During the first U.S. proxy season with widespread advisory votes on compensation, there was broad investor support for corporate pay practices. For the 127 companies for which RiskMetrics Group has results, an average of 87.9% of votes were cast in support of management “say on pay” proposals this year. So far this year, every management proposal has passed; the lowest vote was 59% support at the Bank of the Ozarks. Nine other companies received less than 70% approval. (Editor’s note: This data doesn’t include vote results from small-cap firms below the Russell 3,000.)
Most of the advisory votes were held at the several hundred financial companies required by federal law to hold compensation votes because they received support from the Treasury Department’s Troubled Asset Relief Program (TARP). In addition, 17 non-TARP firms likely will conduct voluntary pay votes this year. However, the House of Representatives has passed legislation to impose marketwide annual votes on pay, so this year’s results may shed light on what might happen in the future.
Several TARP companies, including Flagstar Bancorp, Home BancShares, and Bank of Kentucky Financial, received support from over 98% of votes cast. Notwithstanding the public outcry over the company’s bonuses, American International Group’s pay practices received 98.2% support, but that result was inflated by the U.S. government’s almost 80% voting stake.
Most major financial firms received wide support for their pay practices. Goldman Sachs, JPMorgan Chase, Wells Fargo, Bank of New York-Mellon, and Morgan Stanley all received more than 93% approval. The two notable exceptions were Citigroup (84.2 percent support) and Bank of America (71.3 %). While Citi’s pay practices didn’t spark significant investor complaints this year, the American Federation of State, County, and Municipal Employees (AFSCME) waged a “vote no” campaign against six long-serving audit committee members, and the company posted a 76% share loss during the preceding fiscal year.
At Bank of America, there were two “vote no” campaigns against board members; both dissident groups complained that the company failed to provide adequate disclosure over more than $3 billion in bonuses for Merrill Lynch employees before investors voted in December to acquire the ailing brokerage firm. At the same time, the advisory vote at Bank of America received little attention from investors or the news media, which focused on an independent chair proposal, which won majority support, and the “vote no” campaigns. The company’s ballot also included a shareholder proposal seeking a permanent advisory vote; that resolution received 40.1% support.
Implications
Supporters and opponents of annual pay votes draw different conclusions from this year’s vote results. Ed Durkin, corporate governance director at the United Brotherhood of Carpenters, who has called for multi-part votes every three years instead of annual votes, said the TARP results “reinforce our belief that annual votes would be a mindless process.”
“It is a process that does not allow for thoughtful analysis and voting,” Durkin said of annual votes. “It is going to turn into a ratification process,” particularly if votes are held at an even larger number of companies, he told R&GW.
Annual vote proponents respond by pointing out that this year’s support levels were inflated by the inclusion of uninstructed “broker” votes in vote tallies at many firms. Unlike shