Last week on TheCorporateCounsel.net blog, Dave shared highlights from the discussion during the panel he moderated at the Northwestern Securities Regulation Institute called “Taking a Fresh Look at Company Policies.” One of his blogs is especially relevant to this audience as it focuses on three compensation policies that companies should review in light of recent SEC action. The panel suggested companies establish or revisit their equity grant policies and practices in light of SEC developments in this area — namely, Staff Accounting Bulletin No. 120 and new Item 402(x) of Regulation S-K.
What do those policies look like? This recent client alert from White & Case and Equity Methods includes sample equity grant procedures and guidelines, which “companies can consider as practical guidelines, even if they are not adopting a formal equity grant policy,” and an illustrative timeline for equity awards.
Here’s how the sample addresses a common issue — timing the vesting of full-value awards:
For the vesting of Full Value Awards, if the Company plans to facilitate sales of equity by award recipients with access to MNPI to cover withholding taxes, the vesting date should be scheduled to occur in an open quarterly window under the Company’s insider trading policy and when the Company otherwise is not expected to have MNPI.
If this is not feasible, the Company may provide for language in the award agreement that “locks in” and makes automatic the sales without any discretion by the award recipient. This may be, but is not required to be, in the form of a formal 10b5-1 plan (which includes the applicable cooling-off period and certification of no MNPI by the insider at the time of grant).
CalSTRS is the largest educator-only pension fund in the world – with assets totaling approximately $327 billion as of the end of last year. If your company is one of the 9,000 in the CalSTRS’ portfolio – which you can check on this page – then you should know that these principles will be used as a voting framework at your AGMs – and the stewardship priorities will guide engagements. For executive compensation, CalSTRS says that one of the main changes is to include a provision ESG metrics. Here’s what it says:
ESG Incentive Metrics: Companies should determine how to best incorporate material environmental, social or governance risks into compensation plans. Metrics should be measurable and linked to a company’s ESG risks or key priorities.
Another change that will affect compensation & human capital committees is that the updated principles include detailed expectations on board responsibilities for human capital management and human capital disclosure. Here’s a paraphrased excerpt:
– Human Capital Management: Boards should have an active role in setting company culture and oversight of the company’s approach to human capital management, which comprises employee wellbeing; incentives and compensation; retention and development; health and safety; fair labor practices; commitment to diversity, equity and inclusion; pay equality; employee development; providing a workplace free of sexual harassment and other forms of harassment; and promoting ownership and accountability. Companies should ensure they employ effective oversight of human capital management practices for domestic and international employees, as well as employees throughout their value chain.
– Human Capital Reporting: Comprehensive reporting on human capital incorporates the practices noted above alongside strategy considerations and can be tailored to each business. However, there are metrics that are foundational to all companies and provide investors with a baseline for understanding human capital management quality. Four foundational metrics that are necessary in reporting include: workforce headcount, total workforce cost, workforce stability metrics, and workforce diversity data.
– Employee Diversity Disclosure: Companies should annually disclose their EEO-1 report, to enable shareowners to understand the composition of the workforce and provide context for workforce investment and strategy decisions. This information would also allow investors to assess the board’s diversity, relative to its workforce
On the hot topic of clawbacks, like Glass Lewis and ISS, CalSTRS’ principles also say that they expect companies to have policies that allow recoupment for situations beyond what is legally required.
Both the principles and the stewardship priorities show that CalSTRS is holding steady with ESG-related topics. CalSTRS says that engaging on these topics is consistent with its fiduciary duties:
The Stewardship Priorities lay the foundation for corporate engagements and market-wide efforts to mitigate potential risks to the portfolio. These priorities are designed so staff can use the influence CalSTRS has as a significant global investor to promote sustainable business practices and public policies that drive long-term financial success on behalf of California’s public educators.
