The Advisors' Blog

– Broc Romanek, CompensationStandards.com

This article from the Harvard Business Review is one of the best I have read on say-on-pay in terms of the “big picture”…

– Broc Romanek, CompensationStandards.com

Tune in tomorrow for the webcast – “Proxy Season Post-Mortem: The Latest Compensation Disclosures” – to hear Mark Borges of Compensia, Dave Lynn of CompensationStandards.com and Morrison & Foerster and Ron Mueller of Gibson Dunn analyze what was (and what was not) disclosed this proxy season.

– Broc Romanek, CompensationStandards.com

Personally, I take these types of studies with a grain of salt – but this American Accounting Association press release notes that companies which adopt clawback provisions enjoy a “significantly positive capital market response” when the policy is disclosed.

– Broc Romanek, CompensationStandards.com

From this Towers Watson article:

New York State agencies have recently adopted final regulations to implement the new restrictions on executive compensation and administrative costs at state-funded not-for-profit and for-profit service providers, effective July 1, 2013. In general, the final rules make no significant changes in the regulatory framework proposed earlier this year. The limits will apply to reporting periods commencing on or after the effective date. In other words, for organizations that report on a calendar-year basis, the rules become effective January 1, 2014.

Among other provisions, the rules bar covered service providers from using more than $199,000 in state funds to pay executive compensation, with certain exceptions. Providers can pay executives more than $199,000 in total compensation from a combination of New York State and other funding sources if they meet conditions such as ensuring that the executive’s compensation doesn’t exceed the 75th percentile of that provided to comparable executives in comparable organizations, based on approved compensation surveys.

The final rules specify that guidance regarding acceptable compensation surveys and comparability factors that must be taken into account in applying this exception will be provided prior to the July 1 effective date. (For more on the rules, see “New York Postpones and Refines Its New Limits on Executive Pay at State-Funded Organizations.”

– Broc Romanek, CompensationStandards.com

Here’s an interesting NY Times article…

– Broc Romanek, CompensationStandards.com

There have been 10 more failures during the past few days, including three more companies that have failed two years in a row – and another with that has failed three years in a row! Here are the latest failures:

– Big Lots – Form 8-K (31%; also failed in 2012 with 31%)
– East West Bancorp – Form 8-K (42%)
– Tutor Perini – Form 8-K (38%; the 3-peat with 38% in 2012, 49% in 2011)
– The Children’s Place Retail Stores – Form 8-K (17%)
– Gleacher & Company – Form 8-K (39%)
– Insite Vision – Form 8-K (38%; also failed in 2012 at 49%)
– Radioshack – Form 8-K (46%)
– Delcath Systems – Form 8-K (49% support)
– Equal Energy – Form 8-K (44% support)
– Healthways – Form 8-K (32% support; failed in 2012 with 33% support)
– Hercules Technology Growth Capital – Form 8-K (49%)

Thanks to Karla Bos of ING for the heads up on these! Also check out this Towers Watson article entitled “Smaller Companies Seeing More Say-on-Pay Failures.”

– Broc Romanek, CompensationStandards.com

I told you that I could blog about this topic every day (hence this upcoming webcast – “Law Firms & Independence: What to Do Now“). Here’s a note that I received from a member:

As the July 1st deadline approaches, advisers to companies, particularly outside legal counsel, and board compensation committees have been focusing on what it means to “provide advice” as contemplated by the Instruction to Rule 10C-1(b)(4). The Securities Law Committee of the Society of Corporate Secretaries and Governance Professionals reported in a Society Alert that this question was discussed recently at its regular meeting with the Staff of the SEC’s Division of Corporation Finance.

At this meeting, Tom Kim, the Division’s Chief Counsel, clarified an informal Staff response to a question raised at the beginning of the month on how to determine whether a company’s outside legal counsel (or other outside adviser) was indirectly “providing advice” to a compensation committee. He indicated that, while the question does not lend itself to a “bright line” test, in-house legal counsel should be in the best position to make the determination and control the vetting process. For example, if in-house legal counsel has a lawyer outside the door of the compensation committee meeting and goes out and gets advice and then comes back in and transmits that advice, then obviously that adviser should have been vetted. He called this the “ventriloquist” scenario.

On the other hand, if in-house legal counsel speaks to several outside legal counsel as a matter of course and then is in a compensation committee meeting giving advice based on what he or she has heard and formulated in his or her own mind, this situation would not require that these counsel be vetted.

For everything else – including the more realistic scenario of in-house legal counsel talking to one outside law firm on a regular basis – it is up to the company to use its judgment as to whether, based on the relevant facts and circumstances, a party is providing advice to the compensation committee and, thus, an independence assessment is required.

– Broc Romanek, CompensationStandards.com

Here’s an interesting piece from Towers Watson’s Marshall Scott and Steve Seelig about the current state of pledging in the wake of ISS’ latest policy on the topic. Here is an excerpt:

Many of our clients are working to respond to the proxy voting policies of Institutional Shareholder Services, which for many companies has included an outright ban on stock pledging by executives. ISS policy states that “[p]ledging of company stock in any amount as collateral for a loan is not a responsible use of equity,” adding that pledging may have a detrimental impact on shareholders if the officer is forced to sell (such as to meet a margin call) (italics added).

