The Advisors' Blog

– Broc Romanek, CompensationStandards.com

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…

– Broc Romanek, CompensationStandards.com

Last month, ISS issued seven new FAQs to its “US Equity Compensation Plan FAQs” (for a new total of 55 FAQs) as follows:

– 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?

– Broc Romanek, CompensationStandards.com

I’ve blogged twice before about the Yahoo! compensation case – but thought I would point out these more recent memos:

– Cleary Gottlieb
– Davis Polk
– Kaye Scholer
– Fried Frank
– Sidley

– Broc Romanek, CompensationStandards.com

This Equilar blog has a bunch of pay-for-performance stats, pulling from this “2015 Equity Trends Report.” Here’s an excerpt:

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.

– Broc Romanek, CompensationStandards.com

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.

– Broc Romanek, CompensationStandards.com

We keep posting memos in our “Proxy Season Developments” Practice Area – including this joint 30-page memo from Simpson Thacher and Frederic W. Cook & Co…

– Broc Romanek, CompensationStandards.com

Here’s a blog by Gibson Dunn’s Ron Mueller, Sean Feller and Krista Hanvey (also see these memos):

On March 30, 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-09, which amends ASC Topic 718, Compensation-Stock Compensation, to require changes to several areas of employee share-based payment accounting.

In an effort to simplify share-based reporting, among other things, the update revises requirements in the following areas:

– Minimum Statutory Withholding: The new standard permits share-based withholding up to the maximum statutory tax rates, whereas currently an employer may only withhold up to the minimum statutory tax rate without causing the award to be classified as a liability.
– Accounting for Income Taxes – The revised standard will require recording the tax effects of share-based payments at settlement or expiration on the income statement, whereas ASC 718 previously provided for tax benefits in excess of compensation cost and tax deficiencies to be reported in equity to the extent of any previous excess benefits, and then to the income statement. Under the new rule excess tax benefits are also to be classified with other operating income tax cash flows as an operating activity.
– Forfeitures – Whereas accruals of compensation cost are currently based on the number of awards that are expected to vest, the revised standard allows an entity to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur.
– Intrinsic Value Accounting for Private Entities: Under the update, nonpublic entities will be permitted to make a one-time accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value.

With respect to share-based withholding on equity awards, ASC Topic 718 currently provides that equity awards cannot provide for share withholding in excess of an employer’s minimum statutory withholding requirements in order to qualify for equity treatment under the rule. As revised, the rule will now permit withholding up to the maximum statutory tax rate without causing the award to be classified as a liability. In addition, cash paid by an employer when directly withholding shares for tax-withholding purposes should now be classified as a financing activity.

For public companies, the new rules will become effective for annual reporting periods beginning after December 15, 2016, and interim reporting periods within such annual period. For all other entities, the new rules will take effect for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018.

In light of the new accounting rules, companies will want to review their equity compensation plans and award agreements to determine if they will allow for withholding up to the statutory maximum. In connection with this, issuers that are subject to the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, should review their award agreements with any Section 16 officers and, in order to obtain the exemption under Rule 16b-3 for share withholding in excess of amounts that were previously allowed, may need to provide for compensation committee approval of any new terms that allow for share-based withholding above what was previously authorized.

– Broc Romanek, CompensationStandards.com

Here’s an excerpt from this Washington Post article (also see this Cooley blog):

The big debates on CEO pay tend to focus on one thing: How high it is.

But in a recent essay in the Harvard Business Review, two London Business School professors say the real focus shouldn’t just be on the size of CEO pay, but on how it’s structured. Their argument: Research has shown, among other things, that performance incentives don’t really work for the complex nature of the jobs CEOs do, that high bonuses or stock grants can lead to unethical or even fraudulent behavior, and that lofty awards can crowd out the “intrinsic” motivation of wanting to do a good job for its own sake. Their radical solution: Don’t pay CEOs based on performance. Just give them a fixed salary instead.

We caught up with one of the authors, LBS professor Freek Vermeulen, who wrote the essay with his colleague Dan Cable, by phone while he was in Germany on a ski trip with his family. Our conversation with Vermeulen, which has been edited for length and clarity, is below.

So can you sum up your argument for those who haven’t seen the piece?

For most CEOs — and actually most top senior executives — their pay depends to a very large extent on some measure of performance. And I mean a very large extent in comparison to the rest of us. Most of us get a fixed salary and maybe a Christmas bonus. But for CEOs, it’s actually nothing unusual for 60, 70 or 80 percent of their remuneration to be dependent on performance. But we have quite a bit of research on the effects of that performance-based pay, and it isn’t very pretty. We know from research that it doesn’t have a very positive effect.

Before you get into the research, what’s the core of what you’re saying?

We know from this research that [performance-based pay] isn’t that effective. Others have been saying we need to change the measures of performance. But based on what we know from research, we say no. Actually, what you should do is something radically different. What you should do is not pay them for performance at all, but give them a fixed salary.

– Broc Romanek, CompensationStandards.com

We’ve posted the transcript for our recent webcast: “Key Steps to an Effective Compensation Committee.”

– Broc Romanek, CompensationStandards.com

Here’s the intro from this Willis Towers Watson memo about a proposed settlement in the Espinoza lawsuit (this is the Facebook case that I’ve blogged about before and Mike Melbinger has blogged about a few times – but it’s worth blogging about again, particularly since the court approved the settlement today):

A recent settlement agreement in litigation challenging the compensation paid to a company’s outside directors is attracting considerable attention. The settlement in the Espinoza case (C.A. No. 9745, Del. Ch.) was filed in a shareholder lawsuit alleging that a company’s board had breached its fiduciary duties, committed corporate waste and caused unjust enrichment by paying excessive compensation to non-employee directors. Among its most notable provisions, the proposed settlement calls for the company to obtain shareholder approval of the pay of its outside directors.

Here’s the key takeaways from the memo:

This lawsuit and the proposed settlement serve as yet another reminder that companies should be diligent in developing and periodically evaluating their non-employee director compensation programs. Recall that two other recent Delaware cases (Seinfeld v. Slager and Calma v. Templeton) also involved challenges to non-employee director compensation. In both of those cases, the Delaware Chancery Court denied summary judgment and required the cases to be reviewed under the entire fairness standard (instead of the business judgment rule) because the companies’ equity plans did not impose “meaningful limits” on director compensation. (For more on those cases, see “Delaware Ruling on ‘Excessive’ Director Pay Offers Guidance for Avoiding Future Litigation,” Executive Pay Matters, June 4, 2015.)

While Calma and Seinfeld focus on the content of the shareholder-approved plan (i.e., were there meaningful limits on director compensation in the plan such that shareholders could understand the magnitude of compensation to be paid), Espinoza focuses on the approval process.

While the factual circumstances surrounding Espinoza were unique, the settlement still serves as a reminder that companies should evaluate the limits in their plans with respect to the amount of compensation that directors can award to themselves. If the plan does not impose any “meaningful limits” on director compensation, the company should consider adding them. Companies may also consider whether benchmarking their director cash and equity compensation programs against their peer group is warranted and, if so, they need to be certain that the peer group is appropriate.

Furthermore, companies should review their committee charters and make changes to the process for evaluating and approving director compensation, if necessary. Shareholder ratification of a self-dealing transaction (such as when directors award themselves pay) must be accomplished formally by a vote or by written consent in order to shift the standard of review from the entire fairness standard to the more favorable business judgment rule.