Incentive plans have the potential to drive executives towards achieving superior results for their companies and investors. At the same time, real and perceived risks in these programs can either blunt the potential drive of management or encourage excessive risk taking. A key goal in well-designed executive incentive programs is to motivate executives to take the actions necessary to achieve strong results for shareholders while mitigating the motivation to take excessive risks.
To date, the annual report that Compensation Committees provide in the CD&A on the presence of material risk in pay programs has been based largely on overall qualitative assessments done by the Company or their independent advisor. The most common risk assessment approach has been to look at each of the major incentive design elements in isolation – such as the presence or lack of a “cap” on annual incentives – and then judge the overall risk based on the types and number of potential risk-creating elements observed in the entire pay program. This qualitative approach is a self-assessment, and rarely does it look at relative risk compared to peer companies or a comparator group.
Pay Governance has recently developed a quantitative measurement tool, tested with the Fortune100, that will generate an overall score for both Pay Energy™(the first measurement tool that identifies the degree to which any company’s pay program creates “drive, discipline and speed”) and Pay Risk (in this context, risk refers to financial risk). This can then be used as an additional diagnostic tool to evaluate the potential of a new or existing pay design to achieve an efficient balance of Pay Energy™and risk management.
Stock Options, Restricted Stock Units, young Performance Units and their cousin Non-Qualified Deferred compensation tragically died in 2017 as an unintended consequence of colliding with the 429 page U.S. tax reform called the ‘‘Tax Cuts and Jobs Act.’’ It should be noted that Employee Stock Purchase Plan is currently in critical condition at a local hospital.
– Stock Options had lived an exciting and robust life since the 1980s. Friends and associates attribute the success of their business and the growth of nearly all technology we enjoy today to Stock Options.
– Restricted Stock Units, fondly remembered as “RSUs,” had recently provided stability to the family. After gaining prominence in the early 2000s, RSUs had recently become a leader in the family.
– Performance Units were just youngsters at the time of the accident. Vibrant and imaginative, their creative approach was an inspiration to companies and investors looking to build a brighter, more just, tomorrow. Their surprising loss will change the course of history for years to come.
– Non-Qualified Deferred Compensation (“NQDC” to its friends), a beloved cousin, lived a quiet life at edges of the family. While less well-known, NQDC was a vital component for many of its supporters.
Also impacted by the accident was Employee Stock Purchase Plans (ESPP). ESPP is a beautiful blend of many of the best features found in other members of the family. A favorite of a broad section of the population, ESPP’s mission was to provide an uplifting experience to the “regular folks” who often did not get a chance to meet other family members. ESPP is currently on life-support, with no additional information available at the time this was written.
The Equity Compensation family was often misunderstood, but lived to make people more successful. They enjoyed spending time with small, private companies in need of a spark for growth and well-known public companies working to provide the tools, system, medicine and other advancements that make the world a better place. Their extended family has moved all over the world and remain exciting contributors to the success of individuals in nearly every country on the planet. The loss of Equity Compensation in the United States will put all of us at a disadvantage in the competitive future.
Last week’s tax bill from House Republicans would have a tremendous impact on executive pay if enacted into law. We’re posting memos in the “Regulatory Reform” Practice Area – but here’s a teaser from Skadden that will blow you away:
If enacted, the newly proposed “Tax Cuts and Jobs Act” would effectively put an end to many of the most widely used forms of executive compensation:
– Deferred compensation and stock options would disappear
– Use of performance-based compensation would be severely limited
– Compensation over $1 million to senior executive officers would be nondeductible for public companies and subject to an excise tax for tax-exempt organizations.
Of course, the tax reform bill released by the House Republicans today (November 2) is likely to change, perhaps drastically, in the coming days.
Check out BDO’s latest study on middle-market board director compensation, finding that total board director compensation for middle market companies rose 4%, from $153k to $159k. Other findings include:
– Companies favor equity compensation over cash: use of stock options rose 3%
– Board retainers and fees increased an average of 9% across all industries
– Technology remains the highest compensated industry: Bank directors remain the lowest, earning $45k compared to their tech counterparts at $219k
Here’s the intro from this memo by Andrews Kurth Kenyon’s Tony Eppert & Mike O’Leary:
Many public issuers that are master limited partnerships (“MLPs”) or real estate investment trusts (“REITs”) have no employees, and instead, are externally managed by a related entity pursuant to a service agreement. This fact pattern, which is common to MLPs and REITs, raises a question of whether the issuer has to comply with the pay ratio disclosure rules of Item 402(u) of Regulation S-K if neither it, nor any of its consolidated subsidiaries, have employees.
