The Advisors' Blog

– Broc Romanek, CompensationStandards.com

This recent study entitled “CEO Pay and Shareholder Activism” by Prof. Fabrizio Fabri, Yonca Ertimur and Volkan Muslu allegedly refutes fears expressed by say-on-pay critics by showing that “just vote no” campaigns and voluntary say-on-pay votes did not lead to radical changes pushed by special interest groups. It’s worth a read.

– David Chun, Equilar

Recently, we released the 2010 CEO Benefits and Perquisites Report. The report finds that in 2009, over one third of the Fortune 100 eliminated one or more perquisites from their overall compensation programs. In fact, the median value of “all other compensation” paid to Fortune 100 chiefs reached a five-year low of $249,632 in 2009. By comparison, in 2008 the median value was $348,101. Additionally, the median value of perquisites related to corporate aircrafts – historically one of the more controversial perquisites – fell by 18.3 percent, from $141,477 in 2008 to $115,588 in 2009.

The Report features an in-depth look at the following perquisites, among others, paid to America’s top chiefs:

– Financial Planning and Other Professional Services;
– Flexible Perquisite Accounts;
– Personal Home Security;
– Personal Use of Corporate Aircrafts; and
– Tax Reimbursements

If you would like to request the full report, please e-mail info@equilar.com or visit our website.

– Broc Romanek, CompensationStandards.com

Tune in tomorrow for our webcast – “Gearing Up for Say-on-Pay: What Clients Are Asking Now” – featuring Towers Watson’s Eric Larre; Semler Brossy’s Blair Jones, Pay Governance’s Ira Kay, Deloitte Consulting’s Mike Kesner and Verizon’s Mary Lou Weber as they provide guidance about how you can put your best foot forward with shareholders to help gain their approval on the ballot. This is the first of a trio of say-on-pay webcasts on CompensationStandards.com – renew now for 2011 as all memberships expire at year end.

– Broc Romanek, CompensationStandards.com

A few days ago, I blogged about ISS’s draft policy updates on this topic – and a podcast from Dave Bobker of Phoenix Advisory Partners. Phoenix Advisory Partners has now issued this alert with some useful guidance on this pressing topic.

– Rosanna Landis Weaver and Joann Chya, ISS’s Compensation Research Team

The reverberations of the recent financial crisis continued to ripple through U.S. corporate boardrooms this year, and executive compensation was often the epicenter of challenges and changes. Directors, only too aware of the criticisms they faced on compensation, appeared eager to announce reforms, no matter how small.
Facing increasing pressure from investors and others, some companies took steps to curtail or eliminate certain elements of non-performance-related pay. ISS is aware of at least 228 companies that have revised or eliminated problematic components of their compensation packages within the past year, for example.

The most common changes, by far, continue to be related to change-in-control practices, and more specifically to excise tax gross-ups. Excise taxes are only due upon a change of control, and then only when an executive’s payout exceeds a defined threshold. The original intention of Congress, when it defined an “excess” parachute was to limit the size of such packages by creating tax disadvantages for both the company and the individual in such cases. One unintended consequence of that legislation, though, was a move by many companies to insulate the executive from his or her potential adverse tax consequences. That trend has been changing.

At this time last year, ISS was aware of 60 companies that had made such a change. That total figure is now well over 200. Companies eliminating excise tax gross-ups, in either current or future agreements, cite evolving best practices, feedback from shareholders, the advice of consultants, and a report from the Conference Board as well as the changing policy of proxy advisory organizations. Or, as KBR stated in its proxy statement: “In light of current financial crisis, excise tax gross-ups may no longer be an appropriate component of executive compensation packages.”

Initially, many companies adopted a policy that related only to future agreements, essentially grandfathering in existing employees, and that is still a widely used approach. Interestingly, several companies that took action in 2009 to create such policies subsequently amended existing contracts or plans so that current executives would also be covered by the policy. Lender Processing Service, for example, made a commitment in May 2009 not to enter into future arrangements with the provision, then in December 2009 entered into amended agreements with officers that, among other things, eliminated tax gross-ups. Similarly, Fidelity National Financial adopted a policy in May 2009 and then amended existing contracts in February. In addition, as time passes, it appears that the greater proportion of companies making the change include current executives–rather than “grandfathering” them–either by revising their change in control plan or policies (Western Union and Scana) or by having executives agree to amendments (Analogic Devices, Assurant, BMC Software, Charming Shoppes, Church & Dwight, Global Industries Limited, Kemet, Kindred Healthcare, and Verizon Communications.) In a limited number of cases, some executives voluntarily waived their rights to a gross-up while others did not (e.g., at Dana Holdings and Brink’s Co.).