While we understand the ISS concern that executive sales of large quantities of company stock may depress the market value of the shares, particularly in situations where other events already have created downward pressure on the stock price, we believe the circumstances where this might take place are rare, and we could argue that these companies would have continued on a downward spiral despite the executive sales. In fact, it’s possible the ISS policy will have an unintended consequence that negatively affects shareholders if anti-pledging policies discourage executives from holding company stock.

Academic research continues to find a direct correlation between the level of CEO stock ownership and favorable return to shareholders. The most recent of these studies1 finds that CEOs who receive large blocks of their company’s stock as part of their compensation package tend to spearhead fewer but superior deals that maximize shareholder value and produce better returns. This study references a long line of prior research that similarly ties higher levels of CEO stock ownership to better shareholder returns.

– Broc Romanek, CompensationStandards.com

Given the number of emails I have received in the past two weeks, I could blog about this topic every day. As I blogged recently, there is some confusion about how the new independence of advisors requirement as many law firms have taken different approaches so far – thus, I have calendared this upcoming webcast – “Law Firms & Independence: What to Do Now” – to which I just added two new speakers – Skadden’s Joe Yaffe and Gibson Dunn’s Ron Mueller – to the existing duo of Troutman Sanders’ Brink Dickerson and Bryan Cave’s Randy Wang.

Until that webcast occurs, you can feed your hunger with this Wachtell Lipton memo and Duane Morris blog on the topic – and this blog from Gibson Dunn:

As discussed in our April 26th blog, under recently amended NYSE Rule 303A.05 and NASDAQ Rule 5605(d), board compensation committees cannot select or receive advice from a compensation consultant, legal counsel or other adviser without first taking into consideration that adviser’s independence, including consideration of the factors enumerated in the rules. As compensation committees and their advisers are preparing for the July 1 effective date of these new listing standards, three observations are important:

First, a critical issue is what triggers the requirement. While it will be apparent when a compensation committee has “selected” an adviser, a more difficult issue is determining when a compensation committee will be deemed to have received advice from an outside adviser. Because the NYSE and NASDAQ listing standards were mandated by Exchange Act Rule 10C-1(b)(4), the SEC staff has been providing informal commentary on the application of the rules. The staff’s most recent commentary, presented by the chief counsel of the Division of Corporation Finance at a meeting this week with representatives from the Society of Corporate Secretaries and Governance Professionals, reiterated that outside counsel and other advisers may be deemed to provide advice to a compensation committee indirectly–even if the adviser is not meeting with or speaking directly to the compensation committee. As an example, if in-house counsel reports what outside counsel has advised, that can constitute “receiving advice” from outside counsel. However, the fact that in-house counsel may have consulted with a number of outside lawyers in developing a recommendation or advice for the compensation committee does not mean that the compensation committee will be deemed to have received advice from each of those outside lawyers. In other situations, it will be a facts-and-circumstances determination.

In considering these issues, companies should consider the purpose of the listing standards, which is for compensation committees to be aware of and consider factors that could be viewed as affecting the objectivity of advice they receive. When that advice is effectively coming from outside counsel, or outside counsel is being invoked as the source for particular advice, the requirements of these new listing standards should be borne in mind. As we have previously noted, because of the requirement that compensation committees consider an adviser’s independence in advance of receiving advice from the adviser, companies should consider which consultants, outside counsel and other advisers work regularly with the committee or with management on matters that fall within the committee’s areas of responsibility and whether advice from those advisers will be presented to the compensation committee. If so, those advisers should be requested to provide information on the various factors specified in the listing standards so that the information may be presented for the committee’s consideration. While this information does not have to be presented to the compensation committee before the July 1 effective date of these new listing standards, it should precede the first post-July 1 instance of the adviser’s advice being presented to the compensation committee. After the initial assessment, compensation committees should conduct a similar assessment at least annually.

Second, companies should bear in mind that the independence consideration applies to any compensation consultant, outside counsel or other adviser whose advice is received by the compensation committee, regardless of the nature or subject of that advice. In other words, the listing standards are not limited to advisers addressing executive compensation matters, but could also apply to advisers addressing director compensation, management succession or other issues that are handled by a board compensation committee.

Finally, the listing standards do not require that a board compensation committee use only independent advisers. Moreover, the listing standards do not state that the committee must make a formal determination about whether an adviser is independent, but instead require the compensation committee to consider the adviser’s independence, taking into account certain factors. We expect that, in connection with conducting the assessment required under the listing standards, many compensation committees will continue the practice of making a formal determination as to whether a compensation consultant that is retained by or provides advice to the compensation committee is independent, and that companies will continue to voluntarily disclose in their proxy statements that a particular compensation consultant has been determined to be independent. We expect, however, that it will continue to be less common for companies to provide voluntary disclosure addressing other advisers.

