Given the new importance on clawbacks due to Dodd-Frank, it’s not surprising that firms are conducting clawback studies (as they have been actually even before Dodd-Frank). Here is the latest clawback study from Frederic W. Cook & Co.
And Equilar’s latest study found that 82.1% of Fortune 100 companies have some kind of clawback policy – a major increase from 2006, when just 17.6% had one. The industry with the highest prevalence of clawback policies is the Financial, Insurance, and Real Estate, due to the mandatory clawback requirements of TARP. 90.5% of companies in that industry had a clawback policy in 2010, compared to 82.4% in 2009 and 50% in 2008.
We just mailed the hard copies of Lynn, Borges & Romanek’s “2011 Executive Compensation Disclosure Treatise & Reporting Guide” to those that ordered it. As you can imagine, our members believe this is a critical resource for this proxy season. This hard copy of the 2011 Treatise is not part of CompensationStandards.com and must be purchased separately – however, CompensationStandards.com members can obtain a 40% discount by trying a no-risk trial now. We will then quickly deliver this 1000-plus page comprehensive Treatise as soon as you try the trial.
If you need assistance, call our headquarters at (925) 685-5111 or email info@compensationstandards.com.
The subtitle of a press release relating to a recent survey conducted by PricewaterhouseCoopers of directors jolted me (the survey results are covered in this CNBC article). I know boards had trouble controlling CEO pay, but I have always figured one of the reasons why the excesses have not yet been fixed is that boards were confident they were doing the right thing. I guess even they realize they have trouble controlling CEO pay – although they may be thinking “it’s those other boards, not the ones that I sit on.”
Anyways, here is an except from the PwC press release (the press release was emailed to me, but is not online):
PwC research found that 58 percent of the 1,110 directors surveyed felt US company boards are still having trouble effectively controlling CEO compensation. The boardroom directors surveyed said the three most important factors that should be considered by compensation committees to improve CEO pay policies are:
– Ensuring peer group companies are realistic (83 percent).
– Re-evaluating compensation benchmarks (82 percent);
– Setting minimum stock ownership guidelines and/or holding periods (65 percent)
– Over half of the directors indicated that more time and focus should be spent on risk management.
– Over 70% of the directors stated that they do not believe their board should have a separate risk committee, while 67% concluded that the board is very effective at monitoring risk management to mitigate corporate exposures.
– Over half of the directors stated that the board does not receive general and/or specific customer satisfaction research.
– Most directors stated that during the last 12 months the board had discussed an action plan that would outline steps the company would take if faced with a major crisis.
– Almost 80% of directors indicated that sustainability/climate change is already a major focus and no additional time on the question is required.
– Almost 90% of directors surveyed stated that no additional time is required on social responsibility issues because it is already a major focus.
Regulatory and compliance
– Almost 75% of the directors stated that compliance and regulatory issues are already a major focus and do not require more time.
– The top five items identified as “red flags” in signaling a director to step up his/her board involvement are: (1) a restatement of the financial statements; (2) charges or investigations; (3) management missing strategic performance goals; (4) an adverse 404 opinion; and (5) multiple whistle-blower incidents.
– Almost 25% of the companies involved in the survey do not have an FCPA compliance program.
– Significantly less than half of companies in the survey have an FCPA program which covers employees and agents, while almost 20% have a program limited to employees.
Management
– 90% of the directors surveyed concluded that the board is very effective at standing up and challenging management when appropriate.
– 58% of directors stated that U.S. company boards are experiencing difficulty controlling the size of CEO compensation.
Effectiveness of board
– Only about 30% of directors concluded that the company had an effective board evaluation process.
– Over 81% of directors stated that the most important technique in ensuring that directors continue to be effective on the board is an effective evaluation process.
Recently, we decided to take myStockOptions.com one step further by launching a new site: myNDQC.com. Many executives and highly paid key employees are eligible to participant in these plans. The goal of myNQDC.com is to provide educational content and tools for nonqualified deferred compensation plan participants, their advisors and attorneys, plan providers and administrators, and companies with NQDC plans. With clear writing and independent, unbiased expertise, myNQDC provides education about the financial planning, taxation, risk, and legal issues surrounding nonqualified deferred compensation and encourages participants to fully understand these topics and maximize the value of their plans. With tax rates likely to rise in the future, the tax-deferral advantages of NQDC will make these plans increasingly popular.