It may be that the change is most likely to occur at companies when a current contract or plan expires (e.g., AGL Resources, Group 1 Automotive, and Virgin Media.) However, companies with contracts that include auto-renew features may have more difficulty making such changes. For example, American Medical System noted that its current employment agreements “cannot be amended in any way to adversely affect executives without executive’s consent, the committee determined not to request the consent of the executives” who had agreements but adopted instead a future-focused policy.

In the majority of cases, the companies eliminating gross-up provisions replaced them with an approach often known as “best result,” under which the executive may choose between receiving the full payment and paying any resulting 20 percent excise taxes, or having the payment reduced to an amount below what would be defined as an excess parachute payment, to avoid triggering the excise tax liabilities. In some cases, the executive makes this election, but in others, the company calculates whether reduction would or would not result in the best interests of the executive “receiving greater benefits on an after tax basis.” Since the company loses a substantial tax deduction if the excise tax is triggered, a better practice is to limit the amount paid so that it falls below the threshold. For example, Kennedy-Wilson Holdings’ employment agreements provide that “in the event that CIC benefits would trigger the excise tax under Section 4999 of the [Internal Revenue] Code, benefits are to be cut back to $1 below the tax threshold.” Other companies that have adopted similar policies include Consolidated Communications Holdings and Hawaiian Electric Industries.

Many companies addressing the gross-up feature took the opportunity to make other changes as well. ISS is aware of 27 companies that moved from single-trigger to double-trigger agreements, five that eliminated modified single triggers, and six that reduced at least some severance packages.

Other Reforms

After the reforms related to change-in-control payments, the most common area of change involved executive perquisites. Several companies eliminated all or some perks. eHealth eliminated housing allowances, airfare, and auto lease perquisites, as well as gross-ups on those perks. This week, Sysco reduced its executive relocation benefits and no longer will provide reimbursement for a loss on a house sale. Interestingly, the most commonly eliminated perk was reimbursement for financial counseling, which is not one that shareholders typically object to.

Far more common was the removal of tax gross-ups on perks: 88 companies stopped paying tax gross-ups related to all or some of the perks they offer. While excise tax gross-ups can be worth millions of dollars, gross-ups on perks tend to be for amounts under $100,000. Since the actual amount of such gross-ups is usually not a significant component of what can be a multi-million dollar pay package, directors and executives alike appear to be aware that the cost in bad publicity exceeds the benefits.
A number of companies adopted multiple changes simultaneously. ISS has tracked 53 companies that adopted two pay reforms, and 15 that adopted three or more significant changes. However, it should be noted that some of the companies that adopted multiple reforms also replaced perks with other benefits: AO Smith and PolyOne offered benefit allowances, and Eastman Chemical explicitly increased salary, for example.

– Broc Romanek, CompensationStandards.com

What should be the frequency of our say-on-pay vote? This is a question being mulled at most companies these days. Perhaps we are starting to get an answer when ISS issued its draft policy updates last week for comment, which included this statement, an excerpt of which is below:

The MSOP is at its essence a communication vehicle, and communication is most useful when it is received in a consistent manner. ISS supports an annual MSOP for many of the same reasons it supports annual director elections rather than a classified board structure: because it provides the highest level of accountability and direct communication by enabling the MSOP vote to correspond to the information presented in the accompanying proxy statement for the annual shareholders’ meeting. Having MSOP votes only every two or three years, potentially covering all actions occurring between the votes, would make it difficult to create meaningful and coherent communication that the votes are intended to provide. Under triennial elections companies, for example, a company would not know whether the shareholder vote references the compensation year being reported or a previous year, making it more difficult to understand the implications of the vote.

Recently, I caught up with a proxy solicitor – Dave Bobker of Phoenix Advisory Partners – to get his analysis of what companies should be considering regarding the frequency of their say-on-pay vote in this podcast, in which Dave addresses:

– What frequency do you think most companies will pick? Least?
– What frequency do you see most investors asking for?
– What would you recommend?
– What factors should companies consider when picking a frequency?

– Broc Romanek, CompensationStandards.com

Michelle Lamb recently wrote this interesting piece entitled “Still Flying on the Company Dollar, Just Shorter Flights” for “The Corporate Library Blog.” I would repeat it for you but it has charts and I can’t figure out how to embed them. I wonder how she did it…

– Broc Romanek, CompensationStandards.com

Here are the survey results from our most recent Quick Survey, repeated below (compare these to an identical survey we conducted three years ago):

1. Does your compensation committee:

– have a policy that it will not employ any compensation consultants who perform services for management – 30%
– not have such a policy, but does not intend to employ any of the same compensation consultants as management – 50%
– employ some (or all) of the same compensation consultants used by management – 20%

2. In practice, how does your compensation committee go about hiring an expert for making recommendations regarding CEO compensation?

