In this podcast, Frank Glassner of Veritas discusses engaging with shareholders on executive pay, including:
– What do you think has caused the increase in shareholder engagement on executive pay issues?
– What are the advantages of engaging with shareholders?
– What are some of the pitfalls of engaging with shareholders?
– Is there a better than average method of engaging with shareholders?
– What would a best practice with shareholder engagement process look like, and what do you think companies should do?
As noted in this blog by the CFA Institute’s Matt Orsagh, they are working on updating the CD&A template that they issued in 2011. The updated template is expected in mid-2015. Here’s an excerpt from the blog frontrunning some of the changes they will likely recommend:
Engagement
One of the biggest changes we have seen in the past three years is the increase in engagement between issuers and investors around executive compensation. Mandatory say on pay votes have driven an increase in engagement that has had beneficial effects for both parties. More investors feel they are being heard and more issuers have been able to communicate their messages more effectively. Engagement has led to more disagreeable compensation practices fading away, and more investors pulling shareholder resolutions around pay when they reach a compromise with a company. Therefore, the discussion of engagement will play a more prominent role in the 2nd edition of the CD&A Template.
Executive Summaries
More companies have opted to produce executive summaries at the beginning of the CD&A to quickly summarize key information most important to investors. More detail on an item touched on in the executive summary can then be expanded upon in the CD&A itself. After our recent meetings with issuers and investors, CFA Institute will propose a more graphics based executive summary that is user friendly to investors, and provides key information most important to investors such as: developments in the past year, say on pay results and engagement activities, performance metrics used to set pay, the link between pay and strategy, and pay governance practices.
Core Disclosures
The body of CD&A Template fleshes out the executive summary, and other than the inclusion of discussions concerning engagement activities will remain similar to the previous iteration of the template:
– What has changed in the past year
– Elements of Compensation
– Performance Targets for past year/performance period
– Compensation decisions made in past year
– Compensation framework: Policies, process, risk
– Results of engagement
– Employment and termination agreements
CD&A Production Timeline
We plan to provide companies with a rough CD&A production timeline, highlighting how companies with best in class CD&A disclosures plan for and execute the creation of the CD&A. We believe this will prove highly valuable to small and mid-sized companies with limited resources.
List of Best/Worst Practices
A recent innovation in the CD&A is a list of best and worst pay governance practices, often accompanied by a discussion of why a company does or does not engage in such practices.
Examples of Best Practices
There is no perfect CD&A, but we have found examples of companies whose disclosures in certain areas that stand out as best in class. In addition to listing some best and worst practices, we plan to highlight and reprint some best in class disclosures as examples of innovative ways companies can better communicate with investors.
Required SEC Disclosures
Companies want to make sure the disclosures they make are compliant with SEC protocol. We therefore will include (as we did in the first iteration of the CD&A Template) a list of disclosures required in the CD&A, and where they are discussed in the CD&A Template.
The SEC has approved Auditing Standard No. 18, adopted by the PCAOB in June. The standards become effective for audits of financial statements for fiscal years beginning on or after December 15, 2014, including for emerging growth companies (ECGs).
We previously discussed the three areas of focus for Auditing Standard No. 18 in a prior post. Related party transactions, significant unusual transactions and financial relationships and transactions with executive officers (such as executive compensation and perks) will be under increased scrutiny. The new auditing standards subject these types of transactions to additional risk-based procedures that are designed to assist the auditors in identifying red flags that may cause material misstatements. Companies should also be aware that the auditing standard opens up possible new lines of inquiries from auditors to boards of directors.
Related Party Transactions and the Audit Committee. The revised standard includes a requirement that the auditors communicate to the audit committee their evaluation of the company’s identification of, accounting for, and disclosure of its relationships and transactions with related parties, as well as significant matters arising from the audit regarding the company’s relationships and transactions with related parties. This includes whether all transactions (a) were disclosed to the auditors, (b) were authorized in accordance with established policies and (c) have terms similar to those in arm’s length transactions. In addition, auditors may ask audit committees, or their chairs, about their understanding of the company relationships with related party transactions and whether the audit committee has any concerns about those transactions.
Executive Compensation and the Compensation Committee. While the standard explicitly provides that the auditors’ work does not include an assessment of the appropriateness or reasonableness of executive compensation arrangements, the changes are designed to heighten the auditors’ attention to incentives or pressures for the company to achieve a particular financial position or operating results, recognizing the key role that a company’s executive officers may play in the company’s accounting decisions or financial reporting.
The auditors may ask the chair of the compensation committee and compensation consultants about the structure of executive compensation, including incentive compensation and perks. Audit procedures may include reading employment contracts with executives and proxy statements. In addition, auditors will need to obtain an understanding of established policies and procedures regarding the authorization and approval of executive officer expense reimbursements.
