We continue to be inundated with daily media coverage, articles, and blogs about the shifting landscape for executive pay in the banking sector. Many are asking if these changes will spread to other industries. A while back, a WSJ story talked about a “range of firms” altering their executive pay policies cited six non-banking companies (yes, six) which have changed some aspect of their executive pay for a variety of reasons. These six companies range from $4 billion to $39 billion in market cap and are in six industry sectors as diverse as apparel, mining, and pharmaceuticals. That certainly is a range of firms, both a wide and a narrow one.
The article stated “Among the changes: more stock-based compensation, with longer waiting periods before it can be sold; higher performance hurdles for bonuses; and limits on perks, severance and supplemental pensions.” Yet the article goes on to say “The shifts are far from universal. Some experts say bank-pay limits are having little impact elsewhere in corporate America.” One consultant cited in the article agrees by saying “I don’t see any trend in that direction.” Like Seinfeld, is this a story about nothing?
If you don’t want to read the entire article, you have the crux of it. Huge changes in banking dominate the headlines, but I think many, perhaps most, companies in the US are reading those headlines and stories, and shrugging. Smaller and mid-sized companies, particularly those in the technology and life sciences sectors, reaction range from yawns to smirks. Supplemental pension? They don’t even have a pension to supplement. More stock-based compensation? Given the overhang and run rate constraints and the all-employee equity compensation philosophies of these companies that is not likely to happen. Perks, you mean like the company-subsidized (or company-paid) cafeteria for all employees? You get my point.
So what about the looming question? What if they (the government) extend similar rules to all companies? In some ways they did, and are, via regulation, legislation, and the ripple effect on proxy advisors and institutional shareholders’ policies. It is unfortunate that successful innovative firms who apparently have had the “right” pay model for many decades are subject to increasing disclosure requirements and the associated media scrutiny triggered by those with the “wrong” pay model. The challenge for executive pay advisors is to help clients who are doing it right not get caught up in the frenzy about those doing it wrong, particularly since the “right” and “wrong” columns keep changing. The answer to “what are other companies doing?” is about more than just peer group construction at a time like this.
Remember when restricted stock was wrong – then after Enron and the Breeden Report, it was right? Then after the spread of RSUs without performance contingencies it became wrong again, and now right once again thanks to TARP. Many of us are having trouble understanding how large increases in fixed compensation and restricted stock are reconciled with the “pay for performance” mantra of the past few decades. These high-fixed low-variable models almost look like something a governmental organization would use to pay their employees, and probably do not represent a nascent trend for thousands of US companies.
I think it’s time for the business media to return to reporting news rather than concocting theories and then seeking a few data points that support a headline about nothing.
Below is something I recently blogged on The Corporate Library’s blog:
The news that Hewitt has spun off its compensation consultancy business, the news that Ira Kay left Watson Wyatt to start his own compensation boutique seem to be at odds with the fact that Towers Perrin and Watson Wyatt have joined forces to form some kind of super-consultancy. One thing is sure. This is all a reaction to the news that fees will have to be disclosed in many instances. Not only that but “other work” performed by a consultant beyond its executive compensation work for the board will also have to be disclosed. See this blog post for details.
With this in mind one would have expected all the comp consultants to be divesting like mad, just like the auditors did when consultancy work for the companies they audited was banned in Sox. Unless of course, the merger of Towers Perrin and Watson Wyatt into Towers Watson is prequel to divesting the now super-comp-consultancy.
In our “2010 Consultant League Report,” we took a look at annual reports and proxy filings of public companies to determine which consulting firms had the largest, most profitable clients, and which had the best market share in various indices, sectors, and geographic locations. Although large consulting firms consistently have a bigger presence in the market, we found some smaller firms gaining market share in certain industries and regions. Our data was featured in a recent Wall Street Journal article on current consulting trends, “More Boards Opting for Independent Pay Advisers.”
Below is a sample table from the report, detailing the market share of firms engaged by the Russell 3000 (in comparison, here are last year’s numbers):
Other charts in the 2010 Consultant League Report include:
– Financial Data: Firms’ client base ranked by revenue, net income, year-end market capitalization, total assets, and one- and three-year total shareholder return
– Indices: The firms with the most market share in the Fortune 1000, S&P 1500, and more
– Sectors: Eight different industry categories, from Healthcare to Financial Services
– Geography: The firms with the most market share in each of four U.S. regions
– Engagement: The market share of firms engaged by management
The complete report is provided to all Equilar Knowledge Center subscribers. Non-subscribers can request a copy of the report.
