The Public Company Accounting Oversight Board, or PCAOB, has reproposed a new auditing standard, Related Parties, and certain other amendments to its standards. Overall, the reproposal is directed at detecting material misstatements and fraud. But the proposed standards also include audit procedures related to executive compensation, given the possible incentive compensation can have on to manipulate financial results or engage in fraud.
Required audit procedures include reading employment and compensation contracts with executive officers and reading proxy statements. For some reason, I thought auditors already did this. The term “executive officers” is defined the same as Rule 3b-7 under the Exchange Act. The proposal does not change the existing standard to obtain an understanding of compensation arrangements with “senior management,” a broader term than “executive officers.”
Some procedures the auditors “should consider” include (see pages A3-1 to A3-2):
– Inquiries of the compensation committee chair and any compensation consultant regarding the structure of executive officer compensation; and
– Obtaining an understanding of policies and procedures regarding the expense reimbursements of executive officers.
Influence on Executive Compensation. The reproposal and comments on the original proposal are explained on pages A4-75 to A4-87. Some commenters objected to the initial proposal on the grounds that auditors might influence the design of compensation programs or require the auditor to substantively judge the executive compensation programs. The PCAOB thinks it solved these problems by emphasizing that the purpose of the procedures is to further the auditor’s risk assessment of material misstatement rather than to determine the appropriateness of executive compensation.
Inquiries of Compensation Committee Chair and Consultants. The PCAOB received mixed comments on suggesting the auditors make inquiries of the compensation committee chair and compensation consultants. Not surprisingly, some said this would be intrusive. The PCAOB responded by stating it is not required, the auditors only need consider it. Once this suggestion appears on an audit checklist, we wonder how many auditors will be able to resist, given the threat of a PCAOB inspection.
Litigation. Another commenter pointed out that auditor documentation could complicate any litigation or claims related to executive compensation disclosures. The PCAOB seems to give this the short shrift by stating litigation is not a concern when preparing audit workpapers. We can now see these workpapers on a standard discovery list by the strike-suit types, and can only hope that they are prepared with the same sensitivity as say loss contingency and tax accrual workpapers.
Determination of Executive Officers. Some commenters recommended that the amendments clarify the role of the auditor in determining who is an executive officer. The PCAOBs response is the amendments do not require the auditor to evaluate management’s identification of “executive officers” for SEC filing purposes and that the SEC definition is “objective.” Objective perhaps, but fact intensive and specific, and who knows what happens if the auditors draw a different conclusion, including possible significant Section 16 issues.
As the U.S. annual meeting season reaches its peak, an ISS analysis of early shareholder voting finds less dissent on say-on-pay compared with this time last year, while support for some shareholder proposals has slipped from levels evidenced in 2012. As of May 6, average support for say-on-pay resolutions across the Russell 3000 stands at 92.5 percent, a nearly two point jump over this time last year and three point increase over 2011. ISS is also tracking fewer votes receiving less than majority support this year – six – compared with eight during the same period in 2012 and 11 in 2011. Notably, 2012 and 2011 numbers are based on voting results for 345 and 383 companies, respectively, well below the 417 results collected by ISS through May 6 of this year.
When examining majority supported yet low votes, ISS finds just 4.3 of Russell 3000 companies fall within the 50-70 percent support level range, compared with 6.7 percent through early may 2011. Companies falling between the 70 and 90 percent support level also has dipped by nearly one point to 13.9 percent thus far in 2013.
Larger Companies Lead Gains
Parsing the numbers, large capital companies appear to account for much of the gains in 2013 shareholder support levels. S&P500 firms saw the lowest average support level compared with the broader S&P1500 and Russell 3000 last year at 88.3 percent, which represented no change from 2011 while both of the broader indices saw gains from 2011 to 2012 of roughly one point each. This year, however, large capital companies have seen the greatest growth in average support levels of 3.5 points, compared with three for the S&P1500 and just under two for the Russell 3000.
Driving the change are companies such as International Game Technology, The Bank of New York Mellon, C.R. Bard, Johnson Controls, and Huntington Bancshares, which, as S&P500 constituents, comprise five of the top 10 companies seeing year-over-year gains in say-on-pay voting. By contrast, just one large capital firm–Tyco International–is among the top 10 decliners thus far in 2013, having gone for 94.9 percent support of votes cast “for” and “against” in 2012 to 68.5 percent this year.
Governance watchers suggest large capital firms are doing a better job this year than last in communicating to shareholders steps taken following low support for say-on-pay and also taking steps better align pay and performance. When examining pay-for-performance concern levels undergirding ISS’ pay vote evaluations, S&P500 firms again show the greatest improvement reducing to 7.1 percent the portion of companies deemed to have “high” concerns, compared with just under 12 percent last year. The Russell 3000 broadly, by contrast, has seen no year-over-year change with 10.1 percent of companies analyzed thus far in 2013 netting “high” pay-for-performance concerns. Overall, ISS recommendations against S&P500 companies’ advisory pay resolution are down from 13.5 percent this time last year to 8.2 percent. The figure stands at 10.1 for Russell 3000 firms this year.
“Say-on-pay has proven quite effective in addressing and discouraging cases of pay practices and structures that are viewed by investors as ‘egregious’ or ‘out of line’,” Harvard Law School Prof. Lucian Bebchuk noted on a May 7 ISS GovernanceExchange webcast. “This is an improvement,” he acknowledged.
Bebchuk cautioned, however, that more needed to be done to fully leverage the right, noting the vote has been “less effective or not effective at all” in addressing and discouraging practices that are widespread yet still “subpar and suboptimal.” Bebchuk suggested this will be an issue for institutional investors to “think about, going forward” and, specifically, how investors can use say-on-pay to go beyond addressing egregious practices to include those that are prevalent yet still problematic.
As noted in its Form 8-K, Stillwater Mining is the 9th company holding an annual meeting in 2013 to fail to gain majority support for its say-on-pay (32% support). And as noted in its Form 8-K, AXIS Capital Holdings is the 10th company (also 32% support).
And for the 11th failure, as noted in its Form 8-K, Comstock Resources had just 32% support this week – it also failed last year with 35% support.
The full agendas for the Conferences are posted – but the panels include:
– Q&A with ISS
– Q&A with Glass Lewis
– Say-on-Pay Shareholder Engagement: The Investors Speak
– Compensation Committees & Advisors: The NYSE & Nasdaq Speak
– Realizable Pay Disclosure: How to Do It
– How to Improve Pay-for-Performance Disclosure
– We Don’t Have a Good Pay Story: What Do We Disclose?
– How to Avoid Executive Pay Disclosure Litigation
– Peer Group Disclosures: What to Do Now
– In-House Perspective: Strategies for Effective Solicitations
– The SEC Staff Review Process
– Creating Effective Clawbacks (and Disclosures)
– Pledging & Hedging Disclosures
– The Executive Summary
– The Art of Supplemental Materials
– Dealing with the Complexities of Perks
– Say-on-Parachute & Post-Deal Disclosure Developments
– Compensation Accounting, Tax & Risk Assessment Disclosures
– Shareholder Proposals & Executive Pay
– The Rise of Political Contribution Disclosures
A recent Wall Street Journal article (“Blind Spot Covered Ex-Trader’s Trail,” 4/8/13), describes Morgan Stanley’s plan to claw back $100,000 to $200,000 of deferred compensation as a result of a trader’s guilty plea to charges arising from his work for a prior employer. This proposed clawback suggests a desirable business dynamic, in the sense that employers should have the discretion to decide what circumstances should trigger the forfeiture or repayment of executive compensation.
By contrast, Section 954 of the Dodd-Frank Act requires that employers pursue mandatory clawbacks regardless of business judgment or cost-benefit analysis. The vast majority of employers have clawback policies and rights, and there is a healthy move toward deepening them (as evidenced by the recoupment policy that the major pharmas recently approved in conjunction with an investor coalition.)
Section 954’s misguided mandate is merely getting in the way of healthy governance. Before there is further waste of SEC or business resources, it would be smart to convert Section 954 into a discretionary right for employers. The fix would be simple, and would remove a drag that current law creates.
As noted in its Form 8-K, Dendreon is the 8th company holding an annual meeting in 2013 to fail to gain majority support for its say-on-pay (31% support). Hat tip to Steven Hall & Partners for pointing this out!
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…
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.