A few days ago, I blogged on TheCorporateCounsel.net about ISS’ new policy survey results (here’s the press release – and the full summary). As noted in this Towers Watson memo, this year’s survey was light in questions related to executive compensation, with only three main questions overall. Here’s an excerpt from that memo:
Incentive Plan Design (U.S.)
The use of adjusted (non-GAAP) metrics within incentive plans has been common among U.S. companies. Investor survey participants generally agree that adjusted metrics are acceptable, depending on the rationale for their use and the degree of adjustment made by companies. Investors believe that performance goals and results should be clearly disclosed in the proxy. In addition to disclosing the rationale, companies should also disclose how the adjusted metrics reconcile with similar GAAP metrics.
Regarding the types of adjustments, investors generally feel it’s appropriate to adjust results for such items as discontinued operations, extraordinary charges and foreign exchange volatility, but not for compensation or litigation expenses. Some investors commented that adjustments should be considered on a case-by-case basis as industry and/or business model considerations may have a bearing on appropriateness. Some respondents also commented that the type of adjustments made should be consistent year over year. (For more on the extent to which companies adjust performance metrics for currency movements, see “Survey Reveals How U.S. Companies Address the Impact of Currency Fluctuations on Incentive Plans,” Executive Pay Matters, July 22, 2015.)
Say-on-Pay at Externally Managed Issuers (U.S. & Canada)
For externally managed issuers — generally real estate investment trusts that use external management — ISS sought guidance on the appropriate course of action with respect to say-on-pay resolutions where the issuer provides minimal (or no) disclosure about executive compensation because that is paid by the external manager. Almost three-quarters of investor respondents suggested that ISS should recommend a vote against the proposal for lack of disclosure.
When a say-on-pay resolution is not on the ballot, such as when the issuer doesn’t hold an annual say-on-pay vote, some investors noted that they might consider voting against compensation committee members if the disclosure did not meet minimum informational needs. Factors like stock price performance, the independence of directors and any history of pay or shareholder activism would be considered in these cases.
In the case of either of these topics, proxy disclosure that includes additional information and a clear explanation of the company’s rationale are key to helping investors make informed voting decisions.
Outside Directors & Equity (Global)
ISS sought feedback in the survey on which types of equity compensation, if any, are appropriate for non-executive directors. The investor respondents generally favored grants of shares in lieu of cash retainers or meeting fees, while a slight majority suggested that stock options/stock appreciation rights are inappropriate and over 60% said that performance-based restricted stock is inappropriate for outside directors. The general theme was that tying director compensation to management performance can create a conflict of interest, perceived or actual, because the directors are in charge of setting the underlying performance goals.
This excerpt from this blog from “Crooks & Liars” is startling (see the video of Graham from that blog):
Phil Gramm, a former three-term Republican senator from Texas who once ran the Senate Banking Committee, told the House Financial Services Committee yesterday that “it was an outrage” that his friend Edward Whitacre, the CEO of AT&T, only got “$75 million” when he retired in 2007.
“If there’s ever been an exploited worker” it was Whitacre, said Gramm, testifying on the fifth anniversary of passage of the Dodd-Frank financial reform bill. Gramm appeared genuinely aggrieved by Whitacre’s shabby treatment and literally pounded the table while speaking.
Whitacre actually received a retirement package totaling $158 million.
Gramm attributed public anger at CEOs like Whitacre to “the one form of bigotry that is still allowed in America,” which is “bigotry against the successful.”
With a lot of focus on how to eventually explain pay ratio disclosures to employees, I thought this Towers Watson memo about better communicating incentive plans to employees went hand-in-hand…
No big surprise. This Towers Watson survey finds that the top corporate concern is how folks will perceive their pay ratio. And the survey also finds that few are prepared to comply…
Gain access to the archive of our “Pay Ratio Workshop” now – and also gain access to our upcoming two-day proxy disclosure/compensation practices conference (available live in San Diego or live/archive by video webcast)…
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”…