The Advisors' Blog

– Liz Dunshee

Ed Hauder of Exequity has posted his “2018 ISS “Equity Usage” Calculator.” It allows you to calculate your 3-year average run rate & burn rate – and compare it to the 2018 ISS industry burn rate figures.

– Liz Dunshee

In our “Q&A Forum,” a member recently asked (#1229):

Has anyone dealt with issues relating to a company making a grant under one stock incentive plan but inadvertently documenting the grant using an award agreement related to a different (former) stock incentive plan? If so, how was it handled?

This was my take:

In this situation, both the company and the participant benefit from having the award properly documented. For the company, if there are big differences between the forms it’s risky to issue an award with different terms than what was approved by shareholders and registered with the SEC. And in any event, it’ll be an administrative pain if you have an award floating around with slightly different terms. For the participant, it’s inaccurate and confusing for the award agreement to refer to the prior plan – even though the award is no doubt accounted for in minutes and the company’s equity plan software, they’ll show up in a few years to get their stock and people might scratch their heads and have to comb through records to make sure they’re really entitled to it. And if you have any sort of corporate transaction in that time, it could be even more of an issue.

So even though it’s somewhat embarrassing in the short-term, I’d have the parties execute an amended and restated agreement. You can add a recital acknowledging that the parties previously entered into an agreement for the award but made a clerical error and wish to conform the agreement to what’s permitted by the applicable plan. If there’s reluctance to do that, then at the very least I’d try to get an amendment that corrects the name of the plan under which the award was granted and an analysis of whether the terms of the old form would be permitted by the current plan (including any necessary corrections in the amendment, and reporting any material differences on an 8-K if the person is a PEO, PFO or NEO).

– Liz Dunshee

This year’s “ClearBridge 100″ report notes that – possibly due to increasing scrutiny from shareholders & proxy advisors – almost all large companies have adopted clawback policies, stock ownership & post-vesting holding requirements and anti-hedging/pledging policies. In addition, only 7% of companies said they positioned target compensation above the 50th percentile – down from 24% in 2015. Here’s more detail:

– Most companies apply clawbacks to all aspects of incentive compensation

– For stock ownership guidelines, 75% of companies require a multiple of at least 6x salary for the CEO – up from 62% in 2015

– 59% of companies have post-vesting holding requirements – of those, 85% require executives to hold equity grants until stock ownership guidelines are met

– 97% of companies have an anti-hedging policy & 79% of companies have an anti-pledging policy – up from 71% in 2015

– Liz Dunshee

Recently, Compensation Advisory Partners surveyed non-employee director pay practices among the 100 largest companies. This WSJ article describes the findings. Here’s an excerpt:

– Director pay at large U.S. companies continues to creep upward: half paid a typical board member $300,000 or more last year. As compared to the S&P 500, a 2016 WSJ analysis found median pay was between $230,000 – $295,000.

– As a result of litigation (e.g. Investors Bancorp), 54% of companies now have an award limit for director compensation – up from 47% in the prior year. However, the limits are often significantly above existing pay levels. About half the companies limited pay to between $500,000 and $1 million, and most set limits at least triple what they currently pay in equity grants.

– Other features of director compensation haven’t changed much. Most pay annual stipends rather than per-meeting fees. Equity makes up about 60% of pay overall—primarily restricted stock rather than options—with the rest paid in cash.

– Directors who head key committees tended to receive additional fees, with a median of $15,000 to $25,000, depending on the committee.

– The median additional amount received by lead directors remained about $35,000, while the median additional fee paid to non-executive chairmen was about $233,000.

Also see this blog from Mike Melbinger: “Boards Should Review Non-Employee Director Compensation in Light of Adverse Court Decisions.”

– Liz Dunshee

So far, this year’s say-on-pay failure rate is about 2% higher than last year. This “As You Sow” blog gives a take on why that’s happening. Here’s the intro:

Not all the votes are in, but there are already a significant number low votes and outright losses among the S&P 500 on pay packages. So far there are seven S&P 500 companies that have lost majority votes that I’m aware of for this calendar year: Ameriprise, Disney, Halliburton, Mattel, Mondelez, Western Digital and Wynn Resorts. Chesapeake Energy which was removed from the S&P 500 on March 19, 2018 due to “market capitalization changes” also had a failed pay vote.

Most of the early low votes and failures fell under two categories: transition packages and pay/performance disconnect. In many instances both factors were in play.

– Liz Dunshee

New this year, ISS started taking a closer look at director pay. In the absence of a “compelling rationale” or other mitigating factors, it 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. This means that we could start seeing negative vote recommendations in 2019. Here’s more detail from this Meridian memo:

ISS guidance indicates how it will determine whether director pay is “excessive”: To determine outlier cases, ISS will compare individual non-employee director (NED) pay totals to the median of all non-employee directors at companies in the same index [e.g., S&P 500] and industry [i.e., two-digit GICS group]. The purpose is to identify a pattern of extreme outliers, which historically has represented pay figures above the top 5% of all comparable directors [based on ISS back testing].