– Broc Romanek, CompensationStandards.com

Nice analysis from Steve Seelig and Andrew Goldstein of Towers Watson in this article:

Today, many institutional shareholders consider recommendations from proxy advisors who rely on proprietary pay-for-performance models as their first level of review in making their say-on-pay voting decisions. Over the years, these models have been subject to criticism for imposing quantitative testing regimes that focus on pay opportunity relative to total shareholder returns (TSR). In response, proxy advisors have honed their models to be more granular and more qualitative, although some critics have suggested these analyses don’t focus quite enough on the particular results the programs seek to elicit.

This may be changing. In working with clients in the 2013 proxy season, we’ve reviewed a number of proxy advisor reports regarding qualitative matters and their focus on how incentive programs are structured and precisely what those programs reward. The companies examined in these reports may have failed a quantitative test on pay for performance that necessitated closer scrutiny from the proxy advisor. Understanding these reports is important because, as has become clear in the say-on-pay era, every company is just one bad performance year away from coming in for increased proxy advisor scrutiny. Fortunately this does not mean that all companies end up getting a negative vote recommendation. For example, when we examined S&P 500 companies that triggered a qualitative review by Institutional Shareholder Services (ISS) in 2012 based on their quantitative test results, we found that three-quarters of those companies ultimately received a favorable vote recommendation.

Nonetheless, from our consulting experience we have begun to see a pattern of analysis from proxy advisors on pay structures they find objectionable. Here’s a look at some of the issues they’ve been focusing on:

Degree of difficulty for annual incentives: This gets to the essence of whether compensation committees are setting goals that are challenging enough for executives to warrant a target bonus. While the proxy advisers are not yet making subjective determinations on this issue for all companies, we’ve seen the issue raised for companies where above-target bonus payouts were made in previous years for good performance, but where current-year payouts remained at the same levels even though year-over-year performance declined on key financial metrics such as revenues, earnings or cash flow. Influencing the advisor’s concerns could be payouts above target even though some performance metrics under the annual plan fell below target or where the target itself did not signal improved corporate financial results. While the proxy advisors could be right in their assessment, in most cases they are making such determinations without the benefit of knowing critical factors relevant to the goal-setting process. If the proxy advisors push further on this issue (which we believe is a logical path), then it will be incumbent on companies to provide a descriptive rationale for the incentive plan goals in the CD&A, particularly in cases where performance goals are not higher than the prior year’s results.

Justification and performance conditions for retention awards: It’s established that proxy advisors tend to be skeptical of large retention awards, particularly in circumstances where options are under water or annual bonuses are not earned, but companies will accede to retention grants that include performance hurdles. We’ve seen circumstances in which advisors have questioned whether retention awards should ever be used as they may indicate a company that is not committed to pay for performance. Companies that do not offer a clear explanation of the need for retention awards and for awards granted without meaningful performance conditions are inviting scrutiny.

Duplicate performance measures for both annual and long-term incentives: Proxy advisors tend to favor multiple vehicles for long-term incentive programs and reward companies that focus on performance goals for these plans. But this favorable view can evaporate in cases where a company’s long-term performance share plan uses the same metrics (e.g., net income, total cash flow) as its annual plan, creating a duplication of payouts albeit in different forms: cash and equity. This concern may be exacerbated where the performance period under the long-term plan is shorter than three years or where the plan’s weighting is not pro-rata over the performance period, resulting in more concentration on the same metrics to determine payouts.

Increases in maximum payout potential: Increases in payout maximums from 150% to 200% of target or higher are not common, but there are companies that had lowered their maximums during the recent recession as a mechanism to limit payouts (and avoid windfalls) where goal-setting was challenging. There are also companies that will raise the maximum payout to be more consistent with market practice or to incent even higher levels of stretch performance. We’ve seen cases where proxy advisors have criticized such changes in the annual or long-term plan in years when shareholder returns are down under the assumption that executives are earning more for less, even when that is not really the case.

Absolute metrics for long-term incentives: Finally, we’ve seen proxy advisors find an emphasis on absolute metrics under long-term incentive plans to be inappropriate because performance may reflect economic factors or industry-wide trends beyond the control of executives, rather than the executives’ own performance. Instead, they have insisted that companies should incorporate relative measures to determine awards granted under a long-term incentive plan, regardless of the known pitfalls associated with relative performance goals.

Severance for departed CEOs: Proxy advisors are taking a close look at severance packages for terminated CEOs, particularly when the separation is the result of an extended period of poor company performance. We’ve seen cases in which companies have been taken to task even where their severance payments are absolutely consistent with prior contractual obligations, with no enhancements granted by the board. We interpret this as another attempt to reign in “pay for failure,” but the new twist is that companies will not be able to rationalize such payments simply by saying they were made according to the terms of a previously executed employment contract or severance agreement, or by structuring the terms to be generally in line with market practice.