The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here’s a Glass Lewis blog:

British oil & gas multinational BG Group plc has revised the pay package of incoming CEO Helge Lund in the face of a potential shareholder revolt regarding a proposed (and now withdrawn) £12 million recruitment award, which exceeded the company’s pay policy approved just a few months ago. Instead, BG will grant a £10.5 million award subject to more stretching and transparent performance conditions; because the revised award is allowed for under the approved pay policy, it will not be subject to a shareholder vote.

Despite the slight reduction in maximum award size (and larger reduction in expected value) Mr. Lund will continue to be one of the highest paid CEOs on the London Stock Exchange, with an annual potential pay package in the region of £15 million; however, the climb down from BG represents a victory for investors, as well as Vince Cable, whose introduction of a binding vote on companies’ remuneration policies meant that the Company was required, by law, to seek shareholder approval of the golden hello, due to it falling outside the Company’s approved remuneration policy.

The U-turn on the original pay package follows public complaints from a number of the company’s largest shareholders over the size of the proposed award, and particularly the opacity of performance conditions attached to it; as disclosed by BG, the award would only be reduced if Mr. Lund’s performance deteriorated significantly, with no connection to overall company performance or shareholder returns. The Company had originally described the award as necessary to lure one of the industry’s top executives. While not serving to reduce his pay opportunity greatly, investors may well be satisfied that the new CEO’s joining award will be subject to company performance measures, namely TSR, cash flow and capital efficiency measures, as opposed to relatively vague an unstretching personal objectives.

In addition, investors had spoken of their hesitancy to vote upon a remuneration proposal a mere six months after the policy’s approval, with BG stating: “A significant number of shareholders questioned the structure of the package, in particular whether it was appropriate to go outside the remuneration policy approved by shareholders earlier this year. Both the board and Mr Lund recognise and wish to respond to shareholder concerns.”

While unexpected, the reversal is not entirely unusual; just two years ago, Cairn Energy similarly withdrew a proposed transaction bonus before submitting it to shareholders after institutional investors raised concerns (BG should note that even after withdrawing the award, Cairn Energy faced significant opposition to its next remuneration report). The cancellation of the BG meeting aptly demonstrates the ever-increasing significance of shareholder engagement at UK issuers, with shareholders seemingly defeating a proposal without even casting a vote.

– Broc Romanek, CompensationStandards.com

This op-ed from Simpson Thacher’s Avrohom Kess & Yafit Cohn ran in yesterday’s WSJ:

In 2015 the Securities and Exchange Commission is expected to finalize a new rule that imposes excessive compliance costs on public companies with no discernible benefits to investors. The rule requires that public companies calculate and disclose the ratio of the CEO’s pay to the median annual total compensation of all company employees. Part of the 2010 Dodd-Frank law, this ill-advised rule clearly advances the agenda of interest groups worried about income inequality, politicizes the SEC’s disclosure regime and is inconsistent with the purpose of federal securities laws.

The Securities Exchange Act of 1934, which established the SEC, was intended to protect investors by mandating increased—and truthful—disclosure. After the 1929 stock-market crash, it was thought that enhanced disclosure would restore investor confidence in U.S. capital markets and protect investors against stock manipulation and other deceitful practices.

The law’s stated purpose is “bringing safety to the general public in the field of investment and finance” and regulating the operation of securities and commodities exchanges “for the protection of investors.” The extensive disclosure requirements at the heart of the Exchange Act were predicated on Congress’s philosophy that “[t]here cannot be honest markets without honest publicity.” To this day, the SEC’s mission is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”

The pay-ratio requirement is at odds with the SEC’s mission and the objectives of its disclosure framework. Companies are already required by law to disclose the compensation of their most highly paid executive officers, along with the reasons for both the level and type of pay accorded to them. How exactly will investors benefit from a comparison between the compensation of a U.S. CEO and the entirety of the company’s workforce—including part-time and seasonal workers, as well as those based in other parts of the world?

The legislative history of the provision in Dodd-Frank compelling pay-ratio disclosure is strangely silent on that question. The SEC has also struggled to pinpoint the rule’s value, noting in its September 2013 proposed rule that “the lack of a specific market failure identified as motivating the enactment of this provision poses significant challenges in quantifying potential economic benefits, if any, from the pay ratio disclosure.”

The SEC acknowledged that “precise comparability across companies may not be relevant and could generate potentially misleading interpretations or conclusions.”

Left unsaid is the obvious truth: The pay-ratio rule is an attempt to shame companies and their boards to advance the “social justice” goal of more equitable income distribution. It comes with a high price tag: Complying with the pay-ratio rule will require the private sector to spend $710.9 million and 3.6 million hours a year, according to a recent report by the Center for Capital Markets Competitiveness.

This is not the only instance of Congress abusing securities laws to advance social and political goals. Dodd-Frank also required the SEC to promulgate regulations requiring certain companies to investigate and disclose annually whether particular minerals in their products originated in the Democratic Republic of the Congo or an adjoining country. The disclosure is intended to target “the exploitation and trade of conflict minerals” that are “helping to finance conflict characterized by extreme levels of violence” and “contributing to an emergency humanitarian situation therein.”

Presumably, Congress expected that the disclosures would damage the reputations of “offending” companies and pressure them to stop using conflict minerals, whose trade may have funded armed groups in Africa.

But again, using the SEC disclosure framework to push social and political agendas places a significant financial burden on public companies and their shareholders. For example, while the SEC admitted in its 2012 final rule release that the social benefits of the conflict minerals statute “are quite different from the economic or investor protection benefits that the SEC’s rules ordinarily strive to achieve,” the agency estimates that initial compliance would cost between $3 billion and $4 billion.

Annual compliance would cost between $207 million and $609 million. The losses borne by the U.S. economy may be even greater, as these rules will hinder the ability of U.S. issuers to compete with companies that are not subject to the disclosure requirements.

The ostensible political goals advanced by Congress may be important and laudable. Requiring shareholders to bear the costs is not. It obfuscates SEC filings with immaterial and potentially misleading information, to the detriment of investors, and could impair the SEC’s ability to focus its attention and limited resources on fulfilling its intended functions.

Congress must find alternative ways to address social and political ills without upending the SEC’s disclosure regime, taxing American shareholders and further complicating the efforts of the SEC.

– Broc Romanek, CompensationStandards.com

For the vast majority of S&P 1500 companies, there is a major disconnect between operating performance, shareholder value and incentive plans for executives – among the things noted in this new IRRC study Institute (also see this WSJ article & other piece). As noted in this blog from Jon Lukomnik of the IRRC Institute:

– Economic performance explains only 12% of variance in CEO pay. More than 60% is explained by company size, industry, and existing company pay policy. None of those are performance driven.
– Some 75% of companies have no balance sheet or capital efficiency metrics in their disclosed performance measurement and long-term incentive plan design.
– Only 17% of companies specifically disclose return on invested capital or economic profit as a long-term performance measure for long-term executive compensation.
– Some 47% of S&P 1500 companies over the last five years (2008 – 2012) did not generate a positive cumulative economic profit or return on invested capital greater than their cost of capital.
– More than 85% of the S&P 1500 have no disclosed line of sight process metrics aligned to future value such as innovation and growth drivers.
– Only 10% of all long-term incentives have a disclosed longest performance period for named officers of greater than three years.
– Nearly 25% of companies have no long-term performance based awards at all, relying instead stock options and time-based restricted stock in their long-term compensation plans.

– Broc Romanek, CompensationStandards.com

This article from The Atlantic entitled “Can CEO Pay Ever Be Reeled In?” is interesting. It goes deep into the history of pay, as well as the history of the modern corporation. Here’s an excerpt:

The problem isn’t that the political system doesn’t want to deal with excessive CEO pay. There have been any number of formal efforts to rein in executive pay, involving a host of direct regulation and tax changes. But most of the specific efforts to reduce executive pay—through major policies such as a limit on the tax deductibility of high salaries, as well as more modest accounting and disclosure legislation—have fallen short.

