This report of a survey by Towers Watson shows that 92% of Fortune 500 companies (a universe of 478 public companies) have either ownership guidelines or a retention policy. 90% have stock ownership guidelines, while 45% have both stock ownership guidelines and some sort of retention policy. This represents a steady increase from 43% of large U.S. companies that had guidelines in place in 2004 and the 75% reported in 2007, the year after the SEC required companies to disclose details of ownership guidelines in the new CD&A section of the proxy.
We’re doing CEO pay wrong. Incentive pay — compensation based on verifiable performance measures like stock price — is on the rise. It’s supposed to help align executives’ interests with those of shareholders. Instead, it leads corporate boards to pay executives more than necessary, and ultimately hurts shareholders and workers.
With incentive pay, the company could end up paying the CEO for something over which he had no real influence. Or the company could end up not paying the CEO for actions that were good for the company, but for some reason didn’t raise the stock price. Most likely, the CEO will single-mindedly pursue actions that will boost the metric he’s paid on, even if they only succeed in the short term. Over the longer term, paying your CEO a fantastic amount can hurt stock performance.
The solution, according to a new paper by Peter Cebon, of the Melbourne Business School, and Benjamin Hermalin, a finance professor at the University of California’s Haas School of Business, is for the government to limit performance-based executive contracts and make informal pay agreements more attractive.
An informal contract, in its broadest and perhaps too-simple but illustrative sense, is like a board telling a CEO: “We will pay you for being a good CEO. The better a CEO you are, the more we’ll pay you.” It is, Hermalin said, really just a “series of promises” that aren’t legally enforceable.
Alluding to Odysseus’ escape from the Sirens, the paper’s authors write that corporate boards setting executive pay need be to “lashed to the mast” with restrictions on the size of formal executive pay packages, which are the sorts of contracts that tie pay to objective, verifiable outcomes like the company’s stock price or specific accounting metrics.
But boards can’t actually tie themselves to a mast, Hermalin noted to The Huffington Post. That’s why they need the government to restrict their options. This could be done, he said, by boosting taxes on all performance-based pay, by dramatically increasing taxes on incentive pay above a certain level, or simply putting a cap on total formal incentive-based pay.
In Calma v. Templeton et al, the Delaware Court of Chancery held that grants of restricted stock units, or RSUs, to directors of Citrix Systems, Inc. were subject to an entire fairness standard of review. The court found that the grants were a conflicted decision because all three members of the compensation committee that approved the grants also received the RSU awards. Citing Delaware Supreme Court precedent, the court noted director self-compensation decisions are conflicted transactions that “lie outside the business judgment rule’s presumptive protection, so that, where properly challenged, the receipt of self-determined benefits is subject to an affirmative showing that the compensation arrangements are fair to the corporation.”
The court rejected the defendants position that prior stockholder approval of the plan ratified the grants at issue. The court found that Citrix did not seek or obtain stockholder approval of any action bearing specifically on the magnitude of compensation paid to non-employee directors.
The case was before the court on a motion to dismiss. Accordingly, the court found the defendants’ motion must be denied unless, accepting as true all well-pled allegations of the complaint and drawing all reasonable inferences from those allegations in plaintiff’s favor, there is no “reasonably conceivable set of circumstances susceptible of proof” in which plaintiff could establish that defendants breached their fiduciary duties.
The defendants contended the grants were entirely fair because the grants were in line with 14 companies identified in Citrix’ proxy as its peer group. The plaintiff claimed that the appropriate peer group should be limited to only five of those companies based on comparable market capitalization, revenue and net income metrics.
In the court’s view the plaintiff raised meaningful questions as to whether certain companies with considerably higher capitalization, such as Amazon.com, Google and Microsoft, should be included in the peer group used to determine fair value of compensation for Citrix’s non-employee directors. The court therefore refused to grant the motion to dismiss.
As a result of this decision, many advisors will now likely recommend that concrete, realistic limitations on grants to directors be built into a plan so that directors can rely on a stockholder approval defense. If the decision becomes a prelude to the next wave of compensation litigation, many companies may submit their grant practice for stockholder approval even if they do not need a new plan approved.
If you’re a member of TheCorporateCounsel.net, tune in tomorrow for the webcast – “Form S-8: Share Counting, Fee Calculations & Other Tricks of the Trade” – to hear Gibson Dunn’s Krista Hanvey, Davis Polk’s Kyoko Takahashi Lin, Kaye Scholer’s Jeff London and Goodwin Procter’s John Newell discuss a topic rife with uncertainty and traps for the unwary…
Taped an interview with NPR a few weeks ago on virtual shareholder meetings and thought they scraped it. But a ton of folks reached out on Friday night and said they heard it on the radio. Luckily, NPR trimmed my 4-minute interview down to 7 seconds because I wasn’t fab…
It’s been a long time since we revamped the home page on CompensationStandards.com. But I just retooled it. The content on the site remains exactly the same – but hopefully you can find your destination more easily with much larger tab buttons at the top, etc. Let me know what you think…
Yesterday, as noted in this press release, the SEC proposed pay-for-performance rules as required by Section 953(a) of Dodd-Frank. The vote was 3-2, with Commissioners Gallagher & Piwowar dissenting (Gallagher wrote out his dissent). Here’s statements by Chair White and Commissioner Stein.
– Proposed rules rely on Total Shareholder Return (TSR) as the basis for reporting the relationship between executive compensation and the company’s financial performance.
– Based on the explicit reference to “actually paid” in Section 14(i), the proposed rules exclude unvested stock grants and options, thus continuing the trend to reporting realized pay. Executive compensation professionals will need to sharpen their pencils to explain the relationship between these figures and those shown in the Summary Compensation Table.
– For equity-based compensation, companies would use the fair market value on date of vesting, rather than estimated grant date fair market value, as used in the SCT.
– Proposed rules also would require the reporting and comparison of cumulative TSR for last 5 fiscal years (with a description of the calculations).
– Proposed rules would require a comparison of the company’s TSR against that of a selected peer group.
– Proposed rules would require separate reporting for the CEO and the others NEOs – allowing use of an average figure for the other NEOs.
– Proposed rules would require the use of an interactive data format (ie. XBRL)
– Compensation actually paid would not include the actuarial value of pension benefits not earned during the applicable year.
– Proposed rules would phase-in the number of years covered. For example, in the first year for which the requirements are applicable for larger companies, disclosure would be required for the last 3 years only – with it rising eventually to five years worth of information eventually. For smaller reporting companies, they would start with two years worth of information – eventually moving to three years worth.
– Proposed rules exclude foreign private issuers and emerging growth companies, but not smaller reporting companies. However, the proposed rules would phase in the reporting requirements for smaller companies, require only three years of cumulative reporting, and not require reporting amounts attributable to pensions or a comparison to peer group TSR.
The proposing release will be published in the Federal Register within the next week, followed by a 60-day comment period (here’s our checklist to guide you in drafting comments to the SEC on a rulemaking). Depending on the nature and extent of the comments received, it’s possible that the SEC could adopt final rules sometime in the Fall. Assuming everything goes smoothly, it’s possible that the rules could be in effect next year. As we all know, however, things rarely go as planned…
Here’s a note from Ameriprise Financial’s Thomas Moore in response to my blog last week:
Many thanks for your very helpful thoughts on the pending SEC’s pay-for-performance rule proposal. Ever since Dodd-Frank was proposed, I have been puzzled as to the need for this rule given the SEC’s comprehensive 2006 executive compensation disclosure reform and the advent of the CD&A. In 2006, the SEC tried to eliminate the five-year TSR graph in the belief that it was outdated: “since the disclosure in Compensation Discussion and Analysis regarding the elements of corporate performance that a given company’s policies might reach is intended to allow broader discussion than just that of the relationship of compensation to the performance of the company as reflected by stock price.”
Although the SEC accommodated investors who wanted the graph retained as a ready source of TSR information by requiring that it be presented in the glossy annual report, the SEC continued to believe that presenting the performance graph as compensation disclosure weakened the CD&A’s objective to provide a broad discussion of the various elements of corporate performance that determine executive compensation.
All of this takes us back to 1992, when the SEC first required the stock performance graph in response to the seemingly never ending controversy of pay for performance. Once the graph was adopted, some persons began to express concerns that it over emphasized the relationship between TSR and compensation and possibly encouraged earnings management and fraud. So, in 2006 the SEC rightly recognized the many different measures of financial performance that modern executive comp programs use to determine compensation and divorced the graph from executive compensation – banishing it to the annual report – although companies could also include it in their proxy statements if they wished.
Just four years later in 2010, Congress adopted Dodd-Frank – with Section 953(a), “Disclosure of Pay Versus Performance” – leaving many of us responsible for drafting a CD&A shaking our heads. It’s 23 years back to the future, with TSR once again tied to executive compensation disclosure and our shareholders footing the disclosure costs. Will say on pay become a referendum on TSR performance?
This WSJ article and Bloomberg article previews the SEC’s open Commission meeting today, during which the Dodd-Frank pay-for-performance rules will be proposed. Also weigh in on whether you want us to conduct a webcast on this new proposal:
In this report, Semler Brossy covers equity plan proposal trends for current Russell 3000 companies, finding that companies that do not receive majority support for say-on-pay are 10x more likely to have their equity plan voted against by shareholders.
Thanks to those that participated in this survey – a hot topic! Below are the results from my recent survey on currency fluctuations for incentive comp:
1. Does your company adjust incentive goals/results for currency rate fluctuations?
– Yes, as a policy consistently applied – 24%
– Occasionally, as ad hoc decisions made across years – 15%
– No, we never do – 42%
– Not sure, it hasn’t come up – 20%
2. If your answer to #1 above was “yes,” what is the percent of impact currency rate fluctuations must have for neutralization (i.e. what is the swing/change in the metric due to the currency fluctuation before things get adjusted)?
– Less than 5% – 62%
– 5% to 9% – 10%
– 10% to 14% – 14%
– 15% to 19% – 0%
– 20% to 24% – 14%
– 25% or more – 0%
3. If your answer to #1 was “occasionally” or “never,” are your incentive compensation performance measures predominantly return measures?
– Yes – 32%
– No – 66%
– Not applicable (we don’t use performance measures for our incentive compensation) – 2%
4. If your company makes ad hoc decisions, is the issue decided on whether management raises the issue & how large the impact is?
– Yes – 42%
– No – 8%
– Not sure, it hasn’t come up – 50%
5. If you do adjust your incentive goals/results for currency rate fluctuations, to which type of incentive programs are these adjustments made?
– Short-Term – 61%
– Long-Term – 6%
– Both Short-Term & Long-Term – 33%
As I blogged yesterday, the SEC has calendared an open Commission meeting for Wednesday, April 29th to finally propose the pay-for-performance rules as required by Dodd-Frank. This rulemaking is important as it could become the new standard for measuring pay and performance.
We’ll have to see what exactly the SEC proposes when the proposing release is out – but if it comes out in a form as expected, here are my 8 points of analysis:
1. Companies can get the data and crunch the numbers. I don’t think that the actual implementation itself will be difficult.
2. But I think what could be particularly worrisome is having yet another metric to figure out what the CEO got paid and trying to explain all of it.
3. You know how companies have different schemes for granting equity, including type and timing. If the rules tend to try to fit everyone into a narrow bucket in order to try to line everyone up for comparability, and a company’s program doesn’t quite fit neatly into it, then the disclosure can get even more complicated.
4. There are two elements: compensation and financial performance. What is meant by “financial performance” for example? Maybe the SEC will just ask for stock price, maybe they’ll go broader.
5. A tricky part likely will be the explanation of what it all means – and how it works with the Summary Compensation Table.
6. I don’t think it will be difficult to produce the “math” showing the relationship of realized/realizable pay relative to TSR and other financial metrics, so long as:
– There’s a tight definition of realized pay
– We know what period to measure TSR (and if multiple periods can be used)
– We know what other performance measures can be included (if any) and if they can be as prominent in the disclosure as TSR
7. Another area of potential difficulty is explaining why there is not a tight or tighter correlation with TSR (“we use metrics other than TSR to drive our compensation; thus, the correlation is not very strong; on the other hand, our compensation is based on Revenue Growth and EBITDA Margin, and as Exhibit II demonstrates, the correlation is very significant”).
In addition, Dodd-Frank has no requirement for a relative ranking, and companies will need to decide if TSR and Pay should be put in some type of relative context (“relative to our peers, our realizable pay was well below the peers; so even though compensation is not tightly aligned with stock price performance the last 3 years, we did not pay our bums very much).
8. I think what may be the most difficult to address is a requirement to discuss what the Compensation Committee plans to change – and why is it now that it has performed the analysis?
– Keith Higgins Speaks: The Latest from the SEC
– The SEC’s New Pay-for-Performance Proposal
– Proxy Access: Tackling the Challenges
– Disclosure Effectiveness: What Investors Really Want to See
– Pay Ratio: What Now
– Peer Group Disclosures: The In-House Perspective
– Creating Effective Clawbacks (and Disclosures)
– Pledging & Hedging Disclosures
– The Executive Summary
– The Art of Communication
– Dave & Marty: Smashmouth
– Dealing with the Complexities of Perks
– The Big Kahuna: Your Burning Questions Answered
– The SEC All-Stars: The Bleeding Edge
– The Investors Speak
– Navigating ISS & Glass Lewis
– Hot Topics: 50 Practical Nuggets in 75 Minutes
Early Bird Rates – Act by the end of Friday, April 24th: Huge changes are afoot for executive compensation practices with pay ratio disclosures on the horizon. We are doing our part to help you address all these changes – and avoid costly pitfalls – by offering a special early bird discount rate to help you attend these critical conferences (both of the Conferences are bundled together with a single price). So register by the end of Friday, April 24th to take advantage of the 33% discount.
– Keith Higgins Speaks: The Latest from the SEC
– Proxy Access: Tackling the Challenges
– Disclosure Effectiveness: What Investors Really Want to See
– Pay Ratio: What Now
– Peer Group Disclosures: The In-House Perspective
– How to Improve Pay-for-Performance Disclosure
– Creating Effective Clawbacks (and Disclosures)
– Pledging & Hedging Disclosures
– The Executive Summary
– The Art of Communication
– Dave & Marty: Smashmouth
– Dealing with the Complexities of Perks
– The Big Kahuna: Your Burning Questions Answered
– The SEC All-Stars: The Bleeding Edge
– The Investors Speak
– Navigating ISS & Glass Lewis
– Hot Topics: 50 Practical Nuggets in 75 Minutes
Early Bird Rates – Act by April 24th: Huge changes are afoot for executive compensation practices with pay ratio disclosures on the horizon. We are doing our part to help you address all these changes – and avoid costly pitfalls – by offering a special early bird discount rate to help you attend these critical conferences (both of the Conferences are bundled together with a single price). So register by April 24th to take advantage of the 33% discount.