One area of concern raised by ISS’s evaluation of NED compensation is with respect to non-executive chair pay levels. We have received informal guidance from ISS that it has been comparing non-executive chair pay levels against the median pay of all NEDs at companies in the same index and industry, rather than against the median pay of other non-executive chairs. This methodology will cause non-executive chair pay at many companies to rank high against the comparator group, because non-executive chair pay is often significantly greater than other non-employee directors’ pay. As director pay levels tend to be closely clustered, moderate increases in total compensation can have a material impact on percentile calculations.

To reduce the risk of a negative recommendation, companies should consider disclosing the rationale for director pay (including non-executive chair pay). It’s also helpful to describe the director pay-setting process.

This earlier blog notes that the ISS policy is a good reason to evaluate director pay annually, and lists some practices to avoid. Also see this blog from Mike Melbinger: “Boards Should Review Non-Employee Director Compensation in Light of Adverse Court Decisions.”

– Liz Dunshee

Tune in tomorrow for the webcast — “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Morrison & Foerster, and Ron Mueller of Gibson Dunn analyze what was (and what was not) disclosed this proxy season.

– Liz Dunshee

Recently, I blogged about the business case for adopting robust clawback policies. One of the arguments against doing that is research that shows executives subject to clawbacks might be more likely to resist needed restatements. But according to a new 7-year study of the Russell 3000, that concern is overstated. This “CFO.com” article explains the findings (also see this Cooley blog):

The study, by Peter Kroos and Frank Verbeeten of the University of Amsterdam and Mario Schabus of the University of Melbourne, finds clawback adoption to be associated not with weakened ties between pay and company performance but “with greater CFO bonus incentives tied to accounting measures.” On average, the sensitivity of CFO bonus pay to a company’s return on assets nearly doubles following clawback adoption. Such sensitivity is found to be less pronounced for other top executives.

These developments, the study concludes, have occurred because companies are not only boosting bonuses based on accounting integrity, they’re also increasing bonus pay for strategic output that improves performance. In short, CFOs have less incentive to manage earnings through accounting then they did previously because (1) they’re getting paid for accounting integrity, and (2) they prefer not to jeopardize the bonus money extended for the more creative aspects of their job.

“Prior to clawback adoption,” the professors write, “firms have been under-incentivizing CFOs’ decision-making duties to emphasize the role CFOs have as watchdogs for financial reporting integrity. The implementation of clawbacks could enable firms to incentivize CFOs’ decision-making duties more appropriately … without increasing their propensity to misreport.”

The study also finds that when a company has control weaknesses and other signs of accounting manipulation, there’s a weaker correlation between CFO incentives and clawback policies.

– Liz Dunshee

Last month, I shared some predictions about the impact of tax reform on executive pay. And although other surveys show that companies have considered eliminating “performance-based” structures, this recent “Deloitte Consulting” survey confirms that for now, companies aren’t making many changes in response to the repeal of Section 162(m). Here are the key findings:

– None of the survey participants expect to reduce pay due to the loss in tax deductibility.

– 92% of participants indicated that they aren’t going to change the pay mix (fixed versus variable compensation) or executive incentive design structure. The most common change in executive pay structure reported by participants was adopting a new formulaic incentive plan.

– 55% of participants said they aren’t going to change the administrative provisions in their incentive plan documents.

– Only 44% of participants knew whether their pre-tax reform awards would be “grandfathered.”

– Broc Romanek

I gotta blog about anything entitled “Compensation Wormhole,” right? Love this piece by Performensation’s Dan Walter. Here’s the intro:

Time Travel. In the movies, it usually requires some door into a wormhole or some type of hyper-drive. In the business world, it’s one of the easiest things to do. No special skills or tools are required. Leaping ahead 4 or 5 years is as simple as changing the destination in your GPS.

We have been living in an age of 3% annual increases for several years. Sometimes it’s a bit more; sometimes it’s a bit less. On average, it’s not too inspiring. We do our best to give a bit more to our best performers, but those in the middle must fend for themselves. It’s not hard for them to find a time machine.

Let’s look at it from the perspective of an employee who is doing a good, but not outstanding job.

Let’s say you’re making $100,000 in base pay. You don’t know it, but you are on the low end of your pay range. This is mainly because of the pay from your start date combined with budgetary restrictions. It’s likely that this number is also the basis for much of the rest of your total rewards. Perhaps your STI target is 30% of base. Maybe your LTI target is 40%. Even your 401K contribution is based on your overall pay. Next year all of these things will climb by 3% (if you’re lucky). Over the next three years, the increase will be about 10%.