Heading into the 2014 incentive year, about two-thirds of the companies participating in our survey had not implemented a policy for making adjustments for currency fluctuations in their incentive plans. But, as companies were tallying financial results for 2014, it was apparent that the dollar’s rise, which accelerated in the fourth quarter of 2014, had a negative impact on many companies’ full-year profits — and, thus, on the bonus results.
One of the key questions our survey sought to answer was when it came time for discussions of the bonus decisions in early 2015, did the pressures from currency fluctuations lead companies to consider making adjustments to bonus plan results to address the unanticipated impact of the strong dollar. The answer from our survey was an emphatic no. Our survey found that, despite the negative effects from foreign exchange volatility, nearly all companies with nonadjustment policies stuck with those policies. In other words, they maintained the original bonus goals and used the financial results as reported, even though bonuses may have been adversely affected.
However, another group of companies — roughly a quarter of our sample — took a different approach. At the start of 2014, these companies had established a policy of neutralizing the impact of currency fluctuations. For example, some companies planned to calculate financial results after applying constant currency conversions throughout the year, and to use these results for bonus purposes. Not surprisingly, at the end of the year, the vast majority of these companies maintained their policy and neutralized the impact of currency volatility when determining the bonus payout.
Of these companies that adjusted for currency fluctuations in 2014, most applied adjustments to both corporate and business-unit results. And if they had a long-term performance plan in addition to an annual incentive plan, most neutralized currencies in both types of plans, although some adjusted only for specific incentive plan metrics (e.g., revenues only).
In the wake of yesterday’s merger announcement, a reporter sent me this question: “What do you make of Korn Ferry’s acquisition? Does this raise independence issues under Dodd-Frank for companies that might pay a substantial amount to Korn Ferry for CEO, board search etc. who also consult with Hay Group on executive compensation? Most companies use the same consultant for executive and director compensation consulting. Is there extra due diligence required by the comp committee if they use the same firm for both services? Additional disclosure? Will boards have to start reporting how much they pay for executive and board searches?”
Here’s an answer that I received from Mark Borges:
I wouldn’t think board recruiting would trip a comp consultant’s independence. As you know, advisor “independence” must be considered, but there’s no requirement that a Compensation Committee use an independent advisor. So the assessment is really all about whether, in the opinion of the Compensation Committee, the highlighted relationship with the company impairs independence.
As you note, there is, on its face, a possible independence issue where a company retains Korn Ferry for specific services (such as a CEO, director search) while the Compensation Committee also uses the Hay Group for its executive compensation consulting. It’s really no different than the issue that the major HR firms faced a few years ago when they had to choose between their retirement and health care consulting services and their executive compensation consulting services. They chose the former because it presented a larger revenue stream and spun off their consulting businesses.
You can argue that an organization such as Korn Ferry is large enough to establish an effective barrier between its general services and its consulting business to avoid actual conflict situations (and, I suspect, that’s exactly what they will do). However, for many companies, it’s the appearance rather than the reality of a conflict which caused them to shy away from relationships with companies where they may have been receiving both consulting and non-consulting services. This may, in fact, happen here.
While the rules don’t prevent anyone from using Korn Ferry for their general services and Hay Group for their compensation consulting, it’s probably going to lead to a little extra diligence to justify the arrangement to be able to respond to inquiries about independence.
Here’s the intro of this article by Arthur J. Gallagher’s Jim Reda & David Schmidt:
Like Richard Wagner’s epic opera, “Parsifal”, which depicts King Arthur’s knights in the quest to find the Holy Grail, companies strive heroically to find the right performance measures to improve corporate performance. Based on our recent analysis, we discovered two very interesting points. First, the companies that used the same performance measures in each of the past five years outperformed others that changed measures. Second, the best performance measure is Earnings per Share (“EPS”), followed by Capital Efficiency, and Total Shareholder Return (“TSR”) is the worst measure. These results are not surprising since providing a consistent and “line-of-sight” performance goal is always the best way to provide incentive to management. The era of using stock options, which was more like a “lottery ticket” (as described by Warren Buffet), has come to an end.
“In all instances, we pursue rationality. Arrangements that pay off in capricious ways, unrelated to a manager’s personal accomplishments, may well be welcomed by certain managers. Who, after all, refuses a free lottery ticket? But such arrangements are wasteful to the company and cause the manager to lose focus on what should be his real areas of concern. Additionally, irrational behavior at the parent may well encourage imitative behavior at subsidiaries.”
— Warren Buffett, commenting on stock options in The Warren Buffett CEO: Secrets from the Berkshire Hathaway Managers, by Robert P. Miles, published by John Wiley & Sons
“We seek to design our executive officer compensation programs to attract, retain and motivate key executives who drive our success and industry leadership.” Versions of this statement can often be found as the lead-in for a public company’s Compensation Discussion and
Analysis (“CD&A”) section of their proxy statement. Following closely behind this statement is a declaration that executive pay that is market competitive and reflects performance is key for accomplishing the goals of the compensation program while also being in alignment with shareholders.
An important question coming out of this is — what sort of compensation really motivates top executives today? And, can companies be assured that whatever motivates top executives will also drive company performance? If these two factors are not connected, motivating executives the wrong way could potentially harm company performance.
