For at least the past few years, investors have been pushing for more transparency around non-GAAP adjustments that are made to performance metrics in order to calculate incentive payouts. ISS even included a question about this in the policy survey for this year’s voting policies – and even though there weren’t any formal policy changes on this point, the proxy advisor did update an FAQ to encourage detailed disclosure of adjustments. Glass Lewis also made a relevant clarification. So, the issue isn’t going away.
One question that often arises on the company side is, “What’s the big deal? The reconciliation is only a click away.” From the investor perspective, though, not only is it annoying to have to pull up a separate document, but there is also a recognition that the adjustments may not be exactly the same. This Pay Governance memo gives 5 reasons why there might be discrepancies between financial reporting & incentive adjustments:
1. Threshold amounts that seek to limit the number of adjustments to only those that are materially above a certain dollar amount (i.e., expenses or benefits above $5.0 million)
2. Expenses or benefits that are included in the annual business plan used to establish incentive targets (further adjusting actual performance would result in double counting)
3. Expenses or benefits that may be non-recurring and excluded for financial reporting purposes but still deemed within the control of management for incentive purposes
4. Optics and materiality where omitting a significantly large expense could lead to a severe misalignment due to an above target incentive payout and poor share price performance
5. Matter of importance — for example, foreign currency exchange rates that are used to adjust earnings for year-over-year comparability purposes but are not as important for incentive purposes
The memo goes on to share best practices & potential pitfalls to consider when making non-GAAP adjustments to payout calculations. Pay Governance will be following up with “Part 2” to this memo that will cover more complex issues with M&A-related adjustments as well as other issues.
Here’s a paraphrased recap of the equity compensation plan updates:
– Adjusting the Equity Plan Scorecard Framework (Question 30): Among these adjustments, weighting of the SVT – A+B+C Shares factor decreased for both the S&P 500 and Russell 3000 models. Weighting of the Grant Practices pillar for the S&P 500, Russell 3000, and non-Russell 3000 models decreased, while the weighting of the Plan Features pillar for the same models increased.
– Updates to the pillars and pillar scores for the EPSC frameworks (Question 32): Increasing the “maximum pillar score” for the plan cost, plan features, and grant practices pillars for most categories of issuers. The threshold passing scores are unchanged.
ISS also made a few updates to the value-adjusted burn rate benchmarks – in the index to the equity plan FAQs. For the “compensation policies” FAQs, updates are:
– Pay-for-performance quantitative screens (Question 17): There are no changes to the three primary screens (RDA, MOM and PTA) for 2024. The secondary FPA screen’s “Eligible for FPA Adjustment” thresholds are calculated on an annual basis, and slight changes have been made for 2024. For detailed information on the quantitative screens, see ISS’ Pay-for-Performance Mechanics white paper.
– Consideration of company-responses to pay-related concerns (Question 34): If a company has taken recent actions following the publication of ISS’ research report to address pay-related concerns, any such actions must be disclosed in a public filing in order to be considered by ISS. Based on the additional public disclosure, ISS may issue a “proxy alert” to update the analysis and, if warranted, change a vote recommendation. ISS is generally unable to change vote recommendations if the additional public filing is made in close proximity to the meeting date (specifically, less than five business days before the meeting date). ISS may change its vote recommendation in the proxy alert if the company’s actions sufficiently remedy the concerns driving the adverse vote recommendation. The mitigating weight placed on such actions depends on the specificity of disclosure.
– Disclosure of adjustments to metric results, including non-GAAP adjustments (Question 41): Non-GAAP metrics are commonly utilized in incentive pay programs, and the performance results (and consequently the payouts) can be significantly changed by adjustments approved by the board. If such adjustments materially increase incentive payouts, companies should provide clear disclosure in the proxy explaining the nature of the adjustment, its impact (dollar or percentage) on payouts, and the board’s rationale. Disclosure in the proxy of line-item reconciliation to GAAP results, when possible, is considered a best practice. The absence of these disclosures would be viewed negatively, as would adjustments that appear to insulate executives from performance failures – particularly for companies that exhibit a quantitative pay-for-performance misalignment.
– Distinguishing between problematic CIC severance arrangements and incentive awards that are payable upon a CIC transaction (Question 51): a new or materially amended executive agreement that provides for CIC severance without requiring a qualifying termination (i.e., single or modified single trigger) is considered a problematic pay practice. However, this is distinguishable from a bona fide incentive award that becomes payable upon a CIC transaction. . . . In order to make the distinction between problematic CIC severance and a single trigger CIC incentive award, ISS will review the company’s disclosure of the incentive award structure and award rationale, and whether separate non-problematic severance entitlements are in place.
For the pay-for-performance mechanics, ISS adjusted the quantitative concern thresholds. For the peer group methodology, ISS didn’t indicate any significant updates.
