The WSJ reported that Goldman has been visiting with shareholders in an attempt to justify its extraordinary compensation practices. As the article notes: “So far, Goldman has shown no signs of backing down to anger over the firm’s pay and benefits, on track to hit a record high of about $717,000 per employee, consultant and temporary worker for 2009, nearly double last year’s $364,000.”
As part of these efforts to justify the compensation, Goldman has been distributing a memorandum that asserts that Goldman outperformed other “sectors” of the economy. As the memorandum notes: “Goldman Sachs generated an average pre-tax margin of 29% between 2000 and 2008, besting all the sectors in the Fortune 500.” It is, of course, a cherry picked set of comparisons, one that does not claim it outperformed all other companies, only sectors of the Fortune 500. Presumably other companies have done the same thing without needing to resort to the same levels of compensation as Goldman.
The memorandum by the way put considerable weight on the approval of compensation practices by the independent board of directors. While the compensation of these directors for 2009 has not yet been disclosed, they were paid in 2007 almost $700,000 each. Its not only the officers and other employees who do well at Goldman.
Goldman has certainly done well during the financial crisis. But the amounts and the efforts to justify them reflect at best a tin ear and at worst an indifference to the economic situation of most Americans. Just as this story broke, the Journal reported that the economy had shed another 169,000 jobs, with unemployment remaining at 10.2%. Moreover, as Goldman raises the tide, other companies will likely float along with it, raising their compensation (and justifying it by arguing that they will otherwise lose talent to Goldman).
The story was paired with one about Bank of America deciding to repay its TARP money to the government. The repayment will largely free BofA of government oversight of compensation practices, particularly the onerous requirements imposed by the Pay Czar.
In other words, the limitations in TARP were temporary. The effort to use morality or public pressure to reduce compensation have failed abysmally. Legal restrictions on compensation are necessary. As we will discuss, the American Financial Stability Act is going in the right direction. It contains a prohibition on excessive compensation. Its time to impose a federal standard, one that will subject directors to meaningful standards in setting compensation.
A company’s Compensation Committee decided to provide the CEO with a company car and asked what color car he wanted. The CEO wanted to ensure that his choice of color was consistent with market norms so he asked the HR department to research the car color of the CEOs of its ten peer companies.
The results were presented to the CEO, indicating that, on average, CEOs in the peer group drove a pink car. The CEO, who knew his peer CEOs well, commented that it was hard for him to believe that so many CEOs were driving pink cars (given the absence of any multi-level cosmetics marketing organizations in their peer group.) “Is that the average or the median?” he asked. “Both the average and the median are pink” was the reply. He asked to see the raw data which indicated that five of the CEOs drove a red car and the other five a white car.
Is this a silly parable? Would such a simplistic analytical shortcoming really occur? I recently spoke with the head of compensation for a technology company who was questioning the data for their peer group data cut from a well-known survey. The data indicated that equity grants at the executive level among the peer group companies were averaging a mix of 50% stock options and 50% RSUs. His anecdotal knowledge of the peer practices made him feel that this couldn’t possibly be correct. When the raw data was examined, however, it turned out that only two of their 20 peers had an options/RSU mix near the 50/50 average. Nine were granting all or almost all (80% to 100%) options and the other nine were granting all or almost all (80% to 100%) RSUs. The pink car problem.
At a time when more individuals and organizations than ever are collecting, analyzing, and opining on executive pay levels and practices, it is critical that the underlying data be collected, analyzed, and reported correctly. Could the CEO have identified the pink car problem without access to raw data? Of course. Simply looking at the 10th, 25th, 75th, and 90th percentiles would have told the story. And when n=10 (or any even number), after all, the median is a computed number in a spreadsheet. While “ratcheting” to the median is an oft-mentioned flaw with the benchmarking process, summary statistics can contribute to flawed decision-making even absent any such intent.
The three-legged analytical stool of collection, valuation, and reporting of data needs to receive more integrated attention. Accurate collection has been made more difficult over the past 18 months due to the prevalence of “special actions” taken during the economic crisis. Valuation continues to be a challenge as experts continue to disagree on how to measure pay. The reporting of pay reflects the turmoil in collection and valuation, sometimes exacerbated by the media. Compensation professionals cannot assume that push-button data provides the answer – that data only provides a starting point for questions.
