– Broc Romanek
Recently, a member posted this query in our “Q&A Forum” (#1241):
Having read about ISS’s “wisdom of the crowd” approach to the construction of company-selected peer groups, my thoughts have once again turned to something that has always puzzled me concerning how ISS determines pay-for- performance alignment for the most recent performance year. I’m leaving to one side the issue of how closely the ISS peer group resembles the company’s proxy peer group, as that has improved significantly since 2012. (In any event, some years ago ISS said that its peer group is intended to serve a different purpose than the peer group selected by a compensation committee to benchmark executive pay, and that ISS’s pay-for-performance analysis is not intended to benchmark pay directly, nor is it intended to evaluate the effectiveness of a compensation program in attracting and retaining executives. I’m unclear as to whether that is still the case, but if it is, it argues against compensation committees trying to mirror the ISS peer group, since each peer group group is intended to serve a different purpose.)
Even assuming that a company’s peer group is identical to that constructed by ISS, the compensation and performance data available for each member of the peer group may vary widely, depending on when 10-Ks and final proxy materials are filed. In our case, fully 65% of our ISS peer group files proxy materials after us. In such cases, ISS says that it uses “…the latest compensation data available for the peer companies, some of which may be from the previous year.” U.S. Compensation Policies FAQs, at 33. (Dec. 14, 2017). Of course, due to the one-year lag in reporting equity grants in the Summary Compensation Table, some of the information ISS is using is two years old. That is, a 2017 Summary Compensation Table will show equity grants made in 2016 for 2015 performance.
Furthermore, even assuming that members of a peer group file at the same time, the information they provide will vary based on whether they provide a supplemental table that corrects for the one-year lag in reporting equity awards in order to better tie compensation to the most recent performance year. If Company A provides a supplemental table, it is providing ISS with an advance look at what will be in next year’s Summary Compensation Table. If Company B does not provide a supplemental table, ISS will rely on the Summary Compensation Table, which will show Total compensation that is distorted by the one-year lag in reporting equity awards.
Considering all of this, what is your opinion of the validity of ISS’s pay-for-performance methodology when analyzing the most recent performance year for members of its peer group?
Here’s the response that I posted from Carol Bowie of Teneo Governance:
As you note, the purpose of ISS’ peer groups does differ somewhat from that of the company, which is generally looking to benchmark pay to whatever market its management and board believe is appropriate to attract and retain talent.
According to its policy, ISS’ aim is to compile a peer group of companies that have specific similarities (primarily in size and industry) to the company being reviewed, as the first step in evaluating whether CEO pay and company performance are reasonably aligned. If that initial step indicates potential misalignment, what follows is a more in-depth (than normal) analysis and evaluation of the components and decisions related to the compensation program, with the ultimate recommendation based on whether the company’s disclosures indicate a robust pay process that clearly links pay outcomes to long-term company performance.
In working with our clients, we’ve found that there is no perfect peer group for such an analysis for many reasons, including the primary one the writer notes – i.e., various timing discrepancies. ISS may aim to utilize data as consistently as possible in the quantitative portion of their analysis, but there will almost always be anomalies to some degree, which is why it is critical that the company’s proxy disclosure – which ISS and other advisors rely on for their analyses — be as clear, comprehensive, and compelling as possible to support its pay programs and the decision-making underlying them.
– Liz Dunshee
When it comes to local “pay ratio” taxes, Portland is the only jurisdiction to-date that’s enacted this kind of surcharge. For businesses that earn income in that city, there’s a 10% surcharge if their pay ratio exceeds 100:1 and a 25% surcharge if their pay ratio exceeds 250:1. This blog from Cooley’s Cydney Posner notes that the median pay ratio for the Russell 3000 is 70:1 and summarizes some of the early results from Portland’s “experiment”:
According to this article in Bloomberg BNA, about 500 public companies have now been notified that they will be facing the surcharge because they earned income in Portland and reported pay ratios in their proxy statements that exceeded the thresholds. In one example provided on the city’s website, a public company that pays Portland $250,000 in regular business license taxes that reports a pay ratio of 1,000:1 would have to pay a surtax of $62,500 (25% of its business license tax), resulting in a total tax due to Portland of $312,500. This year, the city expects to raise about $3 million from the surtax, which is “earmarked for Portland’s affordable housing efforts and for funding its police force and fire stations,” according to a current Portland Commissioner. The Commissioner also indicated that, “the penalty is meant as a way to help tackle income inequality, [and she] hopes that it sparks an increase in what companies pay their average employees.”