That’s because the story of skyrocketing executive pay is a story about our conception of the corporation and its responsibilities. And until we rethink our deepest assumptions about the corporation, we won’t be able to master the challenge of excessive CEO pay, or the inequality it generates. Is the CEO simply the agent of the company’s shareholders? Is the corporation’s only obligation to return short-term gains to shareholders? Or can we begin to think of the corporation in terms of the interests of all those who have a stake in its success—its customers, its community, and all of its employees? If we take the latter view, the challenge of CEO pay will become clearer and more manageable.

– Broc Romanek, CompensationStandards.com

For those that want to make changes to the peer groups used by ISS and Glass Lewis, the proxy advisors have kicked off their semi-annual update processes, allowing companies to inform them of any peer group changes that will be disclosed in their next proxy statements. The deadlines are:

– ISS – December 11th
– Glass Lewis – December 31st (via Equilar’s site)

– Broc Romanek, CompensationStandards.com

As I have blogged many times (here’s the latest one), the SEC’s Reg Flex Agendas tend to be “aspirational” – and experience bears that out as the SEC often misses its “targeted” deadlines. So no sooner than I blogged about Corp Fin’s silence about the timing of the Four Horsemen rulemakings at the ABA Fall meeting on Friday, the SEC issued its latest Reg Flex Agenda. This Reg Flex Agenda notes that the pay ratio rules would be adopted by October 2015 (same with investment managers disclosing their say-on-pay votes) – and that the clawback, pay-for-performance and hedging rules would be proposed by October 2015 as well. We’ll see if that really happens. Don’t hold your breath…

As noted in this WSJ article, three Republican members of Congress have asked the SEC to slow down on its pay ratio rulemaking.

– Broc Romanek, CompensationStandards.com

Here’s a memo by Frederic W. Cook & Co. entitled “FASB Commences Project to Improve and Simplify Accounting for Stock Compensation under FASB ASC Topic 718.”

– Broc Romanek, CompensationStandards.com

Here’s a blog by McGuireWoods’ Steven Kittrell:

A new The Conference Board report on proxy voting in 2014 reports a decline in shareholder proposals on executive compensation matters. Among Russell 3000 and S&P 500 companies, the 70 compensation-related proposals was down from 86 proposals in 2013. Almost 70% of the proposals involved either requiring equity retention periods or limits on golden parachute payments. A couple of notes:

– There was majority support for 5 of the golden parachute proposals and 1 of the equity retention proposals.
– Support increased for clawback and SERP limit proposals, but measured on a small number of proposals (3 clawback and 2 SERP proposals).
– 2014 saw a complete lack of proposals on tax gross ups (consistent with the decreased use of gross ups).
– The major area of new proposals (6) related to director compensation, however, these were all part of a single director election proxy fight.

– Michael Lovette, ISS Corporate Services

The use of discretionary awards for senior executives has decreased significantly over the past few years. Shareholder attention, increasingly focused on executive compensation in the age of say-on-pay, has prompted marked compensation reform and better disclosure. As shareholders advocate for more performance-based compensation, compensation committees have increasingly turned to defined performance metrics and explicit performance goals to define compensation packages. And to be clear, that has–for the most part–been a dramatic improvement in the state of executive pay structures, and their accompanying disclosures. But have we gone too far?

Discretionary bonuses have been disappearing at a rapid rate. The prevalence of such awards at S&P 400 firms since 2007 has dropped from roughly 25 to 15 percent. But many boards feel that, by not including a discretionary component in the compensation program, they may be abdicating a key responsibility: to subjectively add context to an executive’s compensation package, or to provide judgment in extraordinary situations where the formulas fail. Compensation has become so formulaic that many boards have little room to maneuver in regards to rewarding outstanding performance. What makes up a discretionary award and how can it be incorporated into a company’s compensation program responsibly?