Do you have a process in place for deploying your new clawback policy in the unfortunate event of a restatement? It may be useful to think through that in advance. But right now, the only thing that people seem to be sure about is that it is going to be a complex exercise to calculate and recover excess incentives. This Barnes & Thornburg blog walks through a hypothetical to help illustrate the types of issues that may arise. Here it is:
John Smith is the chief executive officer (CEO) of Company X, whose equity securities are listed on NASDAQ, and he’s held this role since Jan. 1, 2010. In February 2021, the Board of Company X approved a compensation package for the CEO that included a performance-based equity incentive award for the Jan. 1, 2021, through Dec. 31, 2023 performance period. The target performance-based equity incentive award was based on 150 percent of base salary, which equaled 11,000 shares for the CEO. The payout opportunity equaled 0 percent (minimum), 100 percent (target), and 200 percent (maximum), with the growth in earnings per share (EPS) compared to the growth in peer companies’ EPS during the same period. Each named executive officer (NEO), including the CEO, was entitled to earn the performance shares at the end of the performance period depending on attainment level satisfied in respect of such EPS performance targets.
The Compensation Committee met in February 2024 to review the extent to which the CEO earned the 2021 equity incentive award. During the 2021-2023 performance period, the Compensation Committee analyzed the GAAP EPS growth over the performance period and using previously established payout matrix determined that the CEO was entitled to a payout of 200 percent of the target award. As a result, the CEO was awarded 22,000 shares in February 2024.
The 10-K was filed in late February 2024. In April 2024, the accounting team, working with its external auditor, discovered an accounting issue. After an investigation into the issue, the Audit Committee determined that its financial statements for 2022 and 2023 would need to be restated via a big R” restatement. (A “big R” restatement requires the issuer to file an Item 4.02 Form 8-K and to amend its filings promptly to restate the previously issued financial statements. In contrast, a “little r” restatement generally does not trigger an Item 4.02 Form 8-K, and an issuer may make any corrections the next time the registrant files the prior year financial statements.)
The restatement resulted in a decline in GAAP EPS for both 2022 and 2023. A 10-K/A was filed in May 2024 to restate the financial statements for the fiscal years ended Dec. 31, 2022 and 2023. The restated GAAP EPS amounts meant that the CEO was only entitled to 100 percent of the 2021-2023 target award, not 200 percent.
Will the compensation committee be required to claw back the award? Check out the blog for the answer…
For the first year of pay versus performance disclosure in 2023, Corp Fin took a very high-level approach to comment letters and issued only futures-based comments. This year may be different.
Yesterday at the Northwestern Securities Regulation Institute, Corp Fin’s Chief Counsel Michael Seaman discussed the Division’s expectations for year 2 of this rule. Michael noted that the Staff expects that companies and their counsel have digested comments from the first year of disclosure, as well as the two rounds of CDIs that were issued last fall. In other words, go back and look at those now so that they’re fresh in your mind as you draft this year’s proxy.
While the disclosure review team hasn’t completely finalized its approach, it’s likely that the Staff may ask companies for more analysis and correction rather than simply a commitment to correct issues next year. The Staff is still not out to issue comments that will put your annual meeting date at risk unless there’s a major issue. But you may get a comment after your meeting that delves into disclosure details and requires you to respond with analysis. Michael also shared a few tips and observations for this year’s disclosure:
– Remember to include the required “relationship” disclosure as a separate element of your disclosure. It’s not sufficient to simply say there’s no relationship.
– If you’re using a non-GAAP company selected measure, be sure to disclose how that measure is calculated from the GAAP financials.
– In the table itself, make sure you’re using the exact headings that the rule dictates. If you’re providing supplemental disclosures, take a look at the adopting release for how to approach that.
If you do receive a comment, here’s “what not to do”: don’t try to argue that your disclosures conform to longstanding common practices. Given that this disclosure requirement is only one year old, Corp Fin will not find that persuasive.
We blogged last month about Shearman & Sterling’s annual “Corporate Governance & Executive Compensation Survey” – which always provides a wealth of information. The firm is now out with a 9-page condensed version that is a good reference as we head into proxy season. It includes a handy “housekeeping” checklist at the end. Here are a few key reminders relating to executive compensation:
– New Disclosures. As highlighted above, there is new SEC guidance on pay versus performance disclosure that companies should be mindful of heading into the second year of required pay versus performance disclosure in proxy statements. Companies must also file their clawback policy as an exhibit to their annual report and indicate (via checkboxes on the annual report cover page) whether the filing includes errors or corrections to previously issued financial statements and whether these errors or corrections led to analysis of the clawback of executive officer compensation.
– Equity Grant Timing. The SEC has provided guidance on how to account for and disclose equity compensation awards granted shortly before certain material non-public information is released. Amendmentsto Rule 10b5-1 and Item 402(x) of Regulation S-K requiring tabular disclosure of option awards granted to NEOs within four business days before and after certain filings alongside changes in share price around the time of disclosure will take effect with respect to grants made in 2024 (with disclosure in the 2025 proxy statement). Companies should be mindful of this new disclosure requirement when making grants in 2024.
– Say-on-Pay and Say-on-Frequency. Determine whether the 2024 proxy statement should include either a “say-on-pay” and/or “say-on-frequency” shareholder vote.
– Equity Plan Adoptions or Amendments. If adopting or amending an equity compensation plan, make sure that any disclosure complies with Item 10of Schedule 14A, the plan provides adequate limits on director compensation (including any cash compensation) and be mindful of changes to burn rate calculations within the ISS Equity Plan Scorecard that took effect for meetings held on or after February 1, 2023, and the updates to ISS’s Proxy Voting Guidelines disfavoring equity plans giving boards full discretion over awards in the event of a change in control.
– Alternative Pay Disclosures. Consider whether to include (or continue to include) alternative pay disclosures—such as realized or realizable pay— in light of the addition of the new pay versus performance table while being mindful that shareholders may ask questions to the extent these disclosures are omitted or modified in future years.
Last week, Liz sharedPart 1 of a two-part report from Pay Governance regarding non-GAAP adjustments to payout calculations. Part 2 is now available, covering the myriad of issues and considerations associated with M&A-related comp adjustments and the most common methods of addressing M&A impact on plan payouts.
One of the more complex issues when measuring performance for incentive plan purposes is how to consider the effect of mergers, acquisitions, dispositions, and the related transaction costs (M&A activity) on financial performance during the performance period. This is due in large part to the difficulty in anticipating/budgeting M&A activity when setting incentive plan targets at the beginning of the performance period and the outsized effect such activity can have on financial results (both positive and negative), depending on the measures being used and the effect the transaction may have on shareholder value. Based on our experience, approaches to adjusting for M&A activity are highly situational, and it is difficult to quantify what constitutes “typical” market practice.
Below is a summary of the key considerations, with each described in greater detail in the memo:
– Whether executives/employees will receive a windfall or be penalized without adjustments
– Whether inorganic growth was considered in setting targets (particularly for smaller acquisitions)
– Whether the company is able to track standalone performance of a newly acquired entity
– Whether adjustments will help incentivize management appropriately
– Aligning the treatment of management with the impact of the acquisition on shareholders
– When the transaction occurred in the performance period
The memo then describes common adjustment scenarios (see the memo for examples) and warns that companies need to check their plan documents and consider the accounting and disclosure impact of any adjustments that are considered award modifications.
Fully Adjust Financial Targets for M&A Activity: Some companies adjust performance targets for the estimated impact of M&A activity to try to maintain the same degree of difficulty as the original performance targets. These companies will often rely on the business plan/financial forecast submitted to the board as part of the acquisition approval process to increase both the annual and long-term incentive plan targets. However, small, or late year acquisitions may not require adjustments due to immateriality on incentive plan results.
Exclude M&A Activity from Financial Results in Year of Acquisition: Some companies exclude the impact of acquisitions from the financial performance of the company used to calculate incentive plan results in the year of acquisition. Thus, the annual incentive plan and the 3-year performance share plan cycle ending in the year of acquisition are calculated as though the acquisition did not occur. As noted under transaction timing above, it may be necessary to modify the incentive plan targets for the other open 3-year performance cycles.
Partial Adjustment for M&A Activity: Some companies may adjust their financial results for only a portion of the acquired company’s financial performance (e.g., 50%-80%) and allow the remaining portion to flow through the incentive plan calculations in order to recognize management’s success in completing the acquisition. While the effect of the acquisition may have a positive impact on the in-flight incentive programs, the targets for future performance cycles will reflect 100% of the expected performance of the acquired company.
Based on an analysis of Russell 3000 companies, this Semler Brossy article reports that “only 36% of companies that have been public for less than five years have implemented stock ownership guidelines for executives.” While common for mature public companies, new public companies – particularly EGCs that are not required to hold say-on-pay votes – often wait to adopt these guidelines until three to five years post-IPO when there is mounting pressure on them to do so.
