The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Now that we’ve already had one failed vote in 2012 – please take a moment to participate in this anonymous poll and express how you read the tea leaves for the number of failed say-on-pays to befall companies this year (last year, there were over 40 – many more than I expected, evident by how much I vastly underestimated the range of choices in last year’s poll):

– Broc Romanek, CompensationStandards.com

Recently, Keith Bishop of Allen Matkins blogged about a new California bill that could require companies to disclose the compensation of their “five most highly compensated retired executive officers.” Keith’s blog is repeated below:

In 2002, the California legislature enacted the Corporate Disclosure Act to require publicly traded corporations and publicly traded foreign corporations qualified to transact intrastate business in California to file a statement of information with the California Secretary of State. Cal. Corp. Code §§ 1502.1 & 2117.1. For additional background on the CDA, see my article, California Joins the Parade: The California Disclosure Act, 16 Insights 21 (2002).

The Secretary of State has implemented an online search tool that allows the public to search and view these filings. Unfortunately, the information provided is a poor substitute for the information that these companies include in their filings with the SEC. Thus, the public is more likely to be misled than informed by the these California filings.

Rather than repeal this duplicative and decidedly unhelpful requirement, Senator Mark Leno has introduced legislation that signals an intent to expand it. Currently, SB 1208, consists of only of the following section:

SECTION 1. It is the intent of the Legislature to enact legislation that would require publicly traded corporations to report to the Secretary of State all forms of compensation, including pensions and benefits from other types of employee benefit plans, to the five most highly compensated retired executive officers of the corporation.

– Broc Romanek, CompensationStandards.com

Last week, a new report entitled “The Influence of Proxy Advisory Firm Voting Recommendations on Say-on-Pay Votes and Executive Compensation Decisions” by The Conference Board, the NASDAQ OMX Group, and Stanford University’s Rock Center for Corporate Governance was issued. The title explains what the report is about. And Equilar released a paper entitled: “A Different View of Say on Pay Voting Results in the S&P 500” that analyzes SOP votes by counting only the votes of non-management shareholders.

And also last week, ISS released a white paper entitled – “Parsing The Vote: CEO Pay Characteristics Relative to Shareholder Dissent” – that analyzes how the level of CEO pay impacts shareholder support for say-on-pay, whose findings include:

– CEO pay magnitude, along with poor total shareholder returns (TSR), helped drive investor dissent on 2011 “say on pay” resolutions.
– For example, average CEO bonuses for large capital, S&P 500 firms with low MSOP support stood at $3 million, compared with $1.1 million at higher supported peers.
– The value of “all-other-pay,” including perks and exit compensation, for CEOs at S&P 500 companies with low MSOP support was 138 percent greater than that for high support peers, while that for option grant values was 127 percent greater.

– Broc Romanek, CompensationStandards.com

Tune in tomorrow for the webcast – “What the Top Compensation Consultants Are NOW Telling Compensation Committees” – to hear Mike Kesner of Deloitte Consulting, Jan Koors of Pearl Meyer & Partners, Blair Jones of Semler Brossy and Eric Marquardt of Pay Governance “tell it like it is. . . and like it should be.”

Time permitting, the panel hopes to tackle all of these topics during the program:

– Weaknesses in ISS’ P4P assessment
– How ISS over values options
– Whether to consider ISS’s peer group in addition to their own
– How to best demonstrate pay/performance alignment (like Jan’s “right” pay and “right performance”)
– Rethinking severance (contracts, benefits, etc.) in a P4P world
– Whether to ‘fight’ a ISS recommendation with supplemental materials, etc.
– How and when to move away from a relative TSR program
– Whether to implement a clawback if they haven’t already

– Broc Romanek, CompensationStandards.com

ISS would like to respond to the inaccuracies in the recent blog by Mike Kesner at Deloitte Consulting regarding ISS’ Governance Risk indicators (GRId) as follows:

To begin with, we would like to emphasize that every issuer has access to its own scores and ratings completely free of charge. This includes the company’s answers to every GRId question and an indication of their impact – positive, neutral, or negative. Each question’s impact on the scores and rating is described in the GRId 2.0 technical document (posted at www.issgovernance.com/grid-info). Together, the technical document and the online issuer data verification site provide a clear indication of the particular practices a company would want to target in order to improve its corporate governance profile (and thus its GRId score).