– Management offers up a consultant to the compensation committee that it finds acceptable, subject to committee approval – 55%
– Compensation committee left completely on its own to find and hire whatever consultant it wants – 40%
– Compensation committee has not hired an expert for setting CEO compensation – 4.9%

3. Assume the company already is using consultant A for general compensation advisory purposes, will your compensation committee:

– Use the same consultant to help set executive compensation – 10%
– Use a different consultant to help set executive compensation – 70%
– Too early to tell what the compensation committee will do going forward – 20%

4. Regarding compensation committee charters, the committee has:

– A charter that states that the compensation committee will be the sole entity in the company to hire compensation consultants specifically related to CEO compensation – 80%
– A charter that states that both the compensation committee and management have the authority to hire compensation consultants specifically related to CEO compensation – 0%
– A charter that does not address who hires compensation consultants – 20%

Take a moment to participate in our “Quick Survey on Clawback Policies.”

– Broc Romanek, CompensationStandards.com

When it comes to ISS and the other proxy advisory firms, there certainly are many strong opinions and views. And the SEC’s proxy plumbing project has brought those to the fore. But even before a back-and-forth debate arose over this CNBC article, I recognized the article for what it is – a mass media piece written by someone without a background in the topic – and I tweeted as such.

For starters, I question the veracity of nearly every other premise in the article. There are an increasing number of proxy contests? I don’t think so. Mutual funds began using proxy advisory services in earnest only after the SEC’s 2003 rule that required disclosure of their voting records? Nope. The author mistakenly thinks the demand for proxy advisory services relates to regulations adopted this decade – but the reality is that institutions have been heavily relying on them ever since the first advisory firm was founded shortly after the DOL’s 1994 Avon letter. I would even go as far as to challenge this tenet of the article – that investors are relying more on proxy advisory firms than ever before. I have no hard facts to support this – but anecdotal evidence indicates that the opposite is true: institutions increasingly are choosing to vote their shares relying more on their own analysis.

I do agree with the article’s last words: “We should at least worry that their advice might fail just like the advice of the credit ratings agencies failed.” But my concerns are probably different than those harbored by the article’s author. So far, ISS has wielded its influence remarkably responsibly – unlike the failings of the credit rating agencies, whose blind-eye actions were a major factor in facilitating the recent financial crisis. Regardless of whether you agree with ISS’s views, it is hard to dispute that ISS has done more to effectuate change in corporate governance practices over the past decade than all other movers and shakers combined. Year after year, ISS raises the bar on what it believes are governance best practices. Again, this is something hard to dispute even if you don’t agree with their view on what are best practices.

My big concern these days is that ISS was sold – yet again – earlier this year, and is rumored to be on the block once more. I worry about ISS being capable of being fully supported by a parent and it’s ability to retain good people (Chris Young already has departed as head of ISS’s M&A advisory unit). I worry that ISS won’t have the resources to do a good job and that their reports will be filled with many errors – and that they will be too short-staffed to take corrections on a timely basis. I worry that a new acquiror might change ISS policies in ways that we can’t imagine. That is what CNBC should be writing about.

But the bigger issue perhaps is what type of world would we have without ISS? Does the corporate community really want to navigate a proxy season in which it must keep track of a set of diverse voting policies from all of their numerous holders? Will companies provide the additional resources to the corporate secretary’s office necessary to conduct this important task? Remember that so few companies have failed to earn majority support for say-on-pay in the United Kingdom because the proxy advisors there drive the process in a way that companies know what likely will pass – and what won’t. Without ISS, we may be looking at the Wild West here and companies could well be operating in the dark heading into their annual meeting as to what the outcome will be.

On the other side of the coin, do beneficial holders want to bear the costs of institutions beefing up their woefully understaffed proxy committees? This is the real reason why many institutions rely on ISS – cost savings. They don’t want to spend the money it takes to analyze proxy materials and make the decision about how to vote. Unlike what CNBC wrote, this is why institutions look to proxy advisory firms – and this is why the DOL wrote the Avon letter in the first place (before that letter, very few institutions bothered to vote).