In my next blog posting, I will provide an illustration of another variant of the Pink Car Problem which created a recent headline indicating that a CEO’s pay was “cut by about half.” (the perceived difference was not “about half” and pay was not “cut.”)
We just dropped your Fall 2009 issue of the Compensation Standards print newsletter in the mail. If you want to access it now, we have posted the Fall 2009 issue online. It provides timely analysis of compensation action items that boards should be focused on now.
Time to Renew – Your Membership Expires Soon: Note that because all memberships expire at the end of December, it is time to renew for 2010 for CompensationStandards.com. With all the change going on in the executive compensation area, you can’t afford to be without the critical resources on that site (and in the print newsletter, which you get as a bonus for being a member of CompensationStandards.com).
– Ira Kay and Steve Seelig, Watson Wyatt Worldwide
Sometimes the answer to a complicated question becomes clearer when different perspectives are considered. Such is the case in the debate about whether there has been pay-for-performance through the recent market meltdown. Recently, Paul Hodgson revealed the findings from a The Corporate Library study that found a weak link between CEO pay and firm performance in 2008, as evidenced by a decline in CEO total annual compensation of only 0.08% and a decrease in total realized compensation of 6.28% in 2008 for the more than 2,700 public companies surveyed, compared to a 37% decline in the S&P 500 index.
Our “2009/2010 Report on Executive Pay” reaches a far different conclusion – that CEO pay is still strongly aligned with company performance. We find that the pay-for-performance model underpinning U.S. executive compensation design still works as intended — in good years and bad:
– There is substantial downside risk for CEO wealth: the 967 CEOs in our study lost an aggregate $53 billion in 2008, compared to $3.2 trillion for company shareholders. In fact, we found that the percent decrease for the typical CEO is actually larger than that for shareholders (-42 percent for the CEO versus -34 percent for shareholders).
– CEO pay decreased significantly in 2008: when measured as realizable pay, three-year cumulative realizable LTI values decreased with shareholder returns — down to $1.4 million for 2006-2008 compared with $2.9 million for 2005-2007 and $3.3 million in 2004-2006.
– CEOs at higher performing earn more than their low-performing counterparts: the typical CEO at a high-performing company has a three-year aggregate realizable LTI value that is 150 percent larger than at a low TRS company ($2.3 million versus $0.9 million).
So, how is it two firms well-respected for the important research they do in the area of executive pay can come to such widely disparate conclusions?
One thing both firms have in common is that each goes beyond the Summary Compensation Numbers, which depict only the equity pay opportunity granted, in determining what executives actually earn in measuring pay. Unlike the The Corporate Library study that focuses on realized pay, we look at “realizable” pay as a far more accurate measure of the pay earned by executives. The difference between the two may appear subtle – but will vastly influence the results:
– Realized pay = the W-2 wages reported for the year, including restricted stock vested + performance shares and RSUs vested and paid + options exercised + deferred shares paid
– “Realizable” pay = restricted stock value earned or lost + performance share and RSU value earned or lost + option in-the-money value earned or lost + deferred share value earned or lost
Our concept avoids a focus on when equity is actually paid or monetized, which might often be a volitional act by the executive or the company that fails to consider the equity value earned or lost until the date that happens. We believe strongly that realizable pay is the number that executives think about when they consider the compensation they’ve earned or lost for a year. A proper understanding of how corporate executives think about their compensation drives far better decision making by the compensation committees and, perhaps more importantly, better illustrates the connection between pay and performance. We continue to urge the SEC to consider requiring companies to use it in their proxy disclosure.
Other key findings from our report include:
– Companies with an executive compensation architecture that creates a strong link between CEO wealth and risk had lower realizable total direct compensation (TDC) and superior total returns to shareholders (TRS) than companies with a weaker link to risk reduction.
– The value of broad-based employee option grants declined by 17 percent in 2008.
– Realized gains from employee stock option exercises declined by 55 percent last year — from an average $54 million per firm to $24 million.
– The estimated in-the-money value of options outstanding declined by approximately $100 billion for the firms in our sample in 2008.