Last week, ISS announced that QuickScore 3.0 will be launched on November 24th for the 2015 proxy season (in other words, that’s the first date the new governance ratings will be included in research reports). Ning Chiu highlights some of the changes from last year in this blog – also see this Wachtell Lipton memo and Gibson Dunn blog. Here’s the home for QuickScore 3.0, where you can download the technical document – and here’s the new QuickScore factors by region.
Companies will have from November 3rd to November 14th to verify the underlying raw data and submit updates and corrections through ISS’s data review and verification site. As always, ratings are updated based on a company’s public disclosures during the calendar year.
I’m always curious as to what Bob and Nell think about the issues of the day – here’s a USA Today interview that gives the latest from them. Here’s an excerpt:
Q: Why is that, given the widespread recognition CEO pay, especially relative to what average company employees earn, is a problem?
Monks: People with power are very reluctant to give it up. While all of us recognize the problem, those with the power to change it like things the way they are.
Minow: There’s a strong streak of narcissism, sociopathology, of killing the goose that lays the golden egg. In the long run who’s going to be able to buy products if we have an economy where resources aren’t more evenly distributed?
Here’s something blogged by Towers Watson’s Jacob O’Neill:
The number of mergers and acquisitions announced in 2014 has increased over previous years and includes some of the largest deals in history. Through the third quarter of this year, 73 M&A deals with a total transaction value greater than $1 billion have been announced, including 10 that each had a value greater than $25 billion (three of these deals have since been cancelled). By way of comparison, only nine deals closed in the U.S. with a value of over $25 billion over the four years prior to 2014.
Towers Watson’s Executive Compensation Resources unit tracks and analyzes special compensation arrangements for executives involved in acquisitions on an ongoing basis. For our most recent analysis of retention award practices, we looked at U.S.-based public companies involved in 181 acquisitions with a transaction value greater than $1 billion between the beginning of 2010 and the end of March 2014.
Our analysis specifically reviews retention awards and/or programs put in place at acquired companies in the course of the merger and focuses on awards with executive participation. Our review identified 69 companies (39% of all acquired companies during this period) that offered some form of retention award to employees and/or executives prior to the close of the deal. While we focus on the companies with executive-level retention awards, we also note that there are other considerations involved in retaining and protecting employees during acquisitions, including change-in-control severance agreements as well as retention programs for employees below the executive level./blockquote>
Here’s news from Paul Hastings’ Mark Poerio from his ExecutiveLoyalty.org site:
The hiring of a special compensation consultant increases CEO pay by about 10% (per median survey results), which this Univ. of Cambridge study reports as one finding supportive of the conclusion that there is “strong empirical evidence for the hiring of compensation consultants as a justification device for higher executive pay.” Along this line, an increase in CEO pay was found to reduce the probability that a compensation consultant would be replaced by a competitor. The study reports a result reflecting on the independence of compensation committees, in that median CEO compensation was 13% lower when a board committee hired a compensation consultant than when management made the hire. See more on this blog.
As companies are staffing & gearing up for the FASB/IASB’s new revenue recognition rules, it dawned on me that folks in the accounting world might not be aware of the upcoming Dodd-Frank rulemaking on clawbacks. And those folks that live and breathe compensation might not be aware of the revenue recognition accounting changes that were adopted a few months back (but won’t be effective until fiscal years beginning after 12/15/16).
The implementation of the new revenue recognition rules will create all sorts of opportunities to get it wrong – and it looks like they will coincide with mandatory no-fault clawbacks that have to be applied to a broader range of executives for a longer period of time for any restatement. Section 954 of Dodd-Frank is quite prescriptive so I don’t know how the SEC will have much flexibility. Maybe in the implementation and grandfathering provisions. This convergence of forces may well make for a dandy of a sleeper in Dodd-Frank, years after it was enacted!
The upshot is that we may be living in a world where senior managers will be trying to persuade compensation committees to either have less performance-based compensation that is susceptible to a restatement – or to use metrics that are less susceptible. Stepping back from performance-based pay is not what shareholders want to see – so this likely will cause tension between companies and their shareholders.
It’s ironic that a new accounting standard that will cause more opportunities for restatements will apparently come on board near in time with the Dodd-Frank “super-charged” clawbacks. These newer clawbacks will be super-charged because you don’t need misconduct like under the Sarbanes-Oxley standard.
And the kicker to watch out for right now is that as more companies move to multi-year performance metric setting, there could be companies that are setting performance goals now for years that will be subject to both the new revenue recognition rules (no matter how they wind up getting interpreted) and the Dodd-Frank clawbacks.
The bottom line is that the new clawbacks will certainly up the ante in discussions among auditors, audit committees and management as to whether errors discovered in previously filed financials are material. As with any area of uncertainty, step with caution. Thanks to Steve Bochner of Wilson Sonsini for pointing this out!
Last week, Fed Reserve Chair Janet Yellen delivered a speech about how income inequality concerns her as she issued a warning about the risks of it, as noted in this Huffington Post article.
Here’s other info recently published about income inequality: