The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Recently, Exequity & Alliance Advisors put out this interesting white paper entitled “Equity Plan Proposal Failures: 2007-2012” including how ISS viewed the proposals and key takeaways…

– Subodh Mishra, ISS Governance Exchange

Director age and term limits have been in sharp focus over recent months, particularly as campaigners for greater board diversity seek to promote limits as one means of ensuring avenues to the boardroom for female and minority candidates. Proponents of term limits also contend such policies serve to address concerns over the potential for directors to be co-opted by management by virtue of lengthy stints on a given board. Critics, meanwhile, argue age or terms limits would result in the loss of otherwise well qualified directors whose “long view” can help drive businesses forward.

Against this backdrop though favoring neither approach, ISS examined the affect of director age and tenure on CEO pay (see below for methodology of the analysis) over the course of fiscal years 2009, 2010, and 2011 (as reported in 2012), to identify associational trends between director characteristics and higher levels of CEO pay.

What We Found
– As reported in 2012, older directors were associated with higher levels of total CEO pay at large capital firms paying, on average, 31 percent more than younger counterparts, and 59 percent more than large capital firms broadly.
– Driving the wedge between CEO pay tied to older versus younger directors is the value of bonus and restricted stock awards, with older directors paying 32 and 54 percent more, respectively.
– With regard to tenure, less tenured directors are associated with higher levels of total CEO pay, awarding, on average, $14.9 million reported in 2012, or 6 percent more than more tenured directors.
– Over the three years studied, less tenured directors paid their CEO more in the way of salary, bonus, “all other pay” (such as exit pay and perquisites), and stock options, while more tenured directors paid more in just one category evaluated: stock awards.
– Over the three years studied, the prevalence of older directors was most pronounced at study companies in the Energy sector (57 percent of directors above the median age), followed by Health Care (54 percent) and materials (51 percent).
– Telecommunication Services at 30 percent, and Information Technology at 34 percent, showed the most underrepresentation of older directors.
– Utilities sector directors tend to be the longest tenured with 61 percent of such study company boards sitting above the age median across all sectors, with Telecommunication Services at the other end at 30 percent.

What We Looked At
The analysis examined levels of total direct compensation and various underlying pay elements for CEOs at S&P 500 companies in fiscal 2009, 2010, and 2011 (as reported in 2012). Pay data are drawn from ISS’ proprietary ExecComp Analytics database. The analysis evaluated CEO pay levels vis-à-vis average director age and tenure by company, with the study group split between those above and below the median for the study universe.

To arrive at the study universe, we controlled for companies without a fully independent compensation committee, those with CEO pay outliers (e.g., Apple CEO Tim Cooks $377 million pay for fiscal 2011, former Citigroup head Vikram Pandit’s $1 pay in 2009, etc.), and, with regard to performance, removed companies where three-year total shareholder return (TSR) fell below the median.

Accounting for the above, the study universe of S&P 500 companies was reduced to and finalized at 230 in fiscal 2009, 231 in fiscal 2010, and 215 for fiscal 2011.

Total direct compensation was defined as the sum of pay received from: base salary, bonus, non-equity incentive plan compensation, stock awards, option awards, change in pension value and nonqualified deferred compensation earnings, and all other compensation, such as perquisites. The calculation generally matches corporate Summary Compensation Table with the exception of the stock option value, the calculus for which can be found here.

Note that for purposes of this analysis we’ve combined bonus and non-equity incentive payments–i.e., all non-salary cash awards–under the label of bonus. Take a look at the underlying summary data on ISS’ Governance Exchange.

– Broc Romanek, CompensationStandards.com

Recently, in this blog entitled “The Cruel Gap Between CEO Pay and the Stagnant Minimum Wage,” Ralph Nader weighed in on the pay gap controversy…

Meanwhile, see this blog entitled “Break Up Executive Pay, Not the Banks, to Fix Too-Big-to-Fail“…

– Broc Romanek, CompensationStandards.com

As noted in this WSJ article, more than 60% of Actelion Ltd.shareholders voted to reject its executive pay plan last week – marking the second time this month a Swiss company’s compensation scheme has been rejected.

Also check out this article entitled “Swiss referendum: funds’ headache or investor utopia?“

– Broc Romanek, CompensationStandards.com

From this news brief from Cooley’s Cydney Posner:

The Wall Street Journal published an article regarding the results of a recent Towers Watson survey of 270 proxies. The survey found “pay-for-performance praised but not honored and questioned the nearly universal allegiance to total shareholder return in chief executive pay plans.”

While the concept of pay-for-performance for CEOs has won wide acceptance, it was unclear whether “these plans really reward performance, or just luck and gamesmanship.” With regard to long-term incentives, 27% were performance-based plans, an increase from only 19% in 2010, while stock options accounted for only 35%, down from 41% that year.

According to the article, almost 82% of companies use total shareholder return to determine CEO payout in long-term incentives, and 61% rely solely on total shareholder return to calculate that payout. However, a Towers Watson representative questioned whether total shareholder return was “distorting outcomes” and could “be as much a matter of luck as performance, and can even be gamed.”

First, the article notes, level of pay can depend on “accidents of timing.” If a company begins its performance period with big growth expectations already priced into its stock and then delivers on those expectations, the stock may just stay in the same range without much increase in total shareholder return. On the other hand, if the performance period begins with a depressed stock price, even an increase back to normal levels “could result in a bonanza for the CEO.” Similarly, the CEO has an incentive to create volatility in the stock — a stable-but-high stock does not typically reap big rewards for the CEO based on total shareholder return. As a result, there could be an incentive to “drive the stock down, then win on the move back up. Moreover, a short-term, unsustainable run-up in the stock can still create rich rewards for the CEO.”

For plans that use relative performance measures, the survey suggests that “the selection of the peer group also affects the CEO’s wallet but is often done without enough attention to such financial facts of life as beta, the metric that shows how a stock responds to broader market movements. Even companies in the same industry may move differently, or in different degrees, when the market moves, depending on company-specific risk factors. ‘Most companies don’t net out differences in the company betas in constructing their peer groups,'” according to a Towers representative quoted in the article.

– Broc Romanek, CompensationStandards.com

Seymour Burchman of Semler Brossy recently wrote this blog about a series of four principles to help guide compensation committees’ application of discretion during deliberations.

– Jon Weinstein and Linda Pappas, PayGovernance

The third Say on Pay season is underway and Institutional Shareholder Services (ISS) is continuing to exert its considerable influence on investors through its voting recommendations. While the majority of the proxy season has yet to run its course, initial patterns are emerging from our analysis of ISS Say on Pay recommendations to date – some of which are unexpected and, occasionally, confounding.

While ISS has indeed tried to make some valid attempts to improve its methodology, much of the true self-reflection that is needed at ISS (see “Say on Pay Soul Searching Required at Proxy Advisory Firms“) has yet to occur. In short, it seems as if the ISS “black box” has become blacker, leaving companies with more questions about ISS’ decision-making process than before. This is highlighted by a weakened correlation between a company’s result on ISS’ quantitative pay-for-performance tests and ISS’ overall Say on Pay recommendation: in a recent interview with the Wall Street Journal, ISS’ Special Counsel reported that in 2012, over 50% of companies with “high” quantitative pay-for-performance concerns received ISS “Against” recommendations vs. only 35% thus far in 2013.

So, if ISS is paying less attention to its quantitative analyses, what are they looking at in making recommendations? Some of our early impressions are as follows:

– ISS appears to be performing rigorous qualitative compensation program reviews (e.g., the mix between time-based vs. performance-based LTI, performance metrics, benchmarking practices, etc.) for more companies, even those that score “low” concern on the quantitative pay-for-performance tests (despite initial ISS guidance that such reviews would be focused on “high” and “medium” concern companies). Moreover, the results of these qualitative reviews seem to be having an increased influence on ISS’ recommendations and, in some cases, have resulted in recommendations against Say on Pay at “low” or “medium” concern companies.

– Also contrary to the guidance it provided earlier in the year, ISS is taking into account share pledging policies and arrangements not only for the purpose of evaluating director elections but also for assessing the appropriateness and reasonableness of companies’ compensation programs.

– ISS is no longer providing a pass to companies who have grandfathered change-in-control (CIC) arrangements, including features such as excise tax gross-ups and single triggers, but who have banned such practices going forward. Rather, criticism is being leveled at companies that maintain “problematic” CIC practices even if they have precluded similar arrangements going forward. While ISS’ guidance was supposed to take legacy CIC practices into account only in Say on Golden Parachute votes, ISS seems now to be applying this policy to its Say on Pay assessment criteria.

