A few days ago, I blogged about whether 3-year performance periods align with investor definitions of “long-term.”
In this article, Joe Bachelder of McCarter & English presents a case study of Exxon Mobil’s lengthy vesting periods for Rex Tillerson & suggests a fix to existing incentive programs that would place more emphasis on 5-year or longer timeframes:
New incentive awards (including annual bonuses and three-year “long-term” awards) would be made subject to a “rolling” five-year adjustment factor. The adjustment factor would be applied each year based on a five-year cumulative performance target for the five years ending with that year. For example, the five-year period January 1, 2013 through December 31, 2017 would have a performance target (e.g., return on equity for the five-year period). Actual achievement would be expressed as a percentage of target (100 percent—exactly on target, 90 percent for 90 percent achievement of target, etc.).
This percentage would be applied to incentive awards being earned out at the end of that year. For example, at a 90 percent-achievement of the five-year performance target, each incentive award otherwise earned out would be adjusted to 90 percent of the earned-out award. If the five-year performance exceeded target, a corresponding adjustment upward would be made. In this way existing incentive programs could be continued without basic change but would be subject to adjustment, taking into account how well the employer is doing in its performance over periods longer than three years.
I like the concept – but two questions come to mind:
1. Are there many companies & execs brave enough to trail-blaze longer-term programs? Tillerson’s case is unique due to Exxon’s size & the fact that he worked there over 40 years.
2. Could grant date fair values in the summary comp table easily be adjusted downward to reflect longer vesting periods? You wouldn’t want to rely on investors reading all of the narrative info about the program…
Check out our “LTIPs” Practice Area for more suggestions on plan design & effective long-term incentives.
We haven’t heard much lately about proxy disclosure lawsuits, but they haven’t disappeared. An Intel shareholder is seeking to enjoin a May 18 vote on the company’s amended and restated stock plan – which would add 33 million new shares & extend the term of the plan to 2020.
According to the complaint, Intel’s 2017 Proxy Statement fails to report how many participants are in the plan and why they are receiving these awards. Under Exchange Act Rules 14a-3(a) and 14a-101, the complaint asserts, a proxy statement soliciting a vote on a plan under which compensation may be paid must contain information required by Item 10(a)(1) of Schedule 14A, including the class and number of persons eligible to participate and the basis for their participation. The complaint asks the court to enjoin the vote unless and until Intel furnishes a supplemental proxy statement making the required disclosures.
Yesterday, Intel filed a “Proxy Statement Supplement” – which in addition to responding to shareholder proposals & highlighting Intel’s accomplishments, spells out the number and class of plan participants.
We don’t know whether Intel made any settlement payment in connection with filing the supplement, or whether this complaint signals a renewed trend. But it wouldn’t hurt to check out Intel’s original Proxy Statement and flag this disclosure item for your future EIP proposals…
A recent analysis of 250 large public companies found that nearly all use a 3-year period for “long-term” performance awards. In this article, Tom McNeill & Jon Szabo of Meridian Compensation Partners examine why this is the case – and what companies can do to break free of the norm.
Among other factors, they note:
A practical issue is the need to set fixed, three-year financial goals when using a performance award. While most (85%) companies set multi-year goals, a vocal minority have succumbed to the challenges and uncertainty of setting goals three years into the future, by using an average of three one-year goals. Extending the performance period beyond three years would only serve to increase the challenge and uncertainty of this situation. Resorting to one-year goals set annually will usually result in the proxy advisory firms making adverse comments on this approach.
However, the goal-setting argument does not work when relative TSR is the performance measure (it’s the most prevalent measure, used by 57% of companies). Since no goal-setting is required, decisions instead focus on the shape of the award payout curve – generally defined by the company’s percentile positioning or ranking versus peers. One could argue that for relative TSR plan designs, it should be easier to use a longer performance measurement period. Yet, only 2% of companies have performance periods longer than three years.
I blogged last week that TSR’s popularity is leveling off – maybe this is an argument for keeping it around. In any event, for companies considering a shift to longer-term performance periods – ongoing communication with investors & executives will be key.
Recently, Willis Towers Watson evaluated year-end performance for the S&P 1500 – looking at median results for common pay-for-performance metrics. Here’s a teaser:
The results reflect low single-digit growth, a mixed bag in the balance sheet, less than stellar cash flow results, yet strong stock valuations and shareholder returns. This reminds us that the stock market looks forward, i.e., to 2017 and beyond. This is an important reminder when thinking about pay-for-performance alignment because most bonus plans and a sizable portion of long-term incentive plans pay based on past financial performance.
For 2017, investors appear optimistic – as analysts expect typical performance metrics to increase by 1-3%. But an uncertain policy & business outlook has made goal-setting more difficult…
According to a recent Equilar report, relative total shareholder return remains the most popular pay-for-performance metric – used by 57% of the S&P 500. But its use has leveled off amid recognition that executives can only control factors that influence TSR – not the final outcome.