One thing I probably don’t highlight enough is the wealth of knowledge that can be gleaned from the “Q&A Forums” on our sites. Dave Lynn recently answered this query below on the Forum on TheCorporateCounsel.net:
Question: The new proxy disclosure regulations require a description of excessive risk that may result from a company’s compensation plans for executives and non-executives. As I understand it, disclosure is only required if there is excessive risk. If a company has analyzed its compensation plans and determined there is not excess risk, then am I correct that there does not need to be disclosure about the analysis undertaken?
Even if that is correct are there other reasons why a company may want to disclose that they’ve undertaken the analysis even if it shows no risk (e.g., RiskMetrics, etc. review)?
Dave’s Answer: Actually, the standard is whether the risk is reasonably likely to have a material adverse effect on the company, as opposed to “excessive” risk. No disclosure is required if it is determined that this standard of materiality is not met. There are reasons why a company may want to disclose that it went through the process of evaluating the relationship between compensation and risk, most particularly due to investor interest in the topic (as well as interest of the proxy advisory firms).
There are really two levels of disclosure to consider – whether disclosure is required with respect to the relationship between compensation and risk for all employees pursuant to new Item 402(s) of Regulation S-K, and specifically with respect to the named executive officers pursuant to the pre-existing CD&A requirement.
Yesterday, the SEC announced that it has settled its two actions against Bank of America regarding alleged disclosure deficiencies in connection with BofA’s acquisition of Merrill Lynch (one action regarding bonus amounts; the other over operating losses). Not only will BofA pay $150 million to the SEC (to be distributed to harmed shareholders), it will adopt seven governance reforms – if Judge Rakoff approves the settlement (he rejected a $33 million settlement last September). The settlement doesn’t levy any penalties on current or former executives. Here’s the SEC’s litigation release – and here is the SEC’s brief supporting the settlement and notice of motion (with Exhibit A to that).
Here are the seven governance reforms that BofA would be required to implement for a period of three years:
– Provide shareholders with an annual non-binding “say on pay” on executive compensation
– Retain an independent auditor to perform an audit of the company’s internal disclosure controls
– Have the CEO and CFO certify they have reviewed all proxy statements
– Retain disclosure counsel who will report to the audit committee on the company’s disclosures
– Adopt a “super-independence” standard for the compensation committee that prohibits them from accepting other compensation
– Hire a “super-independent” consultant for the compensation committee
– Implement incentive compensation principles & procedures and prominently post them on the company’s site
While BofA’s problems with the SEC may be coming to a close, it’s problems with NY Attorney General Andrew Cuomo may just be starting over these alleged disclosure deficiencies. Yesterday, Cuomo announced that he had filed a civil suit against Bank of America, Lewis and former CFO Joe Price.
The SEC Enforcement Division’s Use of Governance Reforms: Something New?
I know there have been a number of “governance by gunpoint” settlements driven by judges over the past decade, where institutional investor plaintiffs obtained governance reforms from companies whom they had sued and then settled. But is this something new for the SEC?
Going back in time a little bit, it’s fair to say the SEC has somewhat engaged in this type of practice, but I had trouble digging up examples from the past few years. And there certainly hasn’t been a prior instance of the SEC requiring an advisory say-on-pay vote or imposing “”super-independent” criteria as part of a settlement. It’s certainly an interesting way to remediate what was essentially a disclosure issue (how about the one where an outside law firm will report to the audit committee on disclosure!).
Here are the few precedents I could think of where the SEC has used the settlement process to obtain some type of quasi-governance reform from a company: requiring the company to hire an independent consultant to review and recommend improved policies on things like accounting (e.g., Xerox and others) and FCPA compliance (many FCPA settlements in the 2002-2006 time frame), etc.
It will be interesting to see if this is a one-off type of settlement or a new Enforcement trend. Come hear a panel of former SEC Enforcement Staffers discuss this topic during TheCorporateCounsel.net’s upcoming webcast: “Big Changes Afoot: How to Handle a SEC Enforcement Inquiry Now.”