Mr. Kesner’s posting also mischaracterizes or misunderstands the GRId 2.0 scoring methodology. The goal of GRId is to flag governance-related concerns, and the new scoring system is therefore designed to ensure that important single factors – such as apparent pay-for-performance disconnects, excise-tax gross ups or modified single triggers – or important particular combinations of factors, such as equity granting practices that mitigate (or fail to mitigate) risk – are appropriately reflected in the overall level of concern.

As a result the scoring model is not purely linear – while category scores range from 0 to 100, with 75 being neutral, there are many more than 75 negative points and 25 positive points available within each category. We have paid a great deal of attention to the interaction of a company’s practices in each subsection and how practices either increase or mitigate levels of concern. In some cases (for instance, in the termination subsection), good practices may mitigate concerns seen elsewhere. In others (for instance, pay-for-performance), the absence of a concern does not mitigate concerns identified elsewhere. These interactions – both question-level concerns and the level of concern and/or mitigation available in each subsection – are detailed in the GRId 2.0 technical document.

Indeed, the scenarios described in the original posting are working as designed: it is appropriate that companies with apparent pay-for-performance misalignment raise a concern, even in the presence of good practices elsewhere. These good practices can mitigate but not eliminate the concerns raised under pay-for-performance. Conversely, companies that do not exhibit pay-for-performance misalignment may still receive low scores if there are other concerning practices such as modified single triggers, excise-tax gross ups, incomplete disclosure of performance metrics, etc.

Finally, issuers should know that they can view their scores and underlying data and submit updates at any time before their definitive proxy is filed through the free GRId data verification site. ISS will review any publicly disclosed changes to company governance practices and issue updated GRId scores and ratings, if appropriate, within five business days.

Here is a page with our technical document, issuer FAQs, and more information on the GRId data verification process.

– Broc Romanek, CompensationStandards.com

According to this study by the Institute of Internal Auditors a while back, only 45.3% of respondent organizations conduct even limited reviews of the appropriateness of executive compensation and benefits and about one-third of such reviews are spearheaded by internal auditing. Moreover, the survey indicates that when conducting such reviews, internal auditors are most likely to focus on program compliance rather than on overall program design.

Personally, I’m not surprised given the expertise it would take to conduct a real review of compensation programs – expertise that internal auditors would not be likely to possess. Although I guess that’s true for most areas that internal auditors are called upon to review – that is one tough job…

– Broc Romanek, CompensationStandards.com

I have fond memories of attending a ISS conference about seven years ago, with Disney’s brand new CEO Bob Iger delivering a memorable address on governance (Iger succeeded Michael Eisner not long after the Delaware Supreme Court’s famous executive pay decision). Now, as detailed in this WSJ article by Joann Lublin, Disney is fighting ISS hard over a negative say-on-pay recommendation having filed two separate pieces of supplemental proxy materials on March 1st. As noted in this Davis Polk blog, Disney’s SOP passed yesterday with 56.6% support.

Here are some thoughts from a member about this battle:

Disney is in a “no win” situation with ISS, as they are being compared to Winn Dixie, Best Buy and other consumer goods companies due to the lack of sufficient media companies. I think Disney’s approach of going direct to shareholders with their compensation rationale makes the most sense.

I also believe that companies have to do a much better job defining what pay for performance is, and not allow shareholders to fill the pay for performance void with ISS’ methodology, as it is fundamentally flawed. The ISS pay-for-performance model compares 1 and 3 year historic TSR to potential future compensation values ( i.e., grant date values of long-term incentives) that will be earned on future performance results.

ISS’ methodology is a bit like keeping score at today’s basketball game using the players average points the last three years. You do not win or lose today’s game based on how you scored in the past. If that was the case, why play the game at all? Same for compensation. If future performance did not matter, then why not just write the exec a check for the grant value and call it a day?

In the WSJ article, Joann Lublin tries to make the company’s desire to focus on realizable pay sound like some nefarious way to fool shareholders. But, if CalPERS gets it, then there is a good chance all shareholders will come around and consider realizable pay and performance is far better than using grant date values.

– Broc Romanek, CompensationStandards.com

In our “Say-on-Pay” Practice Area, we have posted the court order issued last week in the Superior Court of California-LA that rules against the plaintiffs. We have also posted this week’s order from the US District Court for the District of Maryland dismissing the lawsuit against BioMed Realty Trust.

As Mark Poerio notes in his blog:

The directors and officers of Jacobs Engineering, and their compensation consultant, have successfully challenged a complaint alleging that poor corporate financial performance made their authorization of significant pay increases for executives “unreasonable, disloyal, and not in good faith, and violated the Board’s pay-for-performance executive compensation philosophy.”