For example, if a company provides short-term and/or long-term incentives to executives with payouts tied primarily to revenue growth, it will likely motivate executives to increase the size of the company in ways that could reduce profit margins and perhaps stock price growth. Understanding the interaction of incentive measures with each other, and with other company measures of performance, is critical in designing an effective incentive program.
We just wrapped up Lynn, Borges & Romanek’s “2016 Executive Compensation Disclosure Treatise & Reporting Guide” — and it’s headed to the printers! This edition has two new key chapters — one on the new SEC’s pay ratio rules, with over 60 pages of practical analysis & model disclosures — and one with over 120 pages of sample proxy disclosures and detailed analysis from the 2015 proxy season!
How to Order a Hard-Copy: Remember that a hard copy of the 2016 Treatise is not part of a CompensationStandards.com membership so it must be purchased separately. Act now as this will ensure delivery of this 1600-page comprehensive Treatise soon after it’s done being printed. Here’s the Detailed Table of Contents listing the topics so you can get a sense of the Treatise’s practical nature. Order Now.
Here’s a response that was anonymously posted by a member recently in our “Q&A Forum” (#1085), answering the query of “I was looking to find articles, survey data that would address “Do we expand the purview of the Compensation Committee to review not only the Executive officers compensation, but to also include their direct reports”? I would really appreciate if anyone could tell me where I can find this information?”:
My sense is most Comp Committees review more than the executive officers and will extend their purview to a select group of other executives that are part of the senior management “Leadership Team.” That might include all the CEOs direct reports, and could also pick-up some Business Unit leaders who may report to a COO, and may not be executive officers or direct reports to the CEO. I generally advise that 5 may be too few and 15 may be too many, so find somewhere in between that makes sense.
Companies that ask the Comp Committee to review too many executives are placing the committee in an awkward position, as they have very little visibility to what these additional executives are doing and how they are performing, yet, they are being asked to review and approve their pay.
I was thinking that a review of Compensation Committee charters might provide some additional insight on how deep the Committee goes in the organization when approving pay, but a quick look at a few charters did not provide much detail.
Last week, the SEC brought an enforcement action in the perks/related-person/internal controls area – In the Matter of MusclePharm Corporation – about how a company paid the spa tab for its CEO and his spouse, etc. The CEO is an ex-NFL football player as noted in this Bloomberg article. Good tabloid stuff to read upon my return.
The case also involved a charge over a failure to retain manually-signed signature pages – a charge that I blogged at length yesterday over on “TheCorporateCounsel.net Blog”…
CEO pay levels continue to be good populist fodder for the campaign trail as Donald Trump weighed in as noted in this article – and this article. As noted in this blog, Hillary Clinton kicked off her campaign on a similar note…
Here’s an interesting paper by Professors Bank and Georgiev entitled “Paying High For Low Performance” (scroll down for the paper). Here’s the abstract:
This essay argues that regulatory reforms introduced by the Dodd-Frank Act of 2010 in the area of executive compensation have not yet achieved their purpose of linking executive pay with company performance. The rule on shareholder say-on-pay appears to have had limited success over the five proxy seasons since its adoption. The rule on pay ratio disclosure, adopted in August 2015, and the rules on pay-versus-performance disclosure and the clawback of certain incentive compensation, proposed in April 2015 and July 2015, respectively, are also unlikely to succeed. For the most part, the rules are intuitive and well-intentioned, but a closer look reveals that they are easy to manipulate, counterproductive, and often interact with one another, and with other regulatory goals, in unintended ways. As a result, five years after the passage of Dodd-Frank, the decades-old goal of aligning pay with performance remains elusive.
Tomorrow’s DealLawyers.com Webcast: “Evolution of M&A Executive Pay Arrangements”
Tune in tomorrow for the DealLawyers.com webcast – “Evolution of M&A Executive Pay Arrangements” – to hear Morgan Lewis’ Jeanie Cogill, Sullivan & Cromwell’s Matt Friestedt, Cravath’s Eric Hilfers and Wachtell Lipton’s Andrea Wahlquist cover the latest about executive compensation arrangements in deals.
Can’t shake Tina Turner’s song off my mind after reading this NY Times column yesterday by Gretchen Morgenson entitled “Safety Suffers as Stock Options Propel Executive Pay Packages” that analyzes this study showing a correlation between a high proportion of stock options relative to total CEO pay and the incidence of serious product recalls. Here’s an excerpt from this article:
“Specifically, we found a positive relationship between the proportion of CEO pay consisting of stock options, measured over a two-year period, and the occurrence of product recalls in the subsequent year,” said Adam Wowak, the study’s lead author. “Our results are consistent with prior research showing that option-heavy pay arrangements engender aggressive risk-taking by CEOs, who stand to benefit greatly from future increases in share prices but lose nothing if share prices fall.”
The researchers theorized that higher levels of stock option pay would cause CEOs to favor aggressiveness over thoroughness in their decisions, a consequence of which would be a higher likelihood of mistakes in the design, production and distribution of products. “This isn’t to say that CEO options are always the culprit when product recalls occur, but our findings suggest that recalls can potentially be an unintended consequence of using options to motivate risk-taking in CEOs,” Adam Wowak said.
Here’s an article from Towers Watson that describes – and provides graphics – about how the Fortune 500 disclose their pay-for-performance practices ahead of the changes that will be required once the SEC adopts final rules in this area…