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…
The thrust of Norges’ positions is that long-term creation best aligns the company’s interests with what shareholders want. Here’s the 1st of four positions that brings this point home:
1. The board should ensure that remuneration is driven by long-term value creation and aligns CEO and shareholder interests. A substantial proportion of total annual remuneration should be provided as shares that are locked in for at least five and preferably ten years, regardless of resignation or retirement.
The 2nd position takes on targets:
2. The board should develop pay practices that are simple and do not put undue strain on corporate governance. Allotted shares should not have performance conditions and the complex criteria that may or may not align with the company’s aims.
The 3rd position looks to install a cap on overall pay:
3. The board should provide transparency on total remuneration to avoid unacceptable outcomes. CEO remuneration should be determined and settled in cash and locked-in shares each year. The board should also disclose a ceiling for total remuneration for the coming year.
The 4th position challenges termination payouts:
4. The board should ensure that all benefits have a clear business rationale. Pensionable income should constitute a minor part of total remuneration. The board should commit to not offering any end-of-employment arrangements that effectively shorten or dilute the lock-in of shares.
As noted in this WSJ article, the bartering to tweak the “Financial Choice Act” continues. Most of the Corp Fin-related notables in the bill remain untouched (eg. pay ratio would still get the axe) – but there are a few proposed changes that would impact you, such as changes to the ownership thresholds under Rule 14a-8, the shareholder proposal rule. This chart contains the changes – so far – from “Financial Choice Act 1.0.”
Of course, it’s still too soon to say what form the Choice Act will ultimately wind up taking – and even too soon to know if this legislation will eventually be “the one” put forward to replace Dodd-Frank…
Recently, Semler Brossy put out a pair of new resources – this memo describing the first failures of the proxy season. And this one predicting how the overall season will go…
Recently, Corp Fin denied a no-action request from Celgene to exclude a shareholder proposal submitted by John Chevedden. The proposal sought a bylaw that would prevent the board from seeing a running vote tally when say-on-pay or shareholder approval of plans were on the ballot. The company made unsuccessful arguments under Rule 14a-8(i)(2) (arguing it was a state law matter) – and (i)(7) ordinary business. Over the years, Corp Fin has allowed exclusion of shareholder proposals that sought confidentiality for preliminary vote tallies for uncontested matters under (i)(7) – a broader plate of topics than the narrower “pay topics only” proposal at issue in this case.
The big news from Wells Fargo yesterday was that the company’s board exercised its discretion to clawback $75 million from its former CEO and former head of community banking. Here’s the 113-page Wells Fargo board report – and here’s the news:
Here’s an excerpt from this note by Willis Towers Watson’s Bill Kalten & Steve Seelig:
A clawback policy addresses what to do after the fact. Helping ensure that a company has done everything it can structurally to discourage actions or events that would cause reputational harm is paramount, although some of those actions are beyond the scope of pay programs. Within the compensation realm, it appears that virtually all public companies already perform some degree of risk review. It might be a good idea to revisit this review process to reassure the compensation committee that reputational risks are unlikely to be exacerbated by pay structures.
This raises the question of whether a review of the mechanics of the pay program and its risk-mitigation features, such as mandatory deferrals, is sufficient. These reviews need to go deeper than a mere “check the box” exercise — real attention should be paid to likely behavioral responses to a given pay structure.
The details of how this might be accomplished and how deep within the organization this inquiry should go will vary for each company. The essence of this review, however, must focus on asking managers to identify the potential unintended consequences of their pay structures, which should turn out to be knowable if the right people are asked.
While a company can’t anticipate and prevent all possible misbehavior, a thorough review focusing on likely responses to specific incentive structures — such as finding that a particular metric and payout curve could provide incentives for overly aggressive growth — should provide additional insights into the organization’s culture and perhaps reduce the motivations that prompt unwanted behavior.