A Los Angeles Superior Court dismissed the complaint for failure to adequately allege either (1) demand futility or (2) facts sufficient to constitute their claim. Notably, the court observed that “The Dodd-Frank Act did not create any binding obligation on the Board” [through its advisory say-on-pay vote requirement], and that there was “no actionable misrepresentation alleged or culpability” alleged to support claims based on false disclosures in the company’s proxy statements.

– Mike Kesner, Deloitte Consulting

ISS published its GRId 2.0 ratings last Monday and updated its technical document too. ISS determined the ratings using its updated GRId scoring system, which examines a company’s board structure, compensation, shareholder rights and audit, and 2011 proxy data as a “trial run” for their new approach. Consistent with the prior GRId System, compensation, by far, has the most evaluation criteria (41 questions in all), including a number of new questions for 2012. The GRId 2.0 score will be updated once 2012 proxies are filed.

ISS not has released the scoring system it is using in calculating a company’s score, so it is impossible to figure out what steps a company can take to move from a high risk to a medium or low risk rating without purchasing ISS’ GRId Analytics for $28,000.

Based on my review of several GRId 2.0 reports, it appears there is a short-circuit in the scoring system. Some companies appear to have very solid pay practices, but received a “high risk” score on one of the four pay for performance questions resulting in a very low GRId score (e.g. 5 of 100). Other companies appear to pass pay-for-performance with flying colors, yet received a high concern on GRId because they did not have holding periods or specific minimum vesting periods in the equity plan and they had employment contracts with excise tax gross-up (in this case a score of 21 of 100).

I also noted companies with very high results (92 of 100) that were lacking holding periods, allowed share recycling, had excise tax gross-ups, permited option repricing without shareholder approval, did not have a hedging policy and allowed the cash buyout of underwater options.

My conclusion based on this review is there might be something wrong with the scoring system since companies with very similar pay practices and pay-for-performance can receive very different scores.

So what to do?

If you have not already done so, check your preliminary GRId 2.0 to make sure it is correct based on your 2011 proxy. ISS made a number of errors – and it is important that companies identify these errors early.

If you have already subscribed to GRId Analytics, you should evaluate how actual – or potential – changes to your pay practices may influence your 2012 GRId score. If you have not already purchased GRId Analytics, you may want to ask your ISS representative when they plan on publishing the scoring system so you can evaluate which changes will most positively impact your GRId score.

It is important to note that any changes you might make (like adopting minimum stock option vesting requirements or committing not to enter into future employment agreements with an excise tax gross-up provision) need to be discussed in this year’s proxy – or filed in an 8-K – to document the change.

– Scott Oberstaedt and Sharon Podstupka, Towers Watson

As we recently blogged: It’s the most wonderful time of year for business writers, especially those looking for a compelling story line that’s sure to generate discussion: “How much did that CEO make this year?”

Yes, it’s the proxy season and, as has become an annual tradition, executive pay is back in the headlines. The inevitable eye-popping ones capture readers’ attention, to be sure, but the narratives often provide few insights into what really was paid — or worse, they mislead the reader into thinking that compensation committees took actions that are not in shareholders’ best interests.

Clearly, there are situations in which media criticism of a company’s executive compensation program is totally warranted. However, if you find yourself staring at an unflattering headline about your company’s executive pay that seems less than fair (or are worried about what future press coverage may bring), you might want to be ready to explain the real story. A little advance planning for negative publicity can help go a long way in helping you prepare an explanation for your key stakeholders. Here are some suggestions for laying the groundwork to respond to six hypothetical headlines (based on real-world examples) that some companies may encounter in the upcoming proxy season.

1. “CEO Pay Rises Dramatically in 2011”

– What the reporter may have done: The reporter may have looked up the Summary Compensation Table’s (SCT) rightmost column, which shows Total Compensation for the past three fiscal years, and then subtracted the 2010 total from the 2011 total to uncover a large increase.

– What you can say in response: “The total shown on the SCT is not what we paid our CEO in 2011. It includes the accounting cost of equity grants we made that don’t vest for years or, in the case of stock options, have no value unless the stock price rises. It even includes things like 401(k) contributions and pension value changes. Our CEO’s W-2 compensation for the year was only a fraction of the amount listed.”

– What you can do: Include a table in your CD&A that highlights realized or realizable compensation. These amounts can be parallel, and in many instances, better indicators of annual executive compensation.

2. “CEO Pockets Huge 2011 Bonus”

– What the reporter may have done: Here, it’s likely that the reporter compared the 2011 annual cash incentive number listed in the SCT to the 2010 annual cash incentive number.