Note that challenges to the CNBC article have been mounted by Andrew Clearfield in the comments to this blog – also see these thoughts from Nell Minow, one of the original leaders of ISS (you might also want to read Nell’s proxy plumbing comment letter).

CNBC’s John Carney then tries to rebut this criticism in this follow-up piece. He bizarrely claims – by citing an academic paper – that ISS’s influence is overstated. Not sure how this supports his original thesis? Anyways, I disagree with that paper’s conclusion that ISS controls 6-10% of the average vote. In practice, I believe most proxy solicitors – and companies – would opine that percentage should be doubled or even tripled.

For what it’s worth, I provided a clear description of how the ISS process works in our July-August 2010 issue of The Corporate Counsel. I wrote that piece because I had never seen anyone explain in detail what is involved – and knowing that is more important than ever now that we have mandatory say-on-pay.

Time to Comment on ISS’s Policies: Time to Speak Up

On Wednesday, as noted in this press release, ISS opened the comment period for it’s 2011 policies, as it has for the past several years. Here is their policy gateway where you can input your views.

The comment period is short – ending on November 11th. Given the importance of this proxy season, this would be a good time to get involved if you haven’t before. ISS expects to release its 2011 policy updates in late November. Pat McGurn will discuss those during his annual webcast with us on January 27th.

– Arthur Kohn, Cleary Gottlieb Steen & Hamilton

It is obvious that there is no simple and broadly accepted way to assess either the performance of a company’s management team or the value of a pay package. In that light, the challenges of developing rules and disclosure in response to the new pay-for-performance disclosure obligation under Dodd-Frank become clear. Aside from widely-noted issues related to the valuation and timing rules for inclusion of different elements of pay, we readily identified many types of business and other considerations that could materially affect the disclosure approach in our recent memo. We suspect that companies will identify many others as they begin to consider how the new requirement could apply to them. We describe a few of them below:

– Lean Management – Arguably, pay versus performance assessments should take into account how much “bang for the buck” a company gets from its total management team. That is, assume two companies that have performed equally well and in which the five most highly-paid executives have earned the same compensation. Now assume further that one of the companies has a senior management team that is twice as large as the other. It would seem that the company with leaner management should provide pay versus performance disclosure that tells that story by looking at the issue on a relative basis and including more than just named executive officers in its analysis. Precise data to support this approach might be difficult to obtain, but it may not preclude the company from making the point.

– Cyclical Businesses – Companies in classically cyclical industries should consider presenting data in a manner that reflects that business reality. Possible approaches could include presenting data using multiple periods, or measuring performance based on the extent to which the variation in profitability was mitigated through the entirety of the cycle.

– Crisis Management – A disclosure approach that fails to distinguish performance in ordinary business environments from performance during short-term crisis periods will often not provide meaningful information. During the recent financial crisis, for example, the performance goals that underlie most incentive programs were set aside as many companies focused on steps needed to manage through the crisis. In addition, not surprisingly, management turnover increased, particularly at financial institutions. In order to present useful information on pay versus performance, those factors should be taken into account.

– Business Organization and the Identity of the NEOs – Between one and three of the named executive officers for a company will typically have divisional responsibilities, while the CEO, CFO and one or two other NEOs will have corporate-wide responsibility. Different divisions could have very different performance profiles. Often, using only corporate-wide performance metrics – or a crude “lumping together” of divisional metrics – to assess the relationship of pay to performance will be uninformative and unreflective of the actual correlation between pay and performance. Similarly, aggregating the pay of the entire executive team may mask significant interesting information about the relationship of pay to performance.

– Allocating Pay to Performance Periods – There are both obvious and subtle challenges in deciding how to best allocate pay to specific performance. For example, should an option be considered “actually paid” – i.e., taken into account in the pay for performance analysis – at the time it is granted or exercised, or at some other time? Should it matter whether the number of options awarded is fixed by contract or practice in relation to base salary levels, or instead varies from year to year based on individual performance assessments?

– The Need to Attract – Should elements of compensation that are explicitly not intended to reflect performance be included in the analysis? In many industries, companies must pay signing bonuses or other guaranteed minimum payment elements to attract employees. Is it appropriate for those elements of compensation to be excluded from the pay for performance presentation on the basis that the compensation committee’s incentive pay decisions should not be obscured by pay elements that are not intended to be performance-driven?

– Risk, Diversity and Other Intangibles – The correlation of pay to performance may be affected by aspects of compensation plan design whose purpose is to mitigate risk. Similarly, other “intangibles,” such as diversity or relative pay levels between senior management and rank and file employees, may be taken into account in assessing pay for performance. Can and should these factors be considered?