On a topic that will be covered more fully in the January-February issue of The Corporate Counsel that will be out within a few days, the Corp Fin Staff recently addressed the fact that hundreds of companies forgot to amend their Form 8-Ks last year to disclose their say-on-pay frequency decision – and how that impacts their Form S-3 eligibility. Here is a WSJ article from yesterday on this topic:
Hundreds of companies “forgot” to comply with an aspect of the say-on-pay advisory vote law that went into effect last year, according to the U.S. Securities and Exchange Commission. As part of the Dodd-Frank law that requires companies to give shareholders an advisory vote on compensation, companies had to let shareholders decide whether say-on-pay votes should occur every one, two or three years and file an amended 8-K within 150 days of the vote explaining their decision on the vote’s frequency. While most companies filed an 8-K with the preliminary results a few business days after the vote, hundreds didn’t follow-up with the other filing, according to the SEC.
Companies that failed to file the reports are technically not in compliance with timely-filing requirements and could be impinging on their shareholders’ rights. However, the SEC said it would likely grant waivers to many companies that missed the filing. “We haven’t seen too many of those amendments, and that’s a problem for companies because the failure to file the amended 8-K means they are not timely for S-3 purposes,” Jonathan Ingram, deputy chief counsel in the SEC’s Division of Corporation Finance, said at the Practising Law Institute’s “SEC Speaks” conference in Washington D.C. last week, referring to the timely filing requirements in S-3 rules companies comply with to register securities.
“We said in the release [companies] need to do this, but we think they just forgot,” Meredith Cross, Director of the SEC’s Division of Corporation Finance, said at the conference. She said the SEC wants companies to file the amended 8-Ks so there would be a record of what shareholders decided for the subsequent proxy season. If the company didn’t implement what the shareholders wanted, then a shareholder proposal would be allowed, which requires the amended 8-K, Cross said.
However, if the company’s board followed the shareholder recommendation and forgot to file the 8-K, the agency will likely grant a waiver, so the company can maintain its S-3 eligibility status, Cross and Ingram said. “If the company did what the shareholders asked for, then it’s not likely the shareholders would have wanted to put in a proposal, so the access to the 8-K wouldn’t have made a difference to them,” Cross said. “But, anyway, please file your 8-Ks.” The frequency vote is only required every six years, so Cross said it “shouldn’t be a recurring problem.”
I’ve been remiss in not blogging about this paper by Michael Jensen and Kevin Murphy sooner – here is the executive summary:
Discussions about incentives for CEOs in the United States begin, and often end, with equity-based compensation. After all, stock options and (more recently) grants of restricted stock have comprised the bulk of CEO pay since the mid-1990s, and the changes in CEO wealth due to changes in company stock prices dwarf wealth changes from any other source. Too often overlooked in the discussion, however, is the role of annual and multiyear bonus plans–based on accounting or other non-equity-based performance measures–in rewarding and directing the activities of CEOs and other executives.
In this paper, Kevin J. Murphy and Michael C. Jensen describe many of the problems associated with traditional executive bonus plans, and offer suggestions for how these plans can be vastly improved. The paper includes recommendations and guidelines for improving both the governance and design of executive bonus plans and, more broadly, executive compensation policies, processes, and practices. The paper is a draft of a chapter in Jensen, Murphy, and Wruck (2012), CEO Pay and What to Do About it: Restoring Integrity to both Executive Compensation and Capital-Market Relations, forthcoming from Harvard Business School Press. Key concepts include:
– While compensation committees know how much they pay in bonuses and are generally aware of performance measures used in CEO bonus plans, relatively little attention is paid to the design of the bonus plan or the unintended consequences associated with common design flaws.
– These recommendations for improving executive bonus plans focus on choosing the right performance measure; determining how performance thresholds, targets, or benchmarks are set; and defining the pay-performance relation and how the relation changes over time.
– In the absence of “clawback” provisions, boards are rewarding and therefore providing incentives for CEOs and other executives to lie and game the system. Any compensation committee and board that fails to provide for the recovery of ill-gained rewards to its CEO and executives is breaching another of its important fiduciary duties to the firm.
Earlier this week, I blogged about a quartet of bills that the House Financial Services Committee approved. Ted Allen of ISS blogged yesterday that one of the bills would exempt newly public companies from holding say-on-pay votes for five years. A similar bill has been introduced in the Senate and has attracted bipartisan support.
The House bill, the “Reopening American Capital Markets to Emerging Growth Companies Act,” H.R. 3606, would create a new class of issuers, “emerging growth companies,” that would be exempt from the Dodd-Frank Act-mandated advisory votes for five years, or until they reach $1 billion in annual revenue or $700 million in public float. These companies also would be exempt from holding separate shareholder votes on “golden parachute” severance arrangements.
The bill would also excuse these emerging companies from Section 953(b) of Dodd-Frank, which would require disclosure of the ratio between a CEO’s total compensation and that of the firm’s median employee. These companies also would be spared from Sarbanes-Oxley’s requirement to hire an outside auditor to attest to the sufficiency of their internal financial controls.
A few weeks ago, GMI released its annual CEO Pay Survey , which found that total realized compensation for CEOs in the S&P 500 rose by a median 36.5% for fiscal year 2010. Key findings from this year’s survey include:
– Total realized compensation for CEOs in the S&P 500 rose by a median 36.5%.
– Total realized compensation for all CEOs in the survey rose 27% compared to a 13% increase in total annual compensation.
– Three of the 10 highest paid CEOs of 2010 are from the Health Care Providers & Services industry, including the top two.
– Four of the 10 highest paid CEOs of 2010 were retired or terminated executives receiving exit packages.
– Perks in the S&P 500 rose 11% from 2009 to 2010.
– Three of the five highest paid CEOs of 2010 received single year pension and deferred compensation increases of $14 million.
– More than 70 percent of CEOs received a restricted stock award in 2010 while only 53 percent received stock options.
As noted in this Towers Watson memo, in fiscal 2009, equity award practices reversed a multiyear trend of decreasing share usage as companies increased the number of shares granted to make up for some — but not all — of the value lost due to declining share prices during the market turmoil. In many ways, 2010 was a return to the norm as share utilization patterns resembled what we would have expected in 2009 without the economic woes that began in the fall of 2008. A preliminary review of grants awarded in 2011 confirms that utilization continued to stabilize last year.
Each year, Towers Watson reviews equity incentive practices at Fortune 500 companies to examine trends in run rate, long-term incentive (LTI) fair value and overhang. Run rate is the total number of shares awarded during a company’s fiscal year as a percentage of average common shares outstanding. LTI fair value is the sum of reported fair value of annual equity awards granted throughout the year as a percentage of average market capitalization. Overhang is the aggregate number of shares reserved for outstanding awards and future grants as a percentage of total common shares outstanding.
We recently mailed the January-February Issue of The Corporate Executive and it includes pieces on:
– Our “Best Practice” Disclosure for Say-on-Pay in 2012
– Model CD&A Disclosure for a Company Receiving Strong Say-on-Pay Support
– Model CD&A Disclosure for a Company that Received Weak Say-on-Pay Support, or Failed to Achieve Majority Support
– When Is a Tax Cut Not a Tax Cut?
– Follow-Up: Modifying Awards in Response to Say-on-Pay
– Trap for the Unwary: Retirement Provisions in Performance Awards
– Cost-Basis Reporting Update
Act Now: If you are not yet a subscriber, get this issue rushed to you when you try a 2012 No-Risk Trial today.
Thanks to Eleanor Bloxham and her “Corporate Governance Alliance Digest” for this blog by Tama Copeman, Chair of the Board of Mid Atlantic Diamond Ventures (tama@alcyone7.com):
Rising CEO compensation frustrates many board members and for good reason: setting CEO pay-above-the-50th percentile broadly leads to unbounded growth in pay. (Similar results will occur if a large portion of companies set aggressive increase targets each year.) Although advisory say-on-pay votes now available to shareholders provide a check, the votes provide a weak check on rising pay.
System dynamics is a methodology for understanding the behavior of complex systems which can be applied to understanding the dynamics of executive compensation. Originally developed by Forrester at MIT Sloan in the 1950s to provide insight into corporate and managerial problems, system dynamics is currently being used by the public and private sectors for policy design, environmental change, economic behavior, project management and supply chain analysis.
The basis of the method is the recognition of feedback, interlocking, and time-delayed relationships among components of a system. A system’s feedback structure drives the dynamics of the system. So-called causal loop diagrams provide a visual representation of the feedback loops in a system and enable the creation of mental models for qualitative analysis.
In a system dynamic of growth, loops with all positive links are self-reinforcing and produce unbounded growth. Balancing loops provide self-correction in the system. They are created when there are an odd number of negative links and are self correcting. John D. Sterman (“Business Dynamics – Systems Thinking and Modeling for a Complex World”, McGraw Hill, 2000) provides many examples of applications of causal loop diagrams.
As a CEO’s compensation is set above the 50th percentile within the peer group, the average of the peer group rises correspondingly. The causal loop model in Figure 1 illustrates self-reinforcing compensation behavior. If the majority of boards employ above 50th percentile pay positioning, the peer-group compensation increases with the rate of growth dependent on the fraction of companies using this strategy. If the majority of boards employ below 50th percentile pay positioning, the peer-group compensation decreases. The latter case is, naturally, less likely. Conversely, as CEO pay increases, say-on-pay concern also increases with a corresponding push to reduce pay. The causal loop model illustrates self-correcting say-on-pay behavior. Within a corporation, the internal “say on pay” is far stronger than the advisory shareholder vote, as senior management, human resources and budgetary factors weigh in.
Figure 1. Causal Loop Model applied to CEO compensation
The above cycles occur on a one-year basis; however other balancing factors can enter throughout the cycle. The Wall Street Journal (June 30, 2011) reported: “Companies may not have to abide by shareholder advisory say-on-pay votes mandated under the Dodd-Frank Act, but lawyers specialized in securities class action suits have already brought a half dozen suits against directors and executives for ignoring their results. A number of firms have tried to settle the claims quickly.”
Peer benchmarking has been a powerful tool in compensation. System dynamics provides a simple perspective to understand the dynamics at work. Unless there are changes to the current systems-dynamics for CEO pay, CEO compensation will continue to spiral upward.
On Monday, Corp Fin granted this no-action relief to Fenwick & West regarding the use of restricted stock units for employees at pre-IPO companies under certain conditions without the company needing to register the securities under Section 12(g) of the ’34 Act (generally, the conditions are similar to those in Rule 12h-1(f) for options). By granting the letter to a law firm – and not a specific company – this no-action letter serves as broad relief for those pre-IPO companies hoping not to be forced to go public before they are ready, a hot topic as it has even attracted attention on Capitol Hill where proposed legislation is afoot to raise the 12(g) thresholds, etc. Previously, Corp Fin had been granting relief in this area on a case-by-case basis (egs. Twitter, Facebook – see this blog).
Yesterday, Corp Fin issued new ’34 Act CDI 169.07 to provide clarity about how companies should be listing their say-on-pay proposals on proxy cards and voting instruction forms. The CDI lists four examples that the Staff believes is consistent with Rule 14a-21 – and one example that the Staff believes is not consistent (ie. “To hold an advisory vote on executive compensation”). I believe many companies are going to need to make a tweak to their proxy cards and VIFs as they used the “inconsistent” language last year…
I’m not sure what to make of this NY Post article noting that a whistleblower – someone at an unnamed proxy solicitor – is claiming that a mid-level employee in ISS’s Boston office has been exchanging confidential voting data for gifts or cash from solicitors. Allegedly, the whistleblower has complained to the SEC – but whomever it is wouldn’t respond to questions from the NY Post reporter. We’ll see if this develops or is an urban myth. Among the odd things, it seems like the information could be valuable to arbitragers in a merger vote, but really not worth that much to companies (and their agents). Here’s today’s WSJ article on the topic…