Bloomberg observes that supporters and opponents alike admit that the surtax is “not likely to put a dent in the coffers of most companies, and whether it spurs changes in corporate compensation practices is likely to hinge on this strategy’s widespread adoption. ‘As a practical matter, it’s still a drop in the bucket for these companies,” [the Commissioner said], ‘Little Portland is not going to make much of a difference on its own.’” According to the Mayor of Portland, quoted in this NYT article, the city has “‘a habit of trying things…; maybe they’re not perfect at the first iteration. But local action replicated around the country can start to make a difference.’”
But as I blogged last month, “pay ratio” taxes don’t seem to be taking off…
– Liz Dunshee
This 26-page study from Meridian describes current pay trends & developments – based on 127 companies in a variety of industries. Here’s some highlights:
– 42% of respondents reported holding CEO base salaries flat for 2018 (17% for other executives). This indicates that many companies may no longer be providing annual base pay increases to CEOs and, instead, are making more periodic adjustments based on significant market movements or other factors.
– Unlike last year, when the majority of respondents reported maintaining LTI grant values from the prior year, this year 54% of respondents reported that 2018 target long-term incentive grant values were greater than 2017 values. The median increase was 9%.
– For annual incentives, a modest decline in the use of an EPS metric was observed, often coupled with a movement to profit metrics not measured on a per share basis.
– Liz Dunshee
In public company deals, target company equity awards are frequently converted into awards under the buyer’s equity plan, and new awards under the buyer’s plan are also often made to target executives who will be retained post-closing. This Hunton Andrews Kurth memo outlines exemptions under NYSE & Nasdaq rules that a buyer can use to make M&A related awards without putting a dent in the shares reserved under its shareholder approved equity plans. This excerpt addresses how shares available under the target’s plan can be used for post-closing awards:
The share reserve under a preexisting shareholder-approved target equity plan may be used for post-transaction grants without additional shareholder approval under certain circumstances. Shares available under such a preexisting plan may be used for post-transaction grants of acquiror equity awards (assuming the acquiror remains a publicly-traded company), under either the preexisting target equity plan or another plan (such as the acquiror’s equity plan), without further shareholder approval, under the following conditions:
– The shares must be available under a plan that was not adopted in contemplation of the M&A transaction.
– The number of shares available for grants is appropriately adjusted to reflect the M&A transaction.
– The time during which those shares are available for grant is not extended beyond the period when they would have been available under the preexisting plan absent the M&A transaction.
– The equity awards are not granted to individuals who were employed, immediately before the transaction, by the acquiror and such grants are therefore generally limited to grants to employees of the target and its subsidiaries who continue employment with the acquiror post-transaction.
The memo also outlines exemptions that would permit outstanding target equity awards to be converted into or replaced by awards denominated in shares of the buyer’s stock without shareholder approval.
– Liz Dunshee
This blog summarizes recent research that examines the link between executive equity pay & “myopic management” – cutting marketing spending to artificially inflate earnings. Interestingly, the researchers didn’t find that CEO equity would lead to this practice. But Chief Marketing Officers (“CMOs”)? That’s a horse of another color. Here’s an excerpt:
In our empirical analyses we find that the mere presence of a CMO in the firm has no effect on either the incidence or the severity of myopic management across all three proxies for marketing spending. We also find that CEO equity incentives are largely unrelated to the incidence and severity of myopic marketing management. CMO equity compensation, on the other hand, is highly predictive of the incidence and severity of myopic marketing management. Contrary to the belief that the presence of a CMO in the organization can help maintain customer focus and support for marketing departments, we find that CMOs not only fail to prevent myopia, but further exacerbate the problem as the market-based (i.e. equity) portion of their personal compensation increases.