– What you can say in response: “Our target bonus amount did not change, but our business performance improved substantially. Our executives’ bonuses paid below target in 2010, but above target in 2011 due to improved performance. We have not changed our approach to bonus payments or targets.”

– What you can do: Include a pay-for-performance chart in your CD&A that plots variable compensation against key financial metrics, such as income growth or TSR. This can be historical performance or relative to a peer group. Explain how pay and performance are aligned, and if not, what the compensation committee has done to ensure better alignment in the future.

3. “Executive Stock Grants Skyrocket in 2011”

– What the reporter may have done: This journalist probably looked at the value of the equity-based awards grants in 2011, also from the SCT, and compared that line to 2010.

– What you can say in response: “If you look at the detail in the Grants of Plan-Based Awards on the following page, you’d see that we granted the same number of options/shares in 2011 that we did in 2010. The accounting cost changed on each share/option, but we haven’t changed our approach to annual share grants.”

– What you can do: Provide a clear explanation of how the company determines equity grant practices. For example, does the committee follow a fixed-value or fixed-share approach in making equity grants? (Note that illustrating realized or realizable compensation and pay-for-performance alignment will also help.)

4. “Departing CEO Gets Huge Parachute”

– What the reporter may have done: This reporter may have compared the pay of an outgoing CEO (which often includes accelerated accounting charges on multi-year vesting of stock and pension benefits) to last year’s pay levels.

– What you can say in response: “The total 2011 compensation cost we reported in the proxy statement is for both current year and future payments that were part of the former CEO’s contract. This included deferred compensation and a pension that was earned over many years of service with the company.”

– What you can do: Explain in the CD&A which payments were made upon termination versus which are payable in future years. Also, it may be helpful to list the values of any awards or other compensation that were forfeited upon termination, such as unpaid bonus or unvested stock options and performance shares. Most termination payment disclosures are one-time events that will cause a temporary disclosure headache, and there may be potential for the company to be accused of “paying for failure,” so stay vigilant about how you explain this one-time payment and how it might compare to future payments for outgoing executives.

5. “CEO Takes Massive Pay Cut”

– What the reporter may have done: This is the inverse of our first headline, involving a comparison of 2011 total pay to 2010 total pay in the SCT, and reporting a large year-over-year decrease.

– What you can say in response: “Our approach to compensation has not changed in the past year. We provide market-competitive target compensation levels that are earned over time based on the company’s performance. We take a long-term approach to compensation, just as we take a long-term approach to building company value. Financial statement users should not read too deeply into one-year changes in reported numbers.”

– What you can do: Provide details on each executive officer’s target compensation value as well as actual compensation paid in the last year. While a decrease in CEO pay may seem like a good thing to some outsiders (and to shareholders especially if the company had a particularly bad year), it will be helpful to highlight the consistency in target pay levels year over year, especially when performance (and pay) bounce back.

6. “Overpaid CEO Cashes in on Millions of Dollars in Options”

– What the reporter may have done: This reporter may have looked at an 8-K filing or the Options Exercised table of the proxy and concluded that the CEO got a massive payment in a year when shareholder returns were flat.

– What you can say in response: “Options are granted to provide our CEO incentives to increase shareholder value over a period of time. By their nature, options give the CEO discretion over the timing of any gains, and this exercise is in line with sound financial planning decisions. It reflects the increased value the CEO has delivered to all shareholders over the past several years.”

– What you can do: Provide a table within your CD&A or in a press release that would illustrate the value delivered to shareholders over the period in which the CEO’s options increased in value. Here again, a pay-for-performance depiction based on realizable pay would best help illustrate the close alignment between CEO pay and shareholder returns.

Ultimately, a company’s ability to affect the numbers reported in the SCT itself is limited by SEC rules. Many companies will decide that a public debate with any reporter or media outlet on executive pay has a limited upside and substantial potential downside. However, the inclusion of realized or realizable compensation tables and/or pay-for-performance charts in the CD&A is becoming increasingly common as more companies view the SCT as providing only an incomplete picture. And, of course, if there is a misalignment between pay and performance, an explanation of why it occurred and how the company’s programs are designed to ensure that pay will be aligned in future years is a critical consideration for investors.

Companies should look to use the CD&A as an opportunity to continue a dialogue on executive rewards between the company and its investors. And, while it may not garner a Pulitzer or be turned into a Hollywood screenplay, a clear and dynamically written CD&A that fully explains a company’s executive compensation philosophy — and how it reinforces the company’s long-term business strategy — is the best defense against media or other outside scrutiny of executive pay practices