That time is near for many companies that went public in 2020 or 2021, but recent market volatility makes this a challenging time to adopt new ownership guidelines. To that end, the article shares questions the compensation committee should ask when determining whether to adopt guidelines and principles to consider when adopting them. Here are two key points:
Are shareholders asking about your stock ownership policies? If shareholders aren’t asking about your stock ownership policies, it may still make sense to establish guidelines (per the two questions above). However, if shareholders are raising questions, it is important to understand why. It could simply indicate rising governance expectations. More alarming, investor interest could directly reflect specific concerns, such as frequent insider share sales and (or) low levels of executive or director ownership. Shareholder interest in these topics may be a key signal to determine how quickly — and how aggressively — the board should respond. […]
Is your goal to have company guidelines meet minimum governance expectations or to be best-in-class? (See Exhibit 1.) How aggressive or conservative you choose to be is typically reflected in the required ownership as a multiple of base salary. This point of view (as well as the underlying design of the compensation program) may also influence what counts toward the guideline. For example, do you include some portion of unexercised stock options in addition to shares owned outright?
The referenced exhibit describes “baseline” and “best-in-class” terms. The article also has this suggestion for dealing with volatility:
It may also be helpful to describe how market volatility could or should influence compliance with the guidelines. For volatile stocks, a fixed share requirement may be more appropriate than a dollar-based approach — some companies even define as a “lesser-of” a fixed share or dollar-based threshold. A retention requirement on vested shares can also help manage volatility so that if an individual no longer meets the guideline, they merely need to retain a portion of the shares from future vesting events (e.g., 50% of the net, after-tax shares) to remain compliant.
Check out our “Stock Ownership Guidelines” page on CompensationStandards.com for related resources.
WTW recently released the results of its annual S&P 500 director compensation analysis comparing year-over-year changes. Here are key findings from the summary:
– Total direct compensation (TDC) rose 2% (from $300,000 to $305,000).
– The median annual cash retainer remains at $100,000. Board and committee meeting fee prevalence continues to whittle down, reaching 3% and 4%, respectively (each down one percentage point from the prior year). As was the case with annual retainers, the median value of most individual cash components remained the same as the prior year, with the exception of additional committee chair retainers, which leapt 14% (from $17,500 to $20,000). This helped push total cash compensation up 5% (from $110,000 to $115,000).
– The median value of annual equity grants increased 3% (from $180,000 to $185,000). Stock option prevalence (8%) and median value ($99,894) were unchanged from the prior year. The prevalence of common stock remained the same (14%), while deferred and phantom stock rose one percentage point to 18% and restricted stock dropped one percentage point to 67%. The median value rose 5% for common stock (from $166,258 to $175,000), 4% for deferred and phantom stock (from $170,000 to $177,002), and 3% for restricted stock (from $175,055 to $180,004). One-time initial stock grants decreased one percentage point to 8%, as the value at the median fell 10% from $200,000 to $180,912.
– Additional pay for the lead director remained $40,000 at the median, while non-executive chair of the board compensation once again outpaced TDC by increasing 5% at the median (from $165,000 to $172,543).
The summary notes that program changes have focused on the compensation of committee chairs:
With two years of significant leaps in the value of additional committee chair retainers (17% in 2022 and 14% in 2023), companies are increasing efforts to make sure committee leadership is adequately compensated. These changes seem to indicate acute interest in making sure that directors in leadership roles on the committees are paid for their expertise in roles with higher expectations of performance.
Check out our “Director Compensation Practices” page for additional resources on director pay programs.
This recent 9-page paper from Stanford’s Rock Center for Corporate Governance looks at where practices stand for climate metrics in executive pay programs – and where they might be going. I blogged last month that “ESG” metrics, on the whole, are improving in the midst of pushback. In a similar vein, this paper says that setting climate goals and incorporating them into pay programs is a journey. Here’s an excerpt:
Most companies acknowledge that it takes time to learn how to break down multi-year targets into one-year goals. Through repeated effort, they learn how efficiency programs, sourcing programs, and technology translate into emission reductions. To many, the process is analogous to continuous improvement programs for capital efficiency. It also takes time to get the largest suppliers on board and to educate smaller suppliers on how they can reduce their carbon footprint.
And:
Companies express very different experiences in the implementation of programs and creating buy in. For most, adopting climate targets and tying these to compensation is a multi-year (even decade-long) process. Companies newer to the effort will be faced with shorter timelines but have the benefit of learning from those who have gone before them. Companies phase the implementation, first adopting metrics to test their use and calculation before tying metrics to compensation. They also start at the top, adding climate goals to senior executive bonuses before rolling out to larger populations.
