faces in quickly analyzing and formulating say on pay voting recommendations for a company and highlights the degree to which ISS substitutes its judgment for that of a board of directors without a firm quantitative basis for doing so. I have seen passing references to this disclosure timing issue in some law firm memos and academic articles, but I don’t think most companies have a reason to focus on the issue as long as they receive a “For” SOP voting recommendation.
I actually have some sympathy for the difficulties ISS has in processing thousands of SOP management proposals each year with a very short turnaround period (cf., Lucy and Ethel working on the candy factory conveyor belt). That said, ISS may wish to consider clarifying the degree to which its SOP voting recommendation for a company relies on the relative quantitative measures as opposed to its own judgment.
You can find more insight into ISS’ methodology by perusing their FAQs and the other resources that we’ve posted in our “Proxy Advisors” Practice Area.
Most companies have now made their first pay ratio disclosure – and held their first say-on-pay vote in which shareholders could consider that information. It’s looking like shareholders consider pay ratio as a factor – but it’s not a primary driver of votes. This Semler Brossy memo analyzes the results in detail. Here’s some highlights:
– Average say-on-pay support of 87% for S&P 500 companies that disclosed an above-median pay ratio, compared to 91.6% support for companies with a below-median pay ratio. This correlation was weaker among Russell 3000 companies.
– Say-on-pay results were 31% lower at companies that received an ISS recommendation “against.”
– While only 21% of the Russell 3000 disclosed a pay ratio above 175:1, those companies made up 46% of all say-on-pay failures.
– Pay ratio typically is more influenced by the CEO’s pay than the median employee’s – especially for ratios below 100:1. This means the ratio tends to grow with company size & revenue (factors which typically lead to higher CEO pay but not higher median employee pay). The median pay ratio of the S&P 500 is more than 2x the median ratio of Russell 3000.
– Pay ratios differ greatly by sector – e.g. utility companies have lower ratios due to unionized labor and higher median employee pay. Companies with bottom quartile median employee pay have significantly higher ratios, driven by part-time or seasonal workers.