– Broc Romanek, CompensationStandards.com
Here’s news from the Glass Lewis Blog:
After targeting executive remuneration at state-controlled companies with new regulation introducing pay caps for CEOs, France’s new government is now considering potentially sweeping reforms for all public companies. In a recent consultation paper released by the Finance Ministry (see Glass Lewis’ response), market participants were asked to comment on numerous questions mainly focused on the approval and structure of executive pay. While shareholders at French companies are currently entitled to resolve on equity-based incentives and severance payments, a vote on a company’s pay practices is either recommended by the AFEP-MEDEF Code (the reference corporate governance code for the majority of French issuers) or required by law. However, France could soon enlarge the number of European countries introducing say-on-pay proposals. The consultation inquiry, in fact, seeks comments on whether such mechanism allowing shareholders to voice their concerns over poorly designed pay policies should be envisaged and whether it should be binding or advisory in nature.
Regarding certain components of variable remuneration such as stock options and restricted shares, the French government goes so far as to consider a ban among the possible policy options. Moreover, the introduction of deferral mechanisms and claw-back provisions is considered in the Finance Ministry’s inquiry together with a requirement for French issuers to allow employee representatives to serve on remuneration committees. Interestingly, the consultation paper also raises some preliminary issues over the scope and nature of any new proposed measures, with the debate centering on the choice between binding legal provisions or “comply-or-explain” best practices.
During his presidential campaign Mr. Holland promised to curb excessively generous pay packages with the French government opposing the severance pay for Safran’s CEO and an indemnity pursuant to a non-compete agreement paid to Air France-KLM’s former CEO. The extent to which the government will be successful in forcing changes at companies where it does not hold a controlling or majority stake will be soon clear as the new measures are expected to be announced in the fall.
– Broc Romanek, CompensationStandards.com
In our “Pay-for-Performance” Practice Area, I recently posted this article by Roland Burgman and Mark Van Clieaf that “identifies the issues associated with the unconsidered use of TSR as a metric to represent the gains (or otherwise) in shareholder wealth and in contexts such as long-term incentive compensation and proxy voting by shareholders (including “say on pay”). Not all TSR is created equal. Other measures, such as economic profit (EP), return on invested capital (ROIC), and future value (FV), need to be introduced to effectively interpret the quality of TSR. There are not one but eight states of the quality of TSR, and this has implications for effectively evaluating true pay-for-performance alignment and considered say-on-pay voting by institutional investors everywhere.”
– Broc Romanek, CompensationStandards.com
Here is a DealBook column entitled “For Whom Golden Parachutes Shine” penned by Harvard Prof. Lucian Bebchuk that explains a recent study. Here is an excerpt:
We confirm that golden parachutes do indeed have a beneficial effect on acquisitions. We find that companies that offer such packages have a higher likelihood of both receiving an acquisition offer and being acquired.
Because golden parachutes make executives more eager to sell, they are also associated with lower premiums in the event of an acquisition. But this effect is sufficiently small so that, over all, golden parachutes are associated with higher expected gains from acquisitions. On average, shareholders in companies with golden parachutes pocket larger benefits from acquisition premiums, and we find evidence that this association is produced by the effect that golden parachutes have on executives’ incentives.
So far, so good. However, when we look beyond acquisitions to examine the relationship between golden parachutes and company value, we find that such packages hardly shine for the shareholders of companies adopting them. Companies that have adopted golden parachutes tend to see their valuations (relative to their industry peers) erode over time. Such companies have lower valuation already before adopting a golden parachute, but their value declines further in the subsequent several years.
We find a similar pattern when analyzing the stock returns of companies with and without a golden parachute during the period of more than 15 years for which we have data. Companies that adopted golden parachutes have lower (risk-adjusted) stock returns relative to those that didn’t – both during the two-year period surrounding the adoption and in the next several years.
What explains this pattern? Why do companies with golden parachutes fail to deliver for their shareholders overall even though they provide them with more benefits in the form of acquisition premiums? This pattern could be at least partly a result of the adverse effect that golden parachutes have on the incentives and performance of executives not facing an acquisition offer.
The market for corporate control benefits shareholders not just by providing the prospect of pocketing an acquisition premium but also by affecting performance more generally. Executives face the possibility that they might be ousted if they underperform. By ensuring executives of a cushy landing in the event of an acquisition, golden parachutes weaken the disciplinary force exerted by the market for corporate control.
Our corporate system provides executives with a significant power to impede or facilitate an acquisition. Golden parachutes are offered as a remedy to the concern that executives will deviate from shareholder interests in exercising this power. But this remedy is a highly imperfect one. While it does lead to more acquisitions, it also carries significant countervailing costs with it. Golden parachutes are not the easy fix for the incentives of executives as some might have hoped.
More work should be done to fully understand the consequences of golden parachutes and how they should be used. In the meantime, however, the evidence suggests that investors should continue to pay close attention to the use — and potential costs — of golden parachutes.
– Broc Romanek, CompensationStandards.com
According to this Reuter’s article:
In an interview published on Friday in Rolling Stone magazine, Obama said that despite passage of Dodd-Frank financial reform legislation, there is more to be done to make financial markets safe after the damage caused by the crisis of 2007-2009.
“The single biggest thing that I would like to see is changing incentives on Wall Street and how people get compensated,” Obama said. It’s questionable, even after enactment of Dodd-Frank reforms, that those incentives have completely been changed, he added. The Rolling Stone interview stirred controversy because of the president’s use, at one point, of a barnyard epithet that some saw as an attack on Republican Mitt Romney.
The White House did not dispute the remarks but a re-election campaign official stressed that the comments were “part of a casual conversation at the end of the interview.” The wide-ranging interview covers Obama’s first term, what he views as his biggest accomplishments and his fierce fight with Romney for the White House.
The president and Romney are running neck and neck ahead of the Nov. 6 election and have stepped up their campaigning. Obama points to financial reform as a signature accomplishment of his four years in office and says the overhaul will prevent a repeat of the devastating crisis that caused the loss of more than 8 million jobs and erased an estimated $19 trillion in household wealth.
However Dodd-Frank reforms are deeply unpopular with the financial industry and many businesses, who say an avalanche of new requirements stands in the way of hiring new workers and making fresh investments, thus holding back the broader economic recovery. Romney has promised to repeal provisions of the 2010 Dodd-Frank law if elected.
Obama said the stability of markets is still at risk because people making risky bets are handsomely rewarded if the bets pay off, but face limited consequences if those bets go sour. “It tilts the whole system in favor of very risky behavior,” he said. “By the time the chickens come home to roost, they’re still way ahead of the game.” Such changes are not entirely up to passing laws in Washington and may require shareholders or company directors to act, Obama said. Changes to the executive compensation system cannot entirely be legislated, he said.
Another challenge to ensuring greater financial stability in the future will be to ensure that the rules that prohibit banks that receive government backstop from making risky trades — the so called Volcker Rule – is adequately enforced, Obama said. Progress in implementing the rule was slowed when regulators received thousands of comment letters. Two influential U.S. senators on Thursday urged regulators to resolve differences and finish writing the rules before the end of the year.
– Broc Romanek, CompensationStandards.com
From this Pensions & Investments article:
The Council of Institutional Investors on Friday approved a new policy specifying that current and former executive officers should be subject to corporate clawback provisions on bonuses, incentive pay and compensation in cases of corporate fraud or misstatement of financial results.CII’s previous policy only mentioned executive officers and gave no further guidance.Also under the new policy, incentive-based compensation should be subject to a recovery period of at least three years.
In a policy statement, CII said the revised language makes it clear than an executive should not be able to terminate eligibility for clawbacks simply by leaving the company. The statement says that the amended language will help ensure that the council is prepared to comment on the SEC’s proposed rule on clawbacks.
The SEC is required under the Dodd-Frank Wall Street Reform and Consumer Protection Act to implement a clawback policy, but it is unclear when the commission will issue its draft rule. CII also amended its policy that opposes corporations subjecting shareholder lawsuits to mandatory court arbitration to include all corporations globally. The previous policy only mentioned U.S. companies.
CII said it doesn’t object to voluntary arbitration for example, between a company and an investor. It said the intent of its expanded policy is to discourage the type of provision put forth by the Carlyle Group before it went public earlier this year to prohibit unit holders from having access to the court in case of a dispute. Carlyle officials later withdrew the policy that would have subject unit holders to mandatory arbitration. The changes were recommended by CII’s board and approved by members in closed session Friday morning. CII has no enforcement powers, but its member pension funds as shareholders vote on corporate board members and individual officers.
– Broc Romanek, CompensationStandards.com
Recently, Glass Lewis published a report linking compensation to sustainability. Here is an excerpt from the blog about it:
Since 2010, Glass Lewis has reviewed this trend and has found a significant increase in the number of companies linking compensation to sustainability. For the 2012 edition of Greening the Green: Linking Executive Compensation to Sustainability, Glass Lewis reviewed the short- and long-term compensation plans disclosed by companies in their annual proxy filings. For this years’ report, we reviewed the constituents of indices in 11 global markets (S&P 100, S&P/STX 60, FTSE 50, S&P/ASX 50, IBrX 50, IBEX 35, CAC 40, AEX 25, OBX 25, SMI 20, DAX 30). We found that 42% of these companies provide a link between executive pay and sustainability, a considerable increase from two years ago, when only 29% of companies provided such a link.
– Broc Romanek, CompensationStandards.com
Here’s an interesting article from Towers Watson’s Steve Seelig and Russ Hall:
We’re receiving a growing number of questions from companies interested in easing their employees’ tax burden in 2013 by paying their 2012 calendar-year bonuses before year-end. Aside from some of the tax-related challenges detailed below, the threshold question compensation committees should consider involves the optics of this decision. Our view is that, although the acceleration is doable and a tax-efficient delivery of compensation is generally preferable, the challenges of explaining the company’s rationale to shareholders, as well as managing and administering an accelerated year-end schedule, are likely to outweigh the benefits of saving executives money. We recognize, however, the school of thought that bonus accelerations may not need to be disclosed to shareholders in a company’s proxy or 10-K, particularly if named executive officers (NEOs) do not participate. In short, there may be more flexibility for an approach covering high earners who aren’t NEOs.
For those who wish to explore the tax implications of this strategy, one issue is whether accelerated payments to top executives would remain tax deductible under the 162(m) “performance-based compensation” exception. A second issue would arise where there are existing nonqualified plan deferral elections in place to delay payment of the 2012 bonus to a later year.
What’s the Issue?
Some clients contemplating the implications of November’s presidential election believe it’s likely that the Bush tax cuts will expire in 2013, resulting in higher tax rates for their higher-paid employees. This could mean that the top marginal income tax rate will increase from 35% to 39.6% unless Congress intervenes.
From a corporate perspective, the tax code recognizes that it is administratively difficult for companies to pay annual performance bonuses before year-end and permits a tax deduction if they are paid within two and a half months after the end of the bonus year, subject to some additional requirements. The same rule applies to settlement of performance shares. Virtually every company uses this rule of convenience. But, for high-income taxpayers to take advantage of potentially lower 2012 tax rates, this regime would need to change so that bonuses are paid during 2012, rather than after year-end.
Doing so would raise an overarching question about changes in tax accounting methods, an issue best discussed with tax advisors. Assuming that hurdle is met, and companies can reasonably value bonus amounts due before the year-end books are closed, there are two other issues that must be confronted: 162(m) and 409A of the tax code.
$1 Million Pay Cap Under Section 162(m)
The first potential challenge is whether companies can meet the “performance-based compensation” exception to the $1 million deduction cap for bonuses paid before year-end to the CEO and three highest paid executive officers (other than the CFO) listed on the company proxy. The complication that arises is whether the compensation committee can certify in writing prior to payment of the compensation that the performance goals were satisfied. The committee cannot approximate that the goals have been met; there has to be an actual performance period that is measured. A similar analysis would apply where companies want to settle performance shares before the end of a multi-year performance period.
How easy it is to accomplish this early certification will depend on the type of performance metrics being used. A performance target such as a revenue goal in excess of 105% of the prior-year level might be measurable if attained before the early payment date. By contrast, a performance goal based on net results, such as earnings per share for a calendar year, might be more difficult to certify before year-end with the uncertainty of events that may occur during the last weeks of the year. Adding to the mix is the open question of whether the IRS agrees that certification can take place before the end of the original measurement period.
Another approach might be to simply truncate the performance period so that it ends, using the above example, on December 15 instead of December 31. However, it’s unclear under the tax regulations, which require that a performance goal for an annual bonus be set by the 90th day from the start of the year, whether the length of the performance period must also be specified on that date. Said differently, can you change a one-year performance period to something shorter during the course of the performance year? The regulations are not clear on this issue.
Assuming the certification hurdle can be met, another arcane — and unresolved — regulatory question is whether the entire bonus can be paid before year-end. Reg. section 1.162-27(e)(2)(iii)(B) provides:
“If compensation is payable upon or after the attainment of a performance goal, and a change is made to accelerate the payment of compensation to an earlier date after the attainment of the goal, the change will be treated as an increase in the amount of compensation, unless the amount of compensation paid is discounted to reasonably reflect the time value of money.”
It’s not clear to us what this regulation is trying to address. Does it endorse early payments like the ones we are suggesting? Does it apply to all situations where a payment is being made earlier than two and a half months from year-end or only when a specified payment date is being overridden by an earlier payment? These are open questions.
Also keep in mind that accelerated or discounted payments must comply with the terms of the executive bonus plan, so the company would need to make sure that the plan at least grants the authority for the compensation committee to pay the bonuses early.
409A Deferral Elections Must Be Honored
Section 409A would come into play in situations where executives have previously elected to defer payment of bonuses earned for 2012 performance under a nonqualified deferred compensation plan. In general, these elections must be in place at least six months before the end of the performance period and may have been made before the start of 2012. Because we’re now well past the end of that six-month period, several potential arguments for revoking existing elections are no longer available, so we see little hope of changing deferral elections currently in place.
In short, early payouts during 2012 of deferred compensation are generally not permissible.
Proxy and 10-K Disclosures
We believe that accelerating NEO bonuses would be considered “material” and, thus, would need to be disclosed in the Compensation Discussion and Analysis section of the proxy. This will be a matter of judgment to be resolved with SEC counsel. Of course, the CD&A disclosure issue would be moot if NEOs are excluded from the accelerated bonus payout.
However, even if the NEOs are included, we don’t believe the pre-year-end payment would change any of the required tabular proxy disclosures. For example, Summary Compensation Table disclosure of Non-Stock Incentive Plan Compensation or Bonuses is based on compensation earned for the year, regardless of when it’s paid. Other tables would similarly be crafted the same way regardless of payment timing. Similarly, because the tax deduction timing rules permit bonus payments made within two and a half months of year-end to be deducted in the year in which they were earned, we don’t see the 10-K financials being any different if the payments are made before the end of the year.
Ultimately, companies will want to give all of the implications of bonus acceleration careful thought before deciding on a course of action.