In prior blogs about the FTC’s proposed ban on the use of non-competes and the many state-level developments in this space, we shared information about legislation in New York that contemplated a very broad ban and was awaiting the Governor’s signature. On December 22, Governor Kathy Hochul vetoed the legislation. This Mintz alert describes the lobbying campaign by groups that opposed the bill and the Governor’s concerns:
The Governor had previously indicated that while she supported a more moderate ban on non-competition provisions that would prohibit mobility restrictions for lower and medium income earners, the Governor wanted to see the incorporation of both a salary threshold for the use of non-competes (i.e., such that higher earners could still be subject to non-compete provisions) and an exception for sale-of-business situations. The bill’s legislative sponsors balked at the “low” $250,000 salary threshold proposed by the Governor and negotiations stalled over not only the amount of the salary threshold but how it would be calculated (e.g., whether and how the threshold amount would include bonuses and commissions earned by New York employees). Ultimately, after negotiations with bill sponsors deteriorated over the past week, the Governor vetoed the legislation, expressing that she had “attempted to work with the Legislature in good faith on a reasonable compromise [while] allowing New York’s businesses to retain highly compensated talent.”
The alert says that we all need to continue to monitor non-compete regulatory developments in other states, at the national level and in New York as well since state legislators have noted a plan to reintroduce a bill in the next legislative session.
As you look ahead to garnering support for your 2024 compensation-related proposals, this new 17-minute episode of “The Pay & Proxy Podcast” will help set you up for success. I spoke with Brian Myers & Heather Marshall of WTW’s Executive Compensation and Board Advisory practice about the meaning behind 2023 voting trends and what you should be doing right now to avoid negative (and possibly embarrassing) results. They cover:
– Trends and process & disclosure improvements impacting say-on-pay results in the 2023 season
– The importance of telling your compensation story
– The most common reasons for say-on-pay opposition
– Heightened scrutiny of equity plan share requests
– Why you need to be thoughtful about managing burn rate
– The year-round process for success: Prepare, engage & disclose
In late December, Dave shared a holiday miracle on TheCorporateCounsel.net blog: ISS Governance announced its 2024 Benchmark Policy Updates effective for meetings on or after February 1, 2024, and no updates are contemplated for the U.S. Benchmark Proxy Voting Guidelines. There’s only one clarification to the U.S. policy shown in Appendix B to this summary:
[The clarification] codifies the case-by-case approach when analyzing shareholder proposals requiring that executive severance arrangements or payments be submitted for shareholder ratification. The updated policy (i) harmonizes the factors used to analyze both regular termination severance as well as change-in-control related severance (golden parachutes) and (ii) clarifies the key factors considered in such case-by-case analysis.
The edits resulting from this codification are detailed on page 3 of this document describing Benchmark Policy Changes for the Americas for 2024. The policy in effect for 2023 annual meetings stated that ISS would recommend voting for shareholder proposals requiring that golden parachutes or executive severance agreements be submitted for shareholder ratification unless they would require approval before entering into employment contracts. Then ISS would apply a case-by-case approach to the proposals to ratify or cancel golden parachutes. It also listed terms that an acceptable parachute should include.
The new policy reads as follows:
Vote case-by-case on shareholder proposals requiring that executive severance (including change-in-control related) arrangements or payments be submitted for shareholder ratification.
Factors that will be considered include, but are not limited to:
– The company’s severance or change-in-control agreements in place, and the presence of problematic features (such as excessive severance entitlements, single triggers, excise tax gross-ups, etc.);
– Any existing limits on cash severance payouts or policies which require shareholder ratification of severance payments exceeding a certain level;
– Any recent severance-related controversies; and
– Whether the proposal is overly prescriptive, such as requiring shareholder approval of severance that does not exceed market norms.
We have posted the transcript for our recent webcast – “More on Clawbacks: Action Items and Implementation Considerations” – during which Compensia’s Mark Borges, Ropes & Gray’s Renata Ferrari, Gibson Dunn’s Ron Mueller and Davis Polk’s Kyoko Takahashi Lin continued their excellent discussion from our 20th Annual Executive Compensation Conference on complex decisions and open interpretive issues that unlucky companies faced with a restatement will need to tackle. They covered:
– What to do if a restatement occurs
– Whether to amend other policies and agreements, or update other disclosures
– Maintaining your policy going forward (we are all going to get smarter about these policies over time!)
Members of this site or of TheCorporateCounsel.net can access the transcript to this program and all of our other webcasts by visiting the “archives” page. If you’re not a member, sign up today to get access to this essential guidance!
Also, if you are a member, make sure to confirm with your knowledge management folks that your subscription is being renewed before year-end. Many of our subscriptions run on a calendar-year basis, and you don’t want any interruption in access as we head into proxy season.
Speaking of year-end, barring big developments, this is our final blog of 2023! Happy holidays, everyone. Thanks for your participation in our sites this year – we couldn’t do this without you! I look forward to seeing many of you in 2024.