The underlying climate progress that the programs are intended to incentivize also takes time:
While some companies aim to realize straight-line reductions (for example, 3 percent annual decreases in absolute terms), others are on a “hockey-stick” trajectory. Targets for the first five to seven years focus on the transition to renewable energy and gross energy reductions in production and supply. Beyond this, there is general acknowledgement that technological innovation (outside the company) is going to be required for companies to achieve their long-term pledges.
The paper gives practical suggestions on overcoming resistance to pay changes, board committee oversight practices, why this topic matters in the first place, and more. Here are recommended “best practices” for integrating climate goals into compensation:
1. Leadership and organizational commitment. A company’s commitment to decarbonization is most effective when leadership (CEO, senior executive team, and board) genuinely embraces climate goals. This includes prioritizing decarbonization so it is not seen as secondary to strategic and financial objectives but integral to them. Climate-related goals are tied to strategy, embedded in budgets, and ultimately made part of culture. The reasons that the organization has committed to climate goals should be clearly and consistently articulated to divisional leaders and within functional groups to overcome resistance, remove inertia, and convince employees of the financial, organizational, and environmental necessity of decarbonization.
2. Metrics and reporting. Climate objectives should be few in number, low in redundancy, and largely quantifiable. We found that the most successful companies adopt science-based targets because of their demonstrable link to net-zero emission goals. Long-term targets are broken down into clearly achievable milestones, which map to quarterly, annual, and multi-year budgets and are supported by granular plans for capital allocation and procurement. Companies should be prepared to invest up front in systems for raw data collection and analytical processes, and entrust the reporting process to a small team of experts to ensure consistency and accuracy. Continuous improvement generally decreases cost and increase reliability over time. Ultimately, reported metrics should be audited to ensure accuracy and reliability.
3. Compensation. Climate programs are most effective when goals are added to executive and senior-manager compensation contracts to fully align the organization with its commitments. While many companies use the annual bonus program to do so, the most successful companies also embed climate in the longterm incentive program (LTIP) to match the timing of goals and compensation payouts. Annual targets in support of long-term goals are then reinforced through the annual incentive program. The achievement of annual goals gives executives and employees confidence that long-term objectives will be met. The rewards for meeting climate pledges should constitute a material part of at-risk compensation to encourage performance. Transparent reporting of interim and long-term targets allows the board and shareholders to monitor progress and hold the company accountable.
I blogged last week on TheCorporateCounsel.net about changes to “corporate diversity” messaging that some companies are making in the wake of the SCOTUS ruling in Students for Fair Admissions v. Harvard. In our informal “Quick Poll,” people were split on whether companies will soften DEI-related disclosures in proxy statements (feel free to add your two cents).
Over half of S&P 500 companies consider diversity metrics in some way in executive incentive plans, according to this WTW article. The article gives tips for how to respond to the ruling in the context of setting these goals. Here’s an excerpt:
3. Be specific in measurement. There are many ways DEI progress can be measured. While leadership and workforce representation goals may be a common approach, they also arguably present the highest reputational and litigation risk, especially if the company does not have strong documentation on career and pay decisions. Some other impactful ways to measure DEI progress include engagement score gaps for under-represented groups or participation in DEI enablement programs such as employee resource groups. In addition, companies should evaluate the pros and cons of using quantitative vs. qualitative measurement, especially in countries where demographic information is often self-reported and can be inaccurate. Companies that choose to assess DEI performance qualitatively should take note that investors strongly prefer quantitative and outcome-based metrics over activities-based and qualitative metrics.
4. Bolster the supporting infrastructure. It is important to acknowledge that litigation risks with DEI programs have existed since before the SFFA decision, and many other corporate programs and policies are exposed to similar litigation risks. It is unrealistic to expect elimination of all risks associated with DEI programs, and companies should know that the benefits of DEI programs far outweigh the potential risks. A more reasonable approach is to proactively assess, quantify, and manage these risks. Companies should review practices in recruiting, career development, training and development, managerial enablement and performance management to ensure robust governance and documentation for how decisions are made and communicated.
I’ll add my own tip, too: in addition to working with DEI practitioners, always consult an employment lawyer on this stuff!