How are companies implementing this shift away from TSR? Return on capital & earnings per share are gaining popularity – along with other metrics that drive TSR. Here’s a blurb from Equilar’s summary:
As a result, other popular metrics like ROC and EPS saw a resurgence in 2015. Only ROC consistently increased every year in the Equilar study, rising from 26.1% in 2011 to 30.6% in 2015 for CEOs. While EPS declined each year between 2011 and 2014, use of this metric in 2015 increased from 27.3% of companies to 29.2% in 2015, though still below its high in 2011 of 34.6%.
Most commonly, companies simply reduced how TSR was weighted, and half of the companies in the study employed this strategy. Companies redesigned these awards so that they were no longer contingent on one factor, instead using multiple measures to drive executive performance.
Interestingly, each company split its weighting in half, with one company reducing its impact on the award’s payout from 50% to 25% and four companies reducing it from 100% to 50%. These four companies balanced the use of TSR as a performance metric by incorporating at least one additional metric that affected the awards’ payouts.
While five companies balanced the use of TSR by introducing other metrics, four out of the 10 changed how TSR affected award payout by transforming it from a weighted metric to a modifier. Weighted metrics determine the initial award payout, while modifiers provide a final adjustment.
Three companies instituted a standard multiplier, which can adjust the final payout up or down. In the study, the smallest multiplier could adjust payout down by 90% and up by 110%, whereas the largest could adjust payout down by 75% and up by 125%. Pfizer had a unique modifier among the set of companies—while unlikely, the modifier has the power to reduce the award level to zero or boost it to the maximum in cases of extreme TSR performance.
Finally, one company completely removed TSR from their award design, shifting from a 100% TSR focus to a 100% EBITDA focus.
This article in “Proxy Insight” (pg. 3) by EY’s Rupal Patel in the UK proposes a new model for executive pay. Here’s an excerpt:
EY’s view is that this simplification agenda cannot be addressed by tweaking aspects of the traditional package. This is not about the number of performance measures used or the length of deferral applied. It is about acknowledging that a desire for simplification requires agreement on what is core to an executive pay strategy and to focus on that exclusively.
EY feels that many aspects of today’s pay structures, which have been viewed as integral to the traditional model, may not be the most efficient way to deliver remuneration or may simply be no longer relevant.
Speaking of the UK, this Manifest blog notes how BP simplified its pay policy in the wake of a failed say-on-pay vote in the UK last year…
This interesting memo from Pay Governance’s John Ellerman & Lane Ringlee describes the benefits of disclosing prospective compensation in the CD&A. Here’s a teaser:
In recent years, the SEC has developed extensive rules and regulations regarding the reporting of executive compensation in the company annual proxy. Such reporting includes the narrative discussion of CD&A executive compensation policies and practices as they pertain to the CEO and NEOs. Additionally, the SEC requires that companies provide numerous prescribed tables and schedules reporting the historical elements of executive pay for the most recently completed fiscal year as well as the past 2 fiscal years.
The thrust of the SEC’s current mandated reporting of executive compensation to shareholders is a “lookback” at executive compensation earned. Current SEC rules require companies to report on the executive compensation that was most recently earned and paid for the fiscal year just completed. For a typical public company that has a fiscal year of January 1 through December 31, the proxy is normally submitted to shareholders in April or May of the ensuing calendar year. Compensation reported for the preceding fiscal year in the proxy may be based upon decisions executed by the Compensation Committee as early as 16 months prior to the proxy reporting to shareholders.
The Delaware Chancery Court recently dismissed a derivative suit – “In re Investors Bancorp Stockholder Litigation” – challenging $50 million worth of director equity grants under a shareholder-approved incentive plan. The business judgment rule protected the directors because the plan limited awards by specific category of beneficiary – in this case, non-employee directors & employees – and the proxy statement adequately disclosed the impact of those limits. This excerpt from Steve Quinlivan’s blog gives more detail (also see this Mark Poerio blog):
The opinion notes the Court of Chancery recently performed an exhaustive review of the law of stockholder ratification with regard to director equity compensation in Citrix. The Citrix court noted that there is a distinction between stockholder approval of a plan that features broad parameters and “generic” limits applicable to all plan beneficiaries on the one hand and, on the other hand, a plan that sets “specific limits on the compensation of the particular class of beneficiaries in question.” Approval of broader plans will not extend to subsequent grants of awards made pursuant to that plan; approval of plans with “specific limits,” however, will be deemed as ratification of awards that are consistent with those limits.
According to the Court, once a plan sets forth a specific limit on the total amount of options that may be granted under the plan to all directors, whether individually or collectively, it has specified the “director-specific ceilings” that Citrix found to be essential when determining whether stockholders also approved in advance the specific awards that were subsequently made under the plan.
As noted on page 45 of their voting report, the UK institutional investor – Legal & General Investment Management – voted against 42% of pay proposals at US companies in 2016, based on its position that at least 50% of long-term equity awards should be based on achieving pre-set performance targets. Compare that number to ISS’s recommendations “against” at “just” 9% of US companies!
LGIM also voted against management on at least one proposal at 65% of its US portfolio companies (see chart on page 10). As noted on page 23, it’s one of those companies that want to see pay ratio disclosure…