From our blog: The Securities Docket reported recently that the SEC was going after Ian McCarthy the CEO of Beazer Homes – using Sox 304 – for clawbacks of his incentive payments, just like it did for CSK Auto Corporation’s CEO. The issue here is the same. The SEC is not alleging that either CEO was responsible for fraud, but simply that the incentives and other compensation were earned based on misstated financial accounts. The accounts are already being restated for 2004-2007 and they are likely to be restated for 1999-2003 as well.
That’s quite a lot of pay. Even for 2004-2007, in bonuses and option profits alone that’s $38 million.
Ian McCarthy has been the CEO for 15 years, so it’s going to be tough to point the finger elsewhere anyway. And we’ve already blogged about this. In the face of a Federal investigation, Mr. McCarthy claimed not to have any knowledge of what was going on, none whatsoever, not at all, no idea, nada, completely bemused by the whole thing, just couldn’t have come as more of a surprise to him that there was mortgage fraud, discount point fraud, down-payment assistance fraud, HUD-licensing fraud, and stated income fraud. Before all this he probably wasn’t even sure how the word “fraud” was spelt, I bet.
As we said then, knowledge has nothing to do with it. Responsibility is everything. And was he responsible? Well, we said yes back in July and apparently the SEC agrees with us.
This is about the clearest evidence yet that a simple fraud-based clawback policy is completely useless and a waste of paper.
– Julie Scott, RiskMetrics’ Canadian Research Team
Nine of the 13 Canadian companies that will give shareholders their first vote on executive compensation have agreed in principle on a draft resolution that will appear on proxy ballots in 2010. The resolution is drawn from a draft model “say on pay” policy crafted by the Canadian Coalition for Good Governance (CCGG), which represents 41 investors managing over $1 trillion in assets.
The CCGG, which drafted its model policy in consultation with Canadian issuers, has urged companies to standardize their “say on pay” policies. While the board will decide the final wording of the proposal in the proxy circular, the nine companies are expected to recommend the CCGG’s draft.
“A lot of drafting and consultation went into this policy,” CCGG director of research Paul Schneider told Risk & Governance Weekly.
The draft resolution is prefaced by a statement noting that the purpose of the “say on pay” vote is to ensure directors are accountable for their compensation decisions. While shareholders provide their collective advisory vote on compensation, directors remain fully responsible for investment decisions. The draft policy suggests the following wording for the say on pay resolution: “Resolved, on an advisory basis and not to diminish the role and responsibilities of the board of directors, that the shareholders accept the approach to executive compensation disclosed in the Company’s information circular delivered in advance of the [insert year] annual meeting of shareholders.”
The CCGG’s model policy states that say on pay resolutions should be seen as part of ongoing engagement efforts between companies and shareholders. At the heart of the policy is the board’s belief that it is important to have regular and constructive dialogue with shareholders. The model policy provides examples of how to elicit feedback, including through meetings between boards and shareholders, investor surveys, town hall meetings, and web-based tools enabling shareholders to ask questions of the board.
The model policy also addresses the question of how the board responds to the results of the say on pay vote. The policy states that companies will disclose the results of pay votes and take the results into account when considering future compensation policies. In the event that a “significant” number of shareholders oppose the resolution, the policy states the board will further consult with shareholders to discuss specific concerns. The company will then disclose, no later than in the proxy circular for the next shareholders’ meeting, a summary of the comments from shareholders and any subsequent changes to compensation policies.
The draft policy does not specify the level of opposition to a “say on pay” resolution which would be considered significant and would prompt the company to consult further with shareholders. The CCGG appears to prefer a case-by-case approach to analyzing against votes, taking into account the shareholder base of each company.
While shareholder proposals filed in 2009 calling for advisory pay votes are largely responsible for prompting the 13 Canadian issuers to provide for the right, the CCGG’s policy urges companies to adopt the vote voluntarily. The Shareholder Association for Research & Education (SHARE), which filed “say on pay” proposals on behalf of Meritas Mutual Funds in 2009, continues to engage with companies on the subject of advisory pay votes. SHARE officials tell RiskMetrics they have contacted about 30 companies since 2007 to recommend adopting a say on pay advisory vote. Of the 13 companies that have committed to a say on pay vote in 2010, Canadian Imperial Bank of Commerce has the earliest meeting date of Feb. 25. The CCGG encouraged interested parties to submit comments on its draft Model Say on Pay Policy by Nov. 25.
