And there’s some truth to all of those things. But the ultimate culprit here is something for which until recently Valeant was lauded far and wide as a role model for other corporations: its executive compensation plan.
Valeant’s plan was praised for years by everyone from activist hedge fund billionaire Bill Ackman to top executive-pay experts at the University of Chicago and Harvard Law School for its unique incentive model. Pearson and other top executives would receive relatively little in the way of cash compensation but massive amounts of incentive stock and options. And that stock would be tied up for extremely long periods (an extended vesting period–then for Pearson another three years). In short, Pearson and his team would be paid handsomely if they could create long-term value, in lockstep with their shareholders. There would be no easy cash-out.
On paper it worked brilliantly, and Pearson went on a tear that created tens of billions in value and continued for several years. Ackman, who invested $4 billion in the company, compared him to Warren Buffett. But the plan also put an inordinate amount of pressure on Pearson to sustain the growth, and the stock price, by whatever means he could. Valeant was built to become a pressure cooker. And eventually the lid exploded, taking the chef out with it.
Here’s this blog by Glass Lewis (also see this note from Manifest):
The 2016 UK AGM season has hardly begun and already two major shareholder revolts have surfaced at FTSE 100 issuers. In one of the most publicised spats over executive pay in recent years, a number of BP plc shareholders voiced their displeasure over the level of pay awarded to Bob Dudley, the company’s CEO, in the lead up to the Company’s 2016 AGM. As a result, the passing of the remuneration report was always likely to be a close-run affair. Investors of all shapes and sizes were angered by the clear disconnect between increasing pay and tumbling financial performance, exemplified by the maximum payouts under the company’s bonus plan and the reporting of a $6.5 billion loss. When the votes were announced, investor discontent was even higher than expected, with shareholders resoundingly rejecting the Company’s advisory proposal on the remuneration report– in total, just shy of 60% of voting shareholders registered against votes at the Company’s heated AGM.
Voting at the Smith & Nephew AGM took place only hours later, and shareholders at the medical-device maker followed the lead of their counterparts at BP, although for materially different reasons. Here, the rebellion focused on the remuneration committee’s decision to override the formulaic outcome of the long-term incentive plan, which stipulated that awards would only vest if TSR was at or above the median of a small, bespoke peer group. After the peer group shrank due to market consolidation and the Company found itself below the median of the partial group, the committee exercised its discretion to permit awards to be released as if the median target had been met. The committee’s detailed disclosure regarding its decision, which included pointing to the company’s significant outperformance of the FTSE 100 and S&P 500, did not placate shareholders’ clear unease surrounding any discretionary uplifts in pay, which remains a red button issue for UK and international shareholders alike.
Prior to Thursday, only seven FTSE 100 companies had failed to secure approval of their remuneration report and the two defeats within hours of one other will undoubtedly call to mind memories of the 2012 AGM season, referred to as the “shareholder spring” due to a spate of revolts relating to executive pay, some of which engendered CEO resignations. It is too early to assess the full extent of the fallout from these latest shareholder rebellions; however, while the proposals were put to shareholders on an advisory basis, it is clear that remuneration structures and levels of pay continue to be areas under intense scrutiny from both investors and the general public, and have the ability to cause a level of discomfort for board members through major PR hiccups.
Both companies expressed their disappointment with the results, while committing to increased dialogue with investors over the coming months; however, both also stood over the decisions made in the past fiscal year. As such, speculation remains rife as to potential board changes in light of the defeats, particularly with regard to remuneration committees who have overseen payments and decisions that have driven some of the highest levels of shareholder discontent the UK market has seen; the Institute of Directors, a body representing company directors, has gone as far as to state that the reaction of BP’s board “will determine the future of corporate governance in the UK.”
It remains to be seen if an increased focus on engagement with shareholders in advance of the 2017 AGMs, when both companies will be required to seek shareholder approval of their remuneration policies on a binding basis, will lead to a softening of shareholder anger. One thing is for certain however, an early shot has been fired across the bow of UK boards: Pay remains a highly contentious issue, and one which shareholders are willing to provide management with bloody noses and public embarrassment over.
With criticism about the impact of buybacks on executive compensation in the news, it appears that the AFL-CIO & other investors are sending shareholder proposals to some companies on this topic. Here’s an excerpt from this Cooley blog:
Now, the AFL-CIO and others are beginning to take steps to eliminate at least one of the motivations for buybacks — or at least one of the side effects. For 2016, the AFL-CIO (and entities apparently acting on its behalf) has submitted a new shareholder proposal asking companies to adjust executive pay metrics to exclude the impact of stock buybacks. According to this AFL-CIO publication, the proposals were submitted this year at IBM, Illinois Tool Works, 3M and Xerox.
Generally, the shareholder proposal urges the target companies’ compensation committees to “adopt a policy that financial performance metrics shall be adjusted, to the extent practicable, to exclude the impact of share repurchases when determining the amount or vesting of any senior executive incentive compensation grant or award. The policy should be implemented in a way that does not violate existing contractual obligations or the terms of any plan.”
The proponent contends that buybacks directly affect many of the financial ratios used as performance metrics, but, while they may boost stock prices in the short term, the proponent is “concerned that they can deprive companies of capital necessary for creating long term growth.” The proponent believes that, because senior executives are responsible for improving operational performance, “senior executives should not receive larger pay packages simply for reducing the number of shares outstanding. Executive pay should be aligned with operational results, not financial engineering.”
The proponent also asserts that, for “the 12 months ended June 30, 2015, S&P 500 companies spent more money on stock buybacks and dividends than they earned in profits.” In addition, the proponent looks to the chair and CEO of BlackRock, who urged that “[l]arge stock buybacks send ‘a discouraging message about a company’s ability to use its resources wisely and develop a coherent plan to create value over the long term.’” In each case, the proponent compares the amount spent on stock buybacks with the amounts spent on R&D and capital expenditures. For example, for Illinois Toolworks, according to the proponent, the company “spent $2.9 billion on share buybacks in 2014, but only $227 million on research and development, and $361 million on capital expenditures.” The proponent also identifies the CEO’s comp and the amount received in awards that are dependent on financial metrics that are susceptible to being goosed by stock buybacks.
Among the arguments made in the companies’ various statements in opposition are that the companies are committed to organic growth through capital expenditures and research and development and that they have capital allocation strategies designed to create growth opportunities through investment and to return excess capital to shareholders, that their boards assess their capital requirements to ensure that there is sufficient capital for investment for future growth, that performance metrics are designed by compensation committees (which, they contend, are in the best position to make these determinations) to align pay and performance, that among the metrics is typically an organic growth metric and that limiting the companies’ ability to use appropriate performance metrics is not in the best interests of the companies or their shareholders.
For the past few years, I have been maintaining a list of companies making voluntary pay ratio disclosures. With mandatory pay ratio on the near horizon, I’m gonna stop doing that – but it’s worth pointing out that 4 companies so far have complied with the SEC’s new rule early – as laid out fully in this blog by Steve Quinlivan…
– FAQ #2: Which equity compensation proposals are evaluated under the EPSC policy?
– FAQ #17: If a company assumes an acquired company’s equity awards in connection with a merger, will ISS exclude these awards in the three-year average burn rate calculation?
– FAQ #28: How does ISS evaluate an equity plan proposal seeking approval of one or more plan amendments?
– FAQ #29: How are plan proposals that are only seeking approval in order to qualify grants as “performance-based” for purposes of IRC Section 162(m) treated?
– FAQ #30: How are proposals that include 162(m) reapproval along with additional amendments evaluated?
– FAQ #31: How does ISS evaluate amendments by companies listed in France that are made in response to that market’s adoption of the Loi Macron (Macron Law)?
– FAQ #47: How does ISS determine the treatment of performance-based awards that may vest upon a change in control?
For example, in a recent study of named executive officers in the Equilar 100, Equilar found at least 70% of the executive pay mix was “at risk” under LTIPs over the last three years, and at a broader level, companies are using more performance-based equity grants in long-term incentive plans. According to Equilar’s 2015 Equity Trends Report, nearly 70% of S&P 1500 companies used performance awards in 2014, up from about 50% in 2010.
A closer look at LTIPs revealed that performance awards (in the form of units, stock, and options) comprised almost 80% of individual incentive plans. Equity awards that vest over time—or time-based awards—made up the remainder, and often receive criticism being referred to as “pay for pulse.” Indeed, the appearance of options in executive pay packages has declined in recent years, included in just 60.7% of S&P 1500 incentive plans, down from 75.2% in 2010.
Here’s a note that I received from a member recently:
This year marks the second proxy season under ISS’ Equity Plan Scorecard, which was introduced during the 2015 proxy season. And, as we all know, the key to obtaining a favorable vote recommendation for an equity-based incentive plan proposal is securing a score of at least 53 points (out of a total 100 possible points). Generally, this means being sensitive to the three “pillars” – plan cost, plan features, and grant practices – that ISS uses to “score” a plan. Further, as set forth in ISS’ materials describing its methodology, there are a few plan provisions or actions that may result in an unfavorable vote recommendation on a plan proposal regardless of the overall EPSC score (the so-called “deal-breakers”). These provisions or actions are:
– The plan provides for excise tax “gross-ups”;
– The plan provides for “reload” options;
– A liberal change-of-control definition that could result in vesting of awards by any trigger other than a full “double trigger”;
– A plan that permits repricing or the cash buyout of underwater options or SARs without shareholder approval; and
– A “pay for performance” disconnect or problematic pay practice has been identified at the company and the equity plan has been identified as a vehicle for said disconnect
Recently, we’ve learned that ISS views this as a “flexible” list that can be expanded as it its sees fit, even if a company has no reason to believe that its equity-based incentive plan contains a problematic feature. Last month, a company proposing a series of amendments to its existing omnibus incentive plan received an unfavorable vote recommendation on its plan proposal from ISS, notwithstanding that (i) it received an overall positive score under the Equity Plan Scorecard methodology (80+ points) and (ii) its plan contained none of the “deal breaker” provisions specified in the ISS literature.
The reason? ISS objected to a plan amendment that would reduce the minimum time-based vesting period for equity awards granted to the members of the company’s board of directors from three years to one year.
Not only was the company blind-sided by the voting recommendation, it was flummoxed by the explanation for the decision. Not only was the proposed amendment consistent with the Plan Features “pillar” (which states that “[i]n order to receive EPSC points for a minimum vesting requirement, the plan should mandate a vesting period of at least one year which should apply to no less than 95 percent of the shares authorized for grant”), but, as the company pointed out, had it been submitting a new omnibus incentive plan for shareholder approval with a one-year vesting requirement – rather than amending an existing plan – the issue would not have arisen in the first place.
Nonetheless, the company was put in the unenviable position of having to scramble for shareholder support for its plan proposal at the 11th hour over an issue that it didn’t know existed.
It’s a sober reminder for all of us that, apparently, ISS doesn’t consider itself to be bound by its published guidance when reviewing an equity-based incentive plan proposal and that it may take inconsistent positions with respect to an issue if it believes that a plan feature is not in the best interests of shareholders. We should keep this in mind when evaluating the likelihood of a favorable vote recommendation under the Equity Plan Scorecard.