– Paul McConnell and Jeff McCutcheon, Board Advisory, LLC
The Dodd-Frank bill contains two new disclosure requirements regarding executive pay: the ratio between the CEO’s compensation and that of the median employee, and the relationship between compensation actually “paid” to executives and company stock performance.
The new pay ratio is flawed on many fronts: it ignores organizational scope and size, it can be biased by outsourcing lower-paid work, it ignores the inordinately large role of benefits in the pay of lower level employees, and most importantly, it ignores the differences between guaranteed compensation and the risk inherent in equity based pay.
In contrast, the disclosure of pay in relation to performance has the potential to present a true picture of executive pay from which shareholders and the public can draw meaningful comparisons. The key is how the SEC eventually defines “pay”.
The Amounts Shown In The Summary Compensation Table Are Not Pay – Disclosure of executive pay has vastly improved over the last two decades. We now have accurate data on all the relevant components of compensation. While this data is extremely useful in designing competitive pay opportunities, the current required format does not show what executives actually earn — or how that pay might relate to company performance.
Cash bonuses are typically paid for financial performance versus targets, rather than for shareholder gain. Presumably, the cash payment relates to drivers ultimately reflected in stock price, but not necessarily reflected in the current year stock price. For most executives, the largest portion of their reported pay is the disclosed value of stock awards. For performance based stock, the disclosed value is a “target” value on the date awarded. It does not reflect the actual number of shares earned or the realized value of the stock over the requisite holding period. Similarly, options awards are shown as the expected value from a probability distribution, not the actual realized gains.
These valuations were never intended to represent the actual value the executive would receive, and were only intended to satisfy the accounting world. Consequently, using current proxy data to explain the link between pay and performance is like using a baseball slugger’s “at bat” statistics to explain the team’s won/loss percentage.
The Best Comparison Comes From a Multi-Year View of Realizable Pay – To best evaluate board decisions regarding pay and to test the overall alignment of executive pay to investor gains, one must compare the value actually realized by the executive to the returns of investors. For this purpose we look at the cumulative salary and cash bonuses received over a multi-year period (e.g., five years) plus the ending-period value of actual stock awards granted, stock acquired from previous awards, and embedded option gains (e.g., the paper profits).
Such pay comparisons are extremely important when evaluating the relative wisdom of a board and their executive pay decisions. By looking at the cumulative effect of decisions over a 5 year period – perhaps the shortest time period when executive effectiveness can be reasonably assessed – management and the Board can more effectively establish for investors the degree of alignment between executive rewards, business strategy and shareholder gains. The data required to perform these calculations are readily available through existing public company disclosure in proxy statements, related SEC filings, and commercial data sources. The general public could produce these calculations; however, use of multiple data sources and obscure reporting rules makes it difficult and time consuming.
Our investor and board clients have found this longer-term pay comparison to be an extremely effective tool for understanding the compounding effect of compensation decisions over time, and as an aid in calibrating prospective equity and cash incentive decisions. Perhaps more importantly, the analysis serves to bridge the communications gap between investors, the board and executive management by simplifying pay arrangements in terms everyone can easily grasp.
Much of the public’s understanding (or misunderstanding) of executive pay is driven by the annualized and hypothetical values disclosed in proxies. Regrettably, the format of the SEC disclosure also shapes how many boards make annual executive compensation decisions. The SEC will not release new rules until the second quarter of 2011, but regardless of the reporting form eventually chosen by the SEC, forward thinking Boards should supplement their CD&A disclosure with a true pay for performance analysis such as that presented above. For most boards this can convey a critical story line for investors wanting to understand how and why executives are rewarded.
A week or so ago, the WSJ ran the following op-ed from Holman Jenkins (this came out before the former Comverse CEO agreed to a $53 million settlement with the SEC):
An array of influential friends urged leniency for Bruce Karatz in his stock-option backdating sentencing last week, including former Los Angeles Mayor Richard Riordan and philanthropist Eli Broad. But these personages weren’t the reason Judge Otis D. Wright II rejected prosecutors’ request for a six-year prison sentence and instead gave Mr. Karatz probation. Judge Wright said he couldn’t see putting the former CEO away for a crime that did no harm to his company, KB Home, or its shareholders.
So endeth another episode in the annals of backdating, in which a fairly meaningless violation of accounting rules (though violation it was) became trumpeted from the media pulpits as the business crime of the century. We suppose it’s humanly understandable that, finding themselves compelled to bring these cases, federal prosecutors stretched and kneaded the evidence to fulfill the media’s stereotype of backdating as theft and fraud against shareholders. Let this be a lesson to the children in how not to respond constructively to cognitive dissonance.
Such prosecutorial misconduct led to the dismissal of the backdating case last year against Broadcom founder Henry Nicholas. A judge also threw out the guilty plea of his partner, Henry Samueli, saying he didn’t think Mr. Samueli committed any crime. The first conviction of former Brocade Communications CEO Greg Reyes was similarly overturned on grounds of prosecutorial misconduct (though Mr. Reyes was retried and convicted by a new jury, and now is appealing). A further irony is that backdating was abetted by a nonsensical accounting rule at the time that treated one kind of option as having value and another kind as having no value (though both have value). This split-the-baby rule itself arguably evolved out of the media’s perennial insistence on portraying stock options as emblems of greed rather than as business tools.
By the estimate of the University of Iowa’s Erik Lie, some 2,000 public companies must have engaged in backdating at some point, as testified by otherwise inexplicable patterns of options pricing. Some 150 companies eventually restated their past results to conform to the proper rule for expensing such options. Yet only a few executives were singled out for criminal prosecution, in a manner that left an observer scratching his head as to why the justice roulette wheel chose some but not others.
Further reason for pause: The handful of subsequent convictions seemed to turn less on the act of backdating than on the self-preserving prevarications executives uttered once the posse arrived at their doorstep.
The ultimate statement in this vein, of course, was the decision by Kobi Alexander, former CEO of Comverse Technology, to decamp to Namibia. We can think of two reasons somebody might flee the law–because he fears he will get justice, or fears he won’t. Presumably Mr. Alexander will one day appear in a U.S. court. It will be interesting to see what countenance he puts on his decision to become a fugitive–perhaps he will cite as a precedent the behavior of the legal system in Salem, Mass., circa 1692.
Meanwhile, the larger lessons of the backdating furor were drawn in an epic piece in May in the American Bar Association’s ABA Journal. By freelance reporter Anna Stolley Persky, the piece connected the dots between (among other things) the backdating witch-hunt, the tainted prosecution of Sen. Ted Stevens, and the government’s use of the vague “honest services” statute to criminalize various kinds of behavior post hoc (a practice the Supreme Court finally curbed earlier this year).
One critique can be found in the title of a book by Boston defense attorney Harvey Silverglate: “Three Felonies a Day: How the Feds Target the Innocent.” Mr. Silverglate believes that only a mobilization of “civil society” can stop what he calls rampant abuse of prosecutorial discretion. In contrast, former federal prosecutor Joseph diGenova puts the onus on DOJ overseers: “If anyone thinks it’s anything other than prosecute at any cost, then they are wrong. . . . The department has been AWOL in supervising the ethics of its prosecutors,” he told ABA Journal.
But it’s also hard not to see the self-interested ethics of the plaintiff’s bar spilling across the entire legal profession. In their official roles, prosecutors invent Kafkaesque new ways to ensnare the unpopular wealthy in legal trouble, then jump to private law firms and make seven-figure livings protecting the wealthy from the monster they themselves unleashed. Shakespeare had a solution, but, alas, this would also be illegal. Thus it must fall to bloggers, the media and judges like Judge Wright to protect Americans from overzealous prosecutors.
We have posted the transcript for our recent popular webcast: “Gearing Up for Say-on-Pay: What Clients Are Asking Now.” Don’t forget that those that renew for 2011 now – all 2010 memberships expire at the end of the year – will gain access to these two upcoming say-on-pay webcasts:
Just after I heard Pat McGurn speak this morning at the ABA Fall Meeting, ISS issued it’s 2011 Policy Updates. Courtesy of Ed Hauder of Exequity, here is a brief summary of the Updates that relate to executive pay:
– Equity Compensation Plans: Burn Rate–ISS is making a change to the Burn Rate policy so that the burn rate caps cannot increase or decrease by more than two (2) percentage points from year-to-year. The 2011 Burn Rate table will be released as part of ISS’ 2011 Summary Guidelines in December 2010.