– Robert Kohl and Jonathan Weiner, Katten Muchin Rosenman
In a November 9th speech at the “4th Annual Proxy Disclosure Conference: Tackling Your 2010 Compensation Disclosure,” Shelley Parratt, Deputy Director of the Securities and Exchange Commission’s Division of Corporation Finance, outlined the SEC staff’s expectations for companies’ executive compensation disclosure for the 2010 proxy season.
Against the backdrop of intense public scrutiny of executive compensation, Deputy Director Parratt urged public companies to enhance their executive compensation disclosure, particularly with respect to their compensation disclosure and analysis (CD&A). She noted that, too often, companies fail to include sufficient analysis of their compensation decisions in their CD&A disclosure. According to Ms. Parratt, a detailed discussion of the process used to determine executive compensation is inadequate to satisfy the requirements of CD&A absent a meaningful analysis of why named executive officers were compensated in a particular manner or amount. Although Ms. Parratt believes process-oriented disclosure of the framework in which compensation decisions are made may provide investors with important context for CD&A, disclosure should focus on how the company applied such framework, including any qualitative factors considered by the company, to determine the amount and structure of executive compensation. However, she added, “If a committee’s pay determinations were simply subjective decisions, the company should say that.”
She also stressed the need to enhance disclosure with respect to performance targets (benchmarks) used to make compensation decisions (i.e., “pay for performance”). According to Ms. Parratt, the staff issues “more comments on performance targets than any other executive compensation disclosure item.”
Applicable rules require companies to disclose performance targets that are material to compensation policies and decisions, unless such information is confidential and disclosure would result in competitive harm to the registrant. As a threshold matter, Ms. Parratt suggested that a company should consider whether performance targets are in fact a material element of compensation policies and decisions, especially where such targets may be disregarded at the company’s discretion or performance-based compensation may otherwise be awarded even if performance targets are not achieved. She said that “when a company states that it determined a material element of compensation [is] based on the achievement of performance targets, [the staff] will ask for specific disclosure of the targets and the actual achievement level against the targets, or for the company to provide [the staff] with an explanation of how such disclosure would cause it competitive harm.” A company claiming that such disclosure would result in competitive harm should nonetheless provide meaningful and specific disclosure regarding how difficult or likely it would be for the undisclosed performance target to be achieved, she said.
Ms. Parratt stressed the need for issuers to be more proactive in updating their CD&A disclosure to reflect staff interpretations expressed in publicly available comment letters and other guidance regarding CD&A. According to Ms. Parratt, “after three years of [staff comments that are applicable only to companies’ future filings, the staff] expects companies and their advisors to understand [the SEC’s] rules and apply them thoroughly. So, any company that waits until it receives staff comments to comply with the disclosure requirements should be prepared to amend its filings if it does not materially comply with the rules.”
Since every company should now consider addressing walkaway numbers in this year’s proxy statements, we have devoted the “Fall ’09 issue of Proxy Disclosure Updates” to analyzing how to draft this type of disclosure. We even provide a model walkaway disclosure in this critical issue.
You will receive this issue, which is posted on CompensationDisclosure.com, by taking advantage of a no-risk trial to Lynn, Borges & Romanek’s “Executive Compensation Service” for 2010 (which includes the 2010 version of Lynn, Borges & Romanek’s “Executive Compensation Disclosure Treatise and Reporting Guide” that we mailed last week to those that ordered the Service).
Act Now: As part of the Lynn, Borges & Romanek’s “Executive Compensation Service,” if you try a no-risk trial now, not only will you receive the walkaway issue described above and the 1000-page plus Executive Compensation Disclosure Treatise, you will also receive the Winter issue of Proxy Disclosure Updates – with important new proxy disclosure guidance – soon after the SEC adopts its new executive compensation rules (which could happen as early as the first weeks of December).
After significant increases in outside director pay in the years following Sarbanes-Oxley, last year’s study saw compensation levels stabilizing. This year’s study finds that companies’ approach to delivering compensation to outside directors has remained consistent.
While competitive cash compensation levels are largely unchanged in the past year, sharp declines in the equities markets impacted the value of outside director compensation programs, particularly at the NASDAQ companies where fixed-share equity grants are more prevalent. Median annual compensation for basic board service increased modestly at the NYSE companies, but declined at the NASDAQ companies. For the first time in the seven years that Frederic W Cook & Co. has conducted its annual study of outside director compensation, median compensation for directors at the 100 largest NYSE companies exceeded that provided by the 100 largest NASDAQ companies.
New to this year’s report is an analysis on the prevalence of mandatory retirement policies for outside directors. Additional details on annualized equity award values are also provided. Some notable findings and trends are:
– The median total value of director compensation for all companies in the study declined by 3% from 2008 levels. A slight increase in median value for the NYSE companies (+4%) was offset by a substantial decline in the median value for the NASDAQ companies (-14%). Year-over-year comparisons of the total value of director compensation programs reflect changes in cash compensation, equity grant levels, stock prices, binomial ratios (for companies granting options) and pay mix (as well as changes in the study sample).
– Overall, Board member cash compensation increased slightly at the median since last year’s study ($75,000 versus $70,000), driven by a slight increase at the NASDAQ companies. The prevalence and median values of board member cash retainers and board meeting fees did not change meaningfully. Overall, median Board member cash compensation is significantly higher at the NYSE companies ($80,000) than at the NASDAQ companies ($57,000).
– Following the trend from recent years, companies continued to move director equity awards out of stock options and into stock awards. Stock awards are used exclusively by 77% of the NYSE companies and by 37% of the NASDAQ companies (compared to 65% and 31%, respectively, last year). Options are used exclusively by only 5% of the NYSE companies and only 23% of the NASDAQ companies (compared to 8% and 32%, respectively, last year).
– The sharp decline in the equities markets in the 12 months ending March 31, 2009 had a significant impact on equity award values at those companies denominating awards on a fixed-share basis. At the NASDAQ companies, where fixed-share awards are more prevalent, median annualized equity value declined by 28%. At the NYSE companies, where equity awards are usually expressed as a dollar value, median annual equity value increased by 4%. Overall, annualized equity compensation values at the NASDAQ and NYSE companies are essentially equal ($126,685 at the NASDAQ companies versus $125,000 at the NYSE companies). This is a dramatic change from last year’s study when the NASDAQ companies granted 46% more in annualized equity value at the median than the NYSE companies.
– Adam Shapiro and David Kahan, Wachtell Lipton Rosen & Katz
The Swiss Financial Market Supervisory Authority (FINMA) recently issued regulations addressing executive compensation at Swiss financial institutions. Notably, the regulations provide significant guidance on appropriate compensation incentives and structures, but emphatically decline to regulate pay directly.
The FINMA regulations will apply on a mandatory basis to the largest Swiss banks and insurance companies and will serve as a guideline for all other firms that FINMA supervises. Most significantly, the regulations require (1) alignment of compensation structures with risk management and promotion of long-term sustainable business objectives, (2) imposition of stock holding periods and compensation deferral arrangements under certain circumstances, (3) integration of compensation decisions with capital and liquidity planning, (4) company-established limits on sign-on bonuses and severance payments that a company may exceed only by obtaining approval from the board of directors, and (5) increased disclosure and transparency, including a comprehensive annual remuneration report from the board of directors.
FINMA rejected calls for a total ban on variable compensation, and the regulations avoid provisions that would directly regulate pay levels or that would mandate or prohibit particular compensation design structures. FINMA notes that it does not regard “a total ban or severe restrictions on variable pay” as a “useful approach” and that direct restrictions on compensation do not represent a “sensible option.” Rejecting a one-size-fits-all framework, FINMA further notes the impracticability of determining a “single appropriate arrangement” for all regulated firms within the Swiss financial sector.
FINMA’s new rules represent a sound approach from a regulator in a jurisdiction that houses a significant number of global financial institutions. The regulations establish core principles designed to ensure that compensation does not create incentives to take inappropriate risks, and impose on boards key oversight and disclosure responsibilities. At the same time, the rules recognize that long-term economic growth requires that individual institutions have the flexibility to implement programs specific to their needs and the ability to attract and retain management talent. A universal principles-based approach would place all financial institutions on a level playing field.