Is it better to propose a new omnibus plan or amend an existing one? This blog by Ed Hauder of Exequity examines the age-old question by presenting voting data for both types of proposals. Here’s a teaser:
For companies that are looking to do everything possible to ensure a favorably vote outcome, then serious thought should be given to adopting a new omnibus plan since such proposals receive higher levels of voting support.
That said, the median level of vote support for proposals to amend an existing omnibus plan are slightly higher than the median support for proposals to approve a new omnibus plan. But this is offset by the fact that proposals to approve new omnibus plans have more votes coming in at or above the 90% level.
Yesterday, as reflected in this press release, ISS announced methodology changes to QualityScore – with an increase from 6 to 21 of the core factors considered. There is a data verification period between November 13th-28th for the changes – and the new changes are effective December 4th. Among others, new factors include evaluation of independence of the audit, nomination & compensation committees; unequal voting rights; and vesting periods for option & restricted stock awards.
As John blogged a while back, the IRS updated its “Golden Parachute Payments Audit Technique Guide” earlier this year for the first time since its 2005 issuance. While intended as an internal reference for IRS agents conducting golden parachute examinations, the Audit Technique Guide offers insight into how IRS agents are likely to approach golden parachutes when conducting an audit as explained in this new McDermott Will memo.
Yesterday, ISS released draft policy changes for comment in 13 areas spanning the globe (based on these survey results from constituents) – the deadline for comment is November 9th. It’s expected that ISS will release its final policies in late November (although burn rate thresholds & pay-for-performance quantitative concern thresholds are typically announced through updated FAQs in mid-December; here’s info about the ISS policy process).
These are the three main areas up for consideration in the US:
For the director compensation draft policy, here’s how Wachtell Lipton describes it: “ISS states that median pay for non-employee directors has increased every year since 2012 and was approximately $211,000 in 2016. In response to alleged “extreme pay outliers,” ISS is proposing to recommend voting against or withholding votes from members of board committees responsible for setting non-employee director compensation when there is a “pattern” (over two or more consecutive years) of “excessive” non-employee director pay without a compelling rationale or other mitigating factors. Among other things, ISS is seeking feedback regarding the circumstances for which large non-employee director pay magnitude would merit support on an exceptional basis, e.g., one-time onboarding grants for new directors.”
For the gender pay gap draft policy, here’s how Wachtell Lipton describes it: “ISS notes that there has been an increasing number of shareholder proposals requesting that companies report whether a gender pay gap exists, and if so, what measures will be taken to address the gap. ISS is proposing to vote case-by-case on requests for reports on a company’s pay data by gender, or a report on a company’s policies and goals to reduce any gender pay gap, taking into account the company’s current policies and disclosure related to its diversity and inclusion policies and practices, its compensation philosophy and its fair and equitable compensation practices. ISS will also take into account whether the company has been the subject of recent controversy or litigation related to gender pay gap issues and whether the company’s reporting regarding gender pay gap policies or initiatives is lagging its peers.”
1. This summary of a Pearl Meyer report includes these interesting pay ratio stats from a survey:
– Just 13% of the directors surveyed indicate their board has talked about the required disclosure of the ratio for the CD&A.
– Only 11% say they have discussed both internal and external communication.
– Companies in technology and healthcare/pharma/biotech appear to be most prepared in their communication, with 44% in each industry reporting some level of board discussion.
– 42% of companies are projecting a CEO Pay Ratio between 101:1 and 250:1, while 18% expect a ratio of 251:1 or higher.
2. This Weil Gotshal blog recaps what Corp Fin Chief Counsel David Fredrickson said at our “Pay Ratio” conference last week.
3. Ran into Maslon’s Marty Rosenbaum at our conference – and he reminded me of this humorous fictional pay ratio disclosure that he drafted several years ago:
[Disclaimer: An attempt at Item 402(u)-related humor follows. Because sometimes we just have to laugh.]
Soon a public company will be required to identify its median compensated employee and compare that employee’s compensation to that of the CEO. What if a company took this disclosure to the next level: don’t we want to learn something about the employee? Maybe you could see something like this in a future proxy statement:
“After a careful study utilizing its proprietary statistical sampling analysis, the Company has determined that its median compensated employee (“MCE”) is Ralph Snowden, age 37, pictured below. Since 2008, Mr. Snowdon has served as a senior fry cook at the Company’s West Des Moines, Iowa restaurant. Prior to that time, he held a wide variety of kitchen positions with companies in the fast food industry. As shown in the Summary Median Compensation Table (“SMCT”) below, in 2015, our MCE’s total annual compensation was $37,440. In 2015, the mathematical ratio of the total annual compensation of Ralph Snowden to that of our CEO, Ruth Swenson (the “Ralph to Ruth Ratio”) was one-to-238, or 0.0042016-to-one.”
Wouldn’t that be more fun? But now that I think about it, I’m not sure any part of Item 402(u) will work in Minnesota, where all the employees are above average.