In talking with clients this year about the new compensation risk assessment in the proxy disclosure rules (S-K Item 402(s)), I have encountered about an even split between (A) those who intend to take the SEC up on its offer to “be silent” if the conclusion is that the company-wide compensation program is not “reasonably likely to have a material adverse effect on the company” and (B) those who, reaching the same conclusion, intend to disclose in general terms the process that was followed and features of the program that led to that conclusion.
Very few have opted to simply state the “all clear” conclusion without elaboration, which could give you all of the potential exposure (for being second-guessed by the plaintiff’s bar if something later goes seriously south) and none of the advantage of having a good story to tell.
Gearing up for 2011 and widely-expected mandatory say-on-pay, it makes good sense to start thinking now about how the CD&A and related compensation disclosures can best be stated to enlighten shareholders and not just technically comply with the disclosure rules. A clear and frank discussion of the risk assessment process can give comfort to shareholders on a number of fronts.
First, they will know that the company did not just overlook the new disclosure requirement. Second, they will see first hand how rigorous the review was and how it was conducted. Third, this is yet another opportunity for the company to extol its positive efforts to manage and control compensation-related risks, such as having an effective recoupment policy, long-term stock retention guidelines and an appropriate balance of compensation elements. In telling the “good story,” don’t let it be lost in a boilerplate recitation of the positive features of the program or the steps of the review. An individualized, thoughtful discussion goes a long way to assuring shareholders that the company is serious about assessing and controlling risk.
While the say-on-pay vote is likely to be limited to the compensation of NEOs, the wider compensation program should be of interest to shareholders and may influence their views.
RiskMetrics Group recently announced that its Research Group is allowing companies some flexibility in their burn rate commitments for 2010. Companies that have a 3-year average burn rate that exceeds their GICS industry group cap must either publicly commit to maintaining their burn rate for the next three years at the burn rate cap for their GICS industry group as determined by RiskMetrics for that year or face a negative vote recommendation on their equity compensation plan proposals from RiskMetrics.
Some of the approaches that RiskMetrics’ Research Group has found acceptable include:
1. Committing to the average between the 2009 and the 2010 RiskMetrics burn rate caps,
2. Committing to the average between the 2010 and the 2011 RiskMetrics burn rate caps, and
3. Committing to the 2010 cap for one year, the 2011 cap for one year, and the 2012 cap for the last year.
As a result of the significant declines in the RiskMetrics Burn Rate Caps for 2010, RiskMetrics had little choice other than to work with companies on this issue. I’ve spoken to companies that were willing to let RiskMetrics recommend against their plans as a result of this policy and would then discuss with their shareholders how inflexible RiskMetrics was being on this issue given the dramatic shift in burn rate caps. It sounds like RiskMetrics’ Research Group heard this message and decided that some flexibility was warranted.
I think this will make the commitment a little easier for companies to swallow, but the last two options do present their own concerns. Yes, equity grants (# of awards granted) probably increased on average for 2009. Yes, that data was not included in the burn rate caps that RiskMetrics came out with for 2010. Yes, when those 2009 grants get factored into the 2011 burn rate caps, the caps will likely rise from where they sit for 2010. But by how much and to where exactly? Good questions, with not very good answers at this time. Hence, the last two options are a little less certain for companies but offer an opportunity for an increase in the rate a company commits to, but the exact extent of it will be unknown until subsequent years, but they should be better than simply committing to the 2010 burn rate caps.
I recently spoke with an audience of in-house lawyers and HR staff and got into a spirited debate over the need to pay excessive CEO packages in order to recruit and retain top talent. The old argument of “everyone else is doing it.”
I’m not going to rehash all of the arguments against such thinking – just leave you with my bottom line. I’ve worked in-house and seen how some managers get elevated to the top position and just simply aren’t as good as others in the CEO job. It’s just a fact of life – not every CEO is best suited for that job. Some are better than others. And some are definitely replaceable. It’s now a party line that “not everyone can be paid in the top quartile” – but when it comes to actually putting together a pay package, people forget the party line.
I leave you with the following excerpt from a recent article in “Corporate Board Member”:
For years boards were held hostage by star CEOs who were in such demand that they could write their own employment contracts. Not anymore. With unemployment at nosebleed rates, your boy or girl is most likely staying put. The employment potential of CEOs is directly proportional to how well their companies’ shares performed during their tenures. David Yermack puts it bluntly: “When you run your own stock down 80%, where are you going to go?”