Further, consistent with the CMO’s personal enrichment motivation, we also find that CMOs take advantage of artificially inflated stock valuation by exercising more stock options and selling more of their personal equity holdings in the years when myopic marketing management occurs. This observation is robust to many alternative explanations such as firm-specific or management-team-specific reasons to trade equity.
– Liz Dunshee
A recent Gallup poll found that opinions of the general public are evenly split when it comes to having federal legislation place a cap on executive pay: 47% favor it – and 48% oppose. This compares to 59% supporting caps in 2009. Pay ratio disclosures might be what’s keeping the level of support relatively high. Here’s an excerpt from the press release:
The focus on high levels of executive pay, however, is still part of the economic discussion – both in the U.S. and abroad. Some of the reported ratios of CEO-to-median worker pay are extremely large, including reports of a CEO’s pay being more than 300 times as high as the pay of the average worker – helping highlight the high executive compensation that is increasingly the norm in large U.S. companies today.
– Broc Romanek
Here’s the intro from this WSJ article by Theo Francis about amended proxy disclosures:
When Laboratory Corp. of America disclosed pay for its chief executive in March, the company said he made $1.5 million in 2016. A week later the diagnostic-lab chain filed a new document listing his pay at $10.9 million. Chief Executive David King didn’t get a retroactive raise. His employer just proofread its work.
Such a big discrepancy is unusual, but LabCorp isn’t the only big company to make significant adjustments to past pay disclosures. At least 16 companies in the S&P 500 have changed 2016 pay figures by more than 10% for one or more executives, while 17 did so for 2015 pay, a Wall Street Journal analysis of data from MyLogIQ LLC shows.
– Broc Romanek
Time to act on the registration information for our popular conferences – “Pay Ratio & Proxy Disclosure Conference” & “Say-on-Pay Workshop: 15th Annual Executive Compensation Conference” – to be held September 25-26 in San Diego and via Live Nationwide Video Webcast. Here are the agendas – nearly 20 panels over two days.
Among the panels are:
1. The SEC All-Stars: A Frank Conversation
2. Parsing Pay Ratio Disclosures: Year 2
3. Section 162(m) & Tax Reform Changes
4. Pay Ratio: How to Handle PR & Employee Fallout
5. The Investors Speak
6. Navigating ISS & Glass Lewis
7. Proxy Disclosures: The In-House Perspective
8. Clawbacks: What to Do Now
9. Dealing with the Complexities of Perks
10. Disclosure for Shareholder Plan Approval
11. The SEC All-Stars: The Bleeding Edge
12. The Big Kahuna: Your Burning Questions Answered
13. Hot Topics: 50 Practical Nuggets in 60 Minutes
14. Dave & Marty: True or False?
15. Steven Clifford on “The CEO Pay Machine”
Reduced Rates – Act by June 29th: Huge changes are afoot for executive compensation practices with pay ratio disclosures on the horizon. We are doing our part to help you address all these changes – and avoid costly pitfalls – by offering a reduced rate to help you attend these critical conferences (both of the Conferences are bundled together with a single price). So register by June 29th to take advantage of the discount.
– Broc Romanek
Here’s the intro from this Wachtell Lipton memo (that memo is posted on TheCorporateCounsel.net – this “Meridian Compensation Partners” memo also covers this development):
In the latest effort to enhance transparency by proxy advisory firms, six members of the Senate Banking, Housing and Urban Affairs Committee sent letters to ISS & Glass Lewis – which they noted control 97% of the proxy advisory industry – requesting information regarding their eligibility for exemption from the proxy rules, accuracy of reporting and potential conflicts of interests.
The Senators’ letters reflect many of the concerns underlying the bill passed by the House of Representatives last December, titled the “Corporate Governance Reform and Transparency Act of 2017,” which would require proxy advisory firms to register with the SEC, disclose potential conflicts of interest and codes of ethics, and publicize their methodologies for formulating proxy recommendations.