Compensation Advisory Partners recently analyzed disclosures made by 100 prominent companies to understand the relationship between CEO compensation and performance over a three-year period. They found that total shareholder return is correlated with executive pay, which is not too surprising since equity is a large pay component for many executives. However, the analysis highlights that other factors also affect pay:
Overall, we found that TSR performance explained 77% of CEO compensation. Although these findings indicate that performance is highly correlated with Compensation Actually Paid, once we eliminated a single outlier, the correlation was weak. To our surprise, TSR performance then explained only 18% of the variation in CEO compensation for the 99-company sample. Revenue explained 19% of the variation for this sample.
We conclude that factors other than TSR performance – for example, industry pay practices, the initial size of CEO packages using the Summary Compensation Table methodology, cash compensation levels and industry TSR performance, collectively explain the majority of the variation observed in Compensation Actually Paid.
The CAP team notes that relative Compensation Actually Paid and relative TSR performance rankings demonstrate that the relationship is sound at most companies, which should give investors comfort. That’s good news for companies too, since PvP may become a factor in say-on-pay voting decisions.
I blogged earlier this month about eroding support for equity plans during the 2023 proxy season. This Glass Lewis blog underscores that you should pay attention to overhang and overall support for your compensation programs if you expect to submit an equity plan proposal in the upcoming year. Here’s an excerpt:
In the U.S., the number of equity plan proposals that failed to receive majority support rose to its highest level in at least five years, more than doubling year-over-year. The number of proposals that passed with significant opposition rose more than 40%. The overwhelming majority of failed proposals had excessive overhang levels, either due to the basic share request or the effects of evergreen provisions. Twelve of the failed proposals had high overhang levels (some with the help of evergreen provisions) while three of the remaining proposals shared ballots with other proposals that saw high compensation-related opposition.
For the past few years, ESG metrics seemed to be gaining in prevalence in executive compensation plans – but, like “ESG” overall, their lack of specificity made them an easy target for criticism. A recent 32-page report from Farient Advisors reaches the conclusion that companies & advisors have taken the feedback to heart. But rather than backing away from ESG metrics, they’re refining them. Farient says:
Linking executive pay to stakeholder incentives is here to stay. For boards of companies, the research provides important insights into how corporate pay is being aligned with stakeholder metrics to better assess management performance and accountability.
Other key takeaways from this year’s research include:
– More than three-fourths of large companies now incorporate stakeholder measures into their incentive plans
– This prevalence is up by 5 percentage points compared to 2021 and 14 percentage points compared to 2020
– Differences between regions are reflective of each region’s industrial base, cultural norms, and local regulations. However, all regions but Canada are moving in the same direction—up
– Europe, the U.K., Australia, and South Africa lead the market with over 80% of large companies incorporating stakeholder measures into their incentive plans
This Morgan Lewis blog addresses when a company may be required to register plan interests under a nonqualified deferred compensation plan. It explains that, under decades-old SEC guidance, the interests of participants in an employee benefit plan constitute “securities” subject to the registration requirements when a plan is both “voluntary” and “contributory.”
– Voluntary plans are plans in which the employees have a choice as to whether to participate, as such choice constitutes an investment decision to participate in the plan. By contrast, if participation in a plan is mandatory, no choice (and thus no investment decision) is made. – Contributory plans are plans in which employees decide to contribute a portion of their earnings or savings to a plan. If a plan consists only of contributions made by the employer without the participants giving up anything to which they would otherwise be entitled, the plan is noncontributory.
Note that one factor that does not change the analysis is whether the plan is a defined benefit plan or defined contribution plan, as both can be contributory.
The blog goes on to address what registration of plan interests entails:
Where plan interests are deemed to be securities, and thus registration under the Securities Act is required absent an applicable exemption (as discussed below), companies register on Form S-8 interests in the plan, rather than a fixed number of shares as a company would do for an equity incentive plan. The Form S-8 will register a dollar amount of plan interests as unsecured debt obligations of the company. The general requirement of Form S-8 is to provide a description of the securities offered; however, this does not apply to plan interests in a deferred compensation plan.
As with an equity incentive plan, registration on Form S-8 also requires the distribution (but not the filing with the SEC) of a prospectus to participants that includes material information about the plan, including its eligibility and contribution rules, investment terms, and tax effects.
This is addressed further in our Form S-8 Handbook, which we make available to members of CompensationStandards.com under our Form S-8 Practice Area. The Handbook includes this “word to the wise” — keep this in mind when looking at “precedent” for Form S-8:
There might not be a more murky area of securities law than Form S-8. Because this area is so challenging, bear in mind that there are varying degrees of compliance for Form S-8s. And even within the zone of compliance, there are also varying degrees of legitimate interpretation—so we typically do not take much comfort from what others are doing (or not doing).