It has taken a little time for boards to realize they have the upper hand. According to Equilar research, at least 40 companies announced that they were paying cash retention bonuses to their top executives between July and December 2008, but fewer than a third included the CEO. Equilar noted that “some special awards, particularly those for chief executives, contain unique performance-based vesting requirements focused on overcoming current challenges.”
For example, JCPenney disclosed in a December 8-K filing that it was granting its CEO, Myron E. Ullman III, as many as 500,000 shares “to provide an incentive for performance during the current economic environment and to recognize Mr. Ullman’s willingness to continue his services to the company.” The award caps out at $25 million, and Ullman, who has no employment contract or severance agreement other than one covering a change in control of the company, could get all of that if he sticks around until December 2011–but only if Penney’s annual total stockholder return grows to 29.1% or more by the end of the period. And he’ll get nothing, even if he hangs in there for three years, unless the return is at least 11.3%.
A common worry that the CEO may have wanderlust could be baseless. When Watson Wyatt surveyed 85 outside directors of large U.S. companies in March and April, 68% of them said that their boards or compensation committees were not concerned or were only slightly to moderately concerned about retaining high-performing executives. In fact, there is so much managerial talent around that this might be an opportunity for companies to upgrade. “Dump the dead wood,” suggests J. Richard, who runs his own J. Richard & Co. compensation consulting firm in Half Moon Bay, California. “That’s where boards should be extremely proactive.”
As you may recall from Corp Fin Deputy Director Shelley Parratt’s speech at our Conference in November, the SEC Staff appears to be drawing a “line in the sand” this year regarding when proxy statement amendments may be necessary. The Staff expects companies to carefully consider the Staff’s positions – including those expressed in comments to other companies – when drafting executive compensation disclosure, and that material noncompliance with the rules and the Staff’s positions will potentially trigger a request for an amendment of the disclosure (rather than fixing the disclosure in future filings).
We just mailed the January-February issue of The Corporate Executive, which includes a comprehensive analysis of typical Staff comments and how you may avoid related pitfalls, including:
– Representative Staff Comments–and Our Practical Guidance
– Guidance for Your 2010 Proxy Disclosures: The Staff’s Executive Compensation Comments
– How We Got To This Point on Executive Compensation Disclosure
– Getting the Analysis Right
– Revisiting Performance Target Disclosure
– Individual Performance
– Benchmarking
Act Now: Please try a 2010 no-risk trial to have this issue rushed to you.
A while back, we conducted a study of IPO compensation and financial data that shows that over the past seven years, founder CEO equity holdings in companies going public have plunged. As a result, there is very little difference between ownership levels of founder and non-founder CEOs at the time of IPO (as noted in this WSJ article). This data came from our new IPO Pay Reporter™.
The study reveals that median founder CEO ownership at IPO fell to under three percent of total shares outstanding in 2008. This is down sharply from a high of over 10 percent in 2002. Conversely, non-founder CEO ownership has remained relatively consistent at slightly greater than one percent of total common shares outstanding at IPO.
Our analysis finds investors are returning to a more rational financial expectation of companies looking to raise public capital. This has forced a change in the financial profile and compensation strategies of IPO companies. In 2008, median company revenue, market capitalization and net income at IPO were at the highest levels since Presidio Pay Advisors began collecting IPO data in 2002.
In an effort to meet a more sustainable financial profile, companies are taking an additional two to three years to file for IPO. The most pronounced result is the dilution of founder CEO ownership; this is likely due to less favorable term sheets or additional rounds of financing required to reach IPO.
Our analysis also found that the mix between options and common stock ownership among all executives has undergone a transformation. In 2002, executive officers had a stronger link to investor success, with over 85 percent of their ownership in the form of common stock and less than 15 percent in stock options. By 2008, nearly 40 percent of executive officer ownership was stock options, which have no downside risk for executives, creating a potential disconnect between the financial interests of executives and company investors.
Other major findings include:
– Companies in 2008 awarded and reserved fewer shares for grants to employees; median stock option overhang was at its lowest level in seven years.
– Since 2005, a 24 percent rise in median CEO base salary has been offset by a 25 percent decrease in annual cash bonuses, leaving total cash compensation essentially unchanged for both founder and non-founder CEOs.