Discretionary awards are compensation that is granted to an executive at the judgment of the Board. Historically, discretionary awards appeared as executive bonuses; today, these discretionary awards more often show up in the Short-Term Incentive (STI) program as an individual performance component or under the Long-Term Incentive (LTI) program as a payout “modifier,” or occasionally, as a one-time grant. (A cynic might even note that some companies could also be implicitly exercising discretion–many times with the executives’ own input–by employing non-GAAP performance metrics.) Often, boards argue that company executives have performed their duties and functions in a way not captured by the executive compensation program, or that they need to motivate and retain executives by granting an additional award, as some of the most common reasons for utilizing discretionary awards. For many shareholders, such justifications, often disclosed in boilerplate format, leave a negative impression of discretionary awards.

Why are discretionary awards viewed negatively? In most cases shareholders are not able to verify that the appropriate discretion was used by the board and, in many investors’ eyes, discretion hasn’t always been used with shareholders’ best interests in mind.

– Broc Romanek, CompensationStandards.com

Here’s analysis from CEOPayRatioWatch.com on a topic that I’ve been waiting for someone to write about: Some companies with workforces outside the U.S. are concerned that data privacy laws in various non-U.S. jurisdictions will adversely impact the cost and practicability of gathering and verifying the data needed to identify the median of the annual total compensation for all employees, as proposed by the SEC in the CEO pay ratio rule.

It seems as though Monolithic Power Systems, Inc. is trying to address this issue partially on a go-forward basis. Looks like they are slipping in a specific reference to the CEO pay ratio rule – here is an excerpt from a grant letter to recipients of options outside the U.S.:

Data Privacy. In accepting this Option:

1. You hereby explicitly and unambiguously consent to the collection, use and transfer, in electronic or other form, of your personal data as described in this document by and among, as applicable, your employer, the Company and its subsidiaries and affiliates for the purpose of implementing, administering and managing your participation in the Plan, as well as for the purpose of the Company’s compliance with Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires certain public companies to calculate and disclose on an annual basis the ratio of the median of the annual total compensation of all employees of an issuer as compared to the annual total compensation of its chief executive officer (the “CEO Pay Ratio”).

2. You understand that the Company and your employer may hold certain personal information about you, including, but not limited to, your name, home address and telephone number, date of birth, social insurance number or other identification number, salary, nationality, job title, any shares of stock or directorships held in the Company, details of all options or any other entitlement to shares of stock awarded, canceled, exercised, vested, unvested or outstanding in your favor, for the purpose of implementing, administering and managing the Plan and complying with the CEO Pay Ratio (“Data”).

3. You understand that the recipients of the Data may be located in the United States or elsewhere, and that the recipients’ country (e.g., the United States) may have different data privacy laws and protections than your country. You understand that you may request a list with the names and addresses of any potential recipients of the Data by contacting your local human resources representative. You authorize the Company and any other possible recipients which may assist the Company (presently or in the future) with implementing, administering and managing the Plan to receive, possess, use, retain and transfer the Data, in electronic or other form, for the purpose of implementing, administering and managing your participation in the Plan and for compliance with the CEO Pay Ratio. You understand that Data will be held only as long as is necessary to implement, administer and manage your participation in the Plan and as is necessary for compliance with the CEO Pay Ratio. You understand that you may, at any time, view the Data, request additional information about the storage processing of the Data, require any necessary amendments to Data or refuse or withdraw the consents herein, in any case without cost, by contacting in writing your local human resources representative. You understand, however, that refusing or withdrawing your consent may affect your ability to participate in the Plan. For more information on the consequences of your refusal to consent or withdrawal of consent, you understand that you may contact your local human resources representative.

Source: http://www.sec.gov/Archives/edgar/data/1280452/000143774914019267/ex4-6.htm