– Say When on Pay Vote–ISS will support annual advisory votes on compensation, as its draft policies released at the end of October suggested. However, it still remains unclear what ISS will do if a company chooses a different frequency or the shareholder vote supports a different frequency.
– Problematic Pay Practices–ISS is revising the list of “major” problematic pay practices which alone could trigger application of the policy. The “major” problematic pay practices are now identified as the following:
– Repricing or replacing of underwater stock options/SARs without prior shareholder approval (including cash buyouts and voluntary surrender of underwater options);
– Excessive perquisites or tax gross-ups, including any gross-up related to a secular trust or restricted stock vesting;
– New or extended agreements that provide for:
1. CIC payments exceeding 3x base salary and average/target/most recent bonus;
2. CIC severance payments without involuntary job loss or substantial diminution of duties (Single” or “modified single” triggers);
3. CIC payments with excise tax gross-ups (including “modified” gross-ups).
– Additionally, ISS is slightly reworking how the presence of problematic pay practices will influences its vote recommendations. As before in such cases,
– ISS will recommend against management say on pay (MSOP) proposals,
– Then ISS will recommend against/withhold on compensation committee members (or in rare cases the full board) in (i) egregious situations, (ii) when no MSOP item is on the ballot, or (iii) when the board has failed to respond to concerns raised in prior MSOP evaluations, and/or
– ISS will recommend against an equity incentive plan proposal if excessive non-performance-based equity awards are the major contributors to a pay-for-performance misalignment.
– Problematic Pay Practices-Commitments–ISS will no longer accept future commitments on problematic pay practices as a way of preventing or reversing a negative vote recommendation.
– Voting on Golden Parachutes–ISS sticks pretty close to the draft policy it issued in late October 2010. Such proposals will be evaluated on a case-by-case basis, but the presence of certain practices could lead ISS to recommend against the proposal.
Recently, Professor Bainbridge ran this blog about a paper entitled “Riskmetrics: The Uninvited Guest at the Equity Table” written by Stanford business school professors David Larcker and Brian Tayan that that relates to the SEC’s proxy plumbing project.
With the new year quickly approaching, many companies are well into the process of considering whether to seek shareholder approval for additional share authorizations for their equity plans. In connection with this review, publicly-held companies that have any type of performance-based incentive compensation plan should also review whether performance-based goals need to be reapproved by shareholders at the next annual meeting pursuant to the regulations under Section 162(m) of the Internal Revenue Code.
Section 162(m) of the Code imposes a $1 million annual limitation on the deduction for compensation paid to each of the CEO and the three most highly compensated executives, other than the CFO, of publicly-held companies. However, “performance-based” compensation is not subject to the deduction limitation of Section 162(m), as long as it meets certain requirements. One such requirement is that the material terms of performance goals must be disclosed and approved by shareholders before the performance-based compensation is paid. For companies whose compensation committee has the authority to change the targets under a performance goal following shareholder approval, Section 162(m) regulations require that the performance goal be reapproved by shareholders no later than the first shareholder meeting that occurs in the fifth year following the year in which shareholders previously approved the performance goal.ยน In other words, reapproval of the performance goals by shareholders is needed at least every five years.
We remind public companies to check the date of the last shareholder approval for performance-based plans, and to ensure that the last shareholder approval covered performance goals for purposes of Section 162(m). Both cash and stock incentive plans may need reapproval at least every five years. If a company’s plan last received approval in 2006, shareholders may need to reapprove material terms of performance goals this coming year.
Not all plans that qualify for the performance-based compensation exception require reapproval every five years. Shareholder reapproval is not necessary if a company relies on an approach to plan design that is commonly referred to as a “plan within a plan” or an “umbrella” plan. Under that approach, generally, a fixed formula (often based on a percentage of earnings) is approved by shareholders and dictates the maximum amount of the payment to the covered executives. The compensation committee retains negative discretion to reduce payouts below the maximum, subject to whatever objective or subjective criteria the compensation committee may wish to apply from year to year. Similarly, a plan that permits only stock options and stock appreciation rights to be granted at fair market value will not require reapproval.