-Perhaps most troublesome to certain companies, ISS has dramatically raised its disclosure expectations for companies that garnered less than 70% Say on Pay support in 2012. For these companies, ISS is criticizing companies who stop short of disclosing specific shareholder feedback and the company’s response to such feedback – even if shareholder input is positive or affirmative of the compensation system now in place. Merely to state the occurrence of a shareholder outreach program or dialogues with investors does not seem to be satisfactory to ISS if the outcomes of the discussions are not disclosed in detail – despite the fact that investor input can yield contradictory recommendations.

– While ISS changed its peer group determination methodology to incorporate a company’s named peers and to reserve the right to relax scope parameters in order to do so more effectively, ISS seems more than ever to be driving the subject company as close to the median of the ISS peer set as possible. It appears to us that ISS’ provision that it can relax revenue scope ranges to include additional company peers has often been ignored.

– Finally, unbeknownst to subject companies and ISS subscribers, there seems to be a new, unofficial ISS Say on Pay determination beyond just “For” and “Against” – the “Qualified For” recommendation. More than in past years, we have noticed that ISS is adding cautionary notes to its favorable Say on Pay opinions, implying that its support is tentative and ephemeral, and urging shareholders to remain vigilant in the future.

Last year, much of the ISS-related struggle companies faced was over defined issues where the parties – subject companies and ISS – essentially agreed to disagree (e.g., peer group selection, the use of realizable vs. target pay in assessing pay-for-performance, etc.). This year, however, the challenge has been to understand how ISS is arriving at its conclusions, particularly when they do not seem to be following their own guidance consistently. We fear that the murky ISS methodology has become murkier, and this lack of clear expectations creates an uneven playing field in companies’ abilities to address ISS concerns while continuing to motivate executive teams. As a result, even companies with strong pay-for-performance records need to be prepared for a potentially unpleasant ISS surprise

– Broc Romanek, CompensationStandards.com

Recently, I received the announcement below (which piggybacks on this press release):

Cleary Gottlieb partners Alan Beller and Arthur Kohn recently guided a working group comprised of six major pharmaceutical companies and a coalition of 12 institutional investors in developing industry-setting principles regarding recoupment policies concerning major compliance failures under health care laws. The working group publicly announced yesterday its successful joint development of a best practices policy.

The objective of the working group was to develop a set of principles for the industry to reference in implementing compensation clawback policies. The policies would be designed to hold individuals accountable for unethical and inappropriate behavior and thus deter any negative impacts on long-term shareholder value. About half of public companies currently have in place some form of clawback policy, as companies wait for the SEC to issue standard rules on clawback policies pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The principles, Principal Elements of a Leading Recoupment Policy, include full discretion of the compensation committee to determine if a material violation of company policy related to the sale, manufacture or marketing of health care services has caused significant financial harm to the company and therefore trigger consideration of a possible recoupment of incentive compensation; application of these principles extending beyond the individuals responsible for the compliance failures to potentially include supervisors who failed to manage or monitor the risk; compensation committee authority to decide whether and when to claw back incentive-based compensation already paid or otherwise recoup compensation that has not yet vested or not yet been paid; and public disclosure concerning decisions to recoup compensation in compliance with SEC rules.

– Subodh Mishra, ISS’ Governance Exchange

While addressing “main street” concerns over executive pay has in recent years undergirded the Democratic Party’s platform, Republican Party officials say they, too, will make it an issue in a bid to dispel notions they favor the rich. In a report released recently examining where the Republican Party fell short in the 2012 election cycle, officials said they would do more to attract new voters, including taking a more populist stance on company-related matters such as executive pay. “We should speak out when a company liquidates itself and its executives receive bonuses but rank-and-file workers are left unemployed,” party bosses wrote in the 100 page Growth & Opportunity Project. “We should speak out when CEOs receive tens of millions of dollars in retirement packages but middle-class workers have not had a meaningful raise in years.”

Officials added the party should “blow the whistle at corporate malfeasance and attack corporate welfare,” sentiments long associated with Democratic lawmakers whose historical base include labor unions and other constituencies expressing deep concerns of rising executive compensation levels. Moreover, the new calls are in stark contrast to images associated with 2012 Republican presidential candidate Mitt Romney, portrayed by opponents as among the ultra-rich and disconnected from working-class voters.

– Broc Romanek, CompensationStandards.com

As noted in its Form 8-K, Cogent Communications Group is the 7th company holding an annual meeting in 2013 to fail to gain majority support for its say-on-pay (40% support). Cogent also failed in 2011, with 39% support. That makes them the first company to fail, pass (68% in ’12), then fail again. Hat tip to Karla Bos of ING Funds for pointing this out!