From “The Mind of an Institutional Investor” Blog: Just yesterday, 23 people gathered in a windowless conference room at a convention hotel in Paris. The ostensible reason was to comment on the work of the International Corporate Governance Network’s remuneration (executive compensation) committee The conversation took a quick and sharp turn, however.
It began normally enough, with a discussion of alignment of interests between executives and shareowners, role of a Board’s compensation committee, disclosure of compensation, etc. However, I decided to ask what I thought was going to be an ineffectual verbal challenge.
Why, I asked, do institutional investors keep preaching alignment? We’ve been doing that for two generations and it has not worked. Perhaps it’s time to admit the obvious: Shareowners’ interests and executives’ are not perfectly aligned and cannot be made to be perfectly aligned. Perhaps it’s time to admit that fact and return to an old idea: Management, even senior management, are employees. They ought to be fairly – and I’d say even generously compensated – but they are employees of the corporation not suppliers of capital. Is it simply time to stop trying for alignment and deal with them as highly-compensated employees for whom the board must make a compensation decision, whether in cash, shares, options or whatever. But that means the Board must consider what has become know in Europe as “quantum,” which is shorthand for both “what do all the various compensation schemes add up to” and “how much is enough”. It does not include, however whether options or restricted shares or phantom shares or time-vested grants or performance-grants or deferred comp or three-year vesting rights or any of the other “comp speak” we’ve all come to know far too well over the years. In some ways, by considering the mechanisms of pay, and trying to make them aligned, we’ve emphasized form over substance, and the amount has become a fall-out, rather than a decision.
Surprisingly, I received an amazing amount of support. The comments came quickly, as if a dam had been broken. “We’ve become too complex,” “Even boards don’t know what they’re paying,” etc. Later, in a plenary session, a banker basically admitted as much, saying that for senior bank executives, compensation had become a slot machine: They pull a lever and three years later out comes a trickle of coins or a fountain of folding money.
To be sure, the shareowner community is not about to consign alignment to the scrap heap of history. Nor should we. The fact that alignment is not perfect is to make the best the enemy of the better. But to admit that alignment can never be perfect means that we must insist that the Board use judgment about quantum as well as instruments that align compensation as best it can. And that has been a taboo topic for institutional investors (including me) for too long.
I’ve now been in this business quite a long time and I can honestly say that the upcoming pair of say-on-pay conferences will be a career peak for me. I’m proud of the high caliber of panelists that I have procured – and I’m now spending several months carefully orchestrating what topics each panel will cover so that there is minimal overlap. In fact, any overlap is intentional as there are numerous panels that have a distinct perspective.
There is a panel comprised solely of institutional investors; two panels with just ISS and Glass Lewis. There is a great panel with experienced corporate directors. But that’s not all – I have tailored many of the panels so they will drill down on practical topics that you hold dearly, such as “How to Work with ISS & Glass Lewis: Navigating the Say-on-Pay Minefield” and “Failed Say-on-Pay? Lessons Learned from the Front.” Check out the agendas for the conferences and see for yourself.
With the economy going into another funk – and anger over CEO pay likely to hit a fever pitch in an election year – I do believe that next year will bear out that this year was just a “test year” and many companies whose pay sailed through in ’11 could experience real struggles next season. This pair of conferences – focusing on both disclosures and practices – takes place on November 1st-2nd in San Francisco and by video webcast. Register now.
If you are experiencing budget woes but recognize that these conferences are a “must” – drop me a line as always.
As I prepared to speak on social media to the crowd last week at the Society of Corporate Secretaries’ Western Regional Conference, I took in a say-on-pay panel – and almost dropped to the floor when Janice Hester-Amey of CalSTRS said no one that they had voted against say-on-pay wise had bothered to contact them yet to ask why they had voted negatively. Since CalSTRS voted “no” for 24% of the 3000 US companies in its portfolio, this means that not a single company out of hundreds has bothered to pick up the phone yet. CalSTRS publishes all of their votes on both its own website and through ProxyDemocracy.org.
As I’ve learned from my prep calls ahead of our pair of executive pay conferences, other institutional investors have been getting calls asking “why” – but this still is startling considering how large CalSTRS is. And it begs the question whether companies who held say-on-pay votes this year remember that they will be required by Regulation S-K Item 402(b)(1)(vii) to disclose whether, and if so how, they considered the say-on-pay advisory vote in determining compensation policies and decisions and how that affected their executive compensation decisions and policies. Maybe some companies are just intending to disclose that they didn’t consider the advisory vote in their deliberations? A dangerous prospect if you ask me…
The following are excerpts from a recent ISS white paper, “Executive Pay Through a Peer Benchmarking Lens,” which summarizes key findings from ISS Corporate Services’ study of almost 15,000 DEF 14A filings over the past four years. Drawing on ISS’ executive compensation database, this report analyzes both pay levels as well as the processes by which companies benchmark their pay relative to peers:
The enhanced executive compensation disclosures mandated by the U.S. Securities and Exchange Commission in 2006 have provided a significant new data set for investors and companies to analyze and benchmark pay practices across a broad set of U.S. corporate issuers. Moreover, precisely how companies choose to benchmark their pay practices has received much attention following the outcry over Wall Street payouts and the recent promulgation of legislation requiring most U.S. issuers to put their pay to a non-binding shareholder vote.
The median value of total CEO compensation for S&P 500 companies decreased 4.8 percent in fiscal 2009 but jumped 20 percent to $10.6 million in fiscal 2010. A similar trend was observed among small-cap companies (defined here as members of the Russell 3000 index excluding the S&P 1500). The decline in median CEO pay for those issuers was 10 percent from 2008 to 2009, followed by a 26 percent surge in fiscal 2010. Although the gains are evidenced across all industries in fiscal 2010, those with the biggest increases were financial and information technology companies with jumps in median pay of 47 percent, followed by energy companies at 30 percent. In fiscal 2009, utility companies were on top, paying their CEOs 13 percent more than the previous period, followed by consumer discretionary companies’ 11 percent jump, when most other industries cut CEO pay.
In fiscal 2009, the global economic slowdown, coupled with increasing pressure from investors to rein in executive pay, resulted in a sharp decline in the use of equity-based compensation. Our study shows that the median option value granted by S&P 500 companies in 2009 declined almost 17 percent, while nearly half of small-cap firms suspended option awards. Instead, discretionary and non-discretionary bonuses became popular alternatives. S&P 500 companies increased their payouts of cash bonuses to CEOs by 13 percent from levels in 2008, for example, while cash bonuses climbed 28 percent at small-cap firms in 2009.
In fiscal 2010, this trend saw dramatic growth. Companies across all indices not only resumed the grant of equity-based compensation but also increased discretionary and non-discretionary bonus awards. S&P 500 companies raised equity-based compensation by 28 percent, while small-cap firms increased such pay by 46 percent. Much of the increase can be attributed to the growing popularity of stock awards. For instance, 53 percent of equity-based compensation was composed of stock in 2010 among S&P 500 companies–up from 46 percent in the previous period. Continuing the trend from 2009, large-cap companies gave 40 percent more in bonus awards to their CEOs, while small-cap companies rewarded their chief executives 54 percent more, as reported in 2011.
Better Disclosure of Benchmarking Peers
More than 97 percent of S&P 1500 companies disclosed their benchmarking practices in fiscal 2010, compared with 84 percent in 2007. Among companies reporting in 2011, we see nearly 60 percent having selected 10 to 20 peers to benchmark their CEO’s pay level, with a median number of peers selected of 15. In addition, we found that peer group size typically increases at larger companies. More than 30 percent of S&P 500 companies selected over 20 peers to benchmark pay, with only 23 percent of companies beyond the S&P 1500 doing so.
When determining peer groups, a key observation is that a majority of companies tend to select benchmarking peers whose sizes are between 0.5 and two times their own. Another observation is that the most popular standards to measure company size are corporate revenue, market capitalization, and assets, in descending order of prevalence.
We studied over 40,000 pairs of company-peer data disclosed for fiscal years 2010 and 2007. Our analysis shows that about 60 percent of peers’sizes are between 0.5 and two times that of the choosing company’s revenue. The trend is consistent between fiscal 2007 and 2010 and applies across all indices. If the focus is turned to the percentage of total peers composed of larger-cap companies, defined as companies with revenues of more than two times their own, we find the percentage is about 19 percent for S&P 500 companies, and increases to 33 percent for small-cap firms.
Payout Targets Can Be Vague or Moving
Despite the SEC’s guidance to encourage companies to increase transparency and disclose targeted levels of compensation, our study found more than 66 percent of the studied sample did not specify targets or provided ambiguous disclosure. The poor quality of disclosure is more prevalent among small-cap companies, with 72 percent of Russell 3000 companies (excluding S&P 1500 constituents) failing to disclose what percentile levels of pay they plan to target, as reported in 2011. For companies revealing the targeted percentile, we find over half set the target at peers’medians while another 40 percent target the top quartile or above median.
The report’s other key findings include:
– Peer selection remains a key concern with roughly 1,400 companies including peers that significantly increased their CEO pay while, concurrently, shareholders saw weak returns.
– Highly paid CEOs are the most prevalent peers for benchmarking. For the highest paid group in our study, the average number of times that a company is benchmarked is 27, which is 34 percent higher than that of the lowest paid group at 20.2 times.
– For a sizeable portion of study companies, our analysis found a significant misalignment between our measure of relative pay rank and relative performance rank.
Our pair of popular executive pay conferences – “6th Annual Proxy Disclosure Conference” & “The Say-on-Pay Workshop Conference” – is quickly approaching and the Conference hotel is nearly sold out; register for the Conference today and make your hotel reservations online or by calling them at 800.445.8667 or 415.771.1400. Be sure to mention the Conferences to get the best rate. The Conferences will be held on November 1-2 in San Francisco and by video webcast. If you have difficulty securing a room, contact us at 925.685.5111.
With Conference registrations going strong – on track to reach nearly 2000 attendees – you don’t want to be caught unprepared as we head into next year. The last time we held our Conferences in San Francisco – two years ago at the height of the recession – we sold out a month in advance: the Conference itself, not just the hotel! And that was without the reality of Dodd-Frank and mandatory say-on-pay hanging over our heads. Register today to ensure you don’t miss out.
Last week, the 9th company that failed to garner majority support for their say-on-pay was sued – Dex One Corp in a federal district court in North Carolina (here’s the complaint). We continue to post pleadings from these cases in our “Say-on-Pay” Practice Area.
But that’s not all in the area of lawsuits over pay practices. Last week, Chesapeake Energy’s board was sued for allegedly bailing the company’s CEO out of financial trouble by awarding him bonuses – as well as buying his personal art collection for $12.1 million and relying only on the CEO’s art dealer for determining the value of the art – in a federal district court in Oklahoma. Not sure why, but it doesn’t seem like the mass media has caught up with this one. Thanks to Paul Hastings’ Mark Poerio for pointing it out!
And then as I blogged last week, arguments where just made in a lawsuit in the Delaware Chancery Court over Goldman Sach’s pay practices. If the case survives, it should be interesting – as will the Citigroup case where discovery ended last week and now we’re just waiting for a trial date to be set before VC Glasscock…
With the proxy season long over, it’s been a long time – 9 weeks – since we’ve seen a company fail to garner majority support for its say-on-pay. But as Mark Borges reported over the weekend in his blog, Exar has become the 41st company to do so this year.
In this Form 8-K, Exar reports that it was a close vote with the company receiving more “for” votes compared to “against” – but as Mark notes, the Delaware company counted its “abstentions” as “against” votes back when the company filed its proxy statement (see pg. 4) – thus resulting in the receipt of 49% in support. A list of the Form 8-Ks of the “failed” companies is in our “Say-on-Pay” Practice Area.
If it survives at all, this case might be worth watching. This Bloomberg article reports on arguments heard in In re the Goldman Sachs Group Inc. Shareholder Litigation in the Delaware Chancery Court. Counsel for plaintiff Southeastern Pennsylvania Transportation Authority argued that Goldman’s compensation plan unfairly rewards the investment bank’s employees at shareholders’ expense, that Goldman “is being run for the benefit of employees rather than shareholders,” and that the firm’s compensation system is wasteful and rewards employees for taking risks that hurt the firm’s stock price, such as the creation and sale of CDOs that resulted in Goldman’s paying a $550M settlement with the SEC.
According to the article, Goldman has lost $50 billion in market value since 1999 while the company has paid out billions in compensation, including $19 million to CEO Lloyd Blankfein for 2010. His compensation was almost double the prior year’s award and included a $5.4 million cash bonus, even though Goldman’s profits fell. The derivative suit against the Goldman directors seeks to hold them “responsible for the firm’s flawed pay plan and for not properly overseeing the company’s employees.”
The author reports that Goldman’s counsel argued in response that it is not the role of the courts to decide how much risk a firm should take or how much compensation its employees should be paid. As I said, if this case survives at all, it should be interesting.
Equilar recently released a report -“TSR Performance and CEO Pay Report” – about the relationship between total shareholder return (TSR) and CEO compensation in the S&P 1500. The report’s findings include:
– 23.9% of firms increased their CEO’s pay, despite below-median TSR, in the past year (2008-2009).
– 30.0% of firms increased their CEO’s pay, despite below-median TSR, in the past three years (2006-2009).
– Almost all companies studied increased their CEO’s base salary from 2006 to 2009, even if the CEO’s total compensation went down.
Normally, you can request a copy of Equilar’s reports – but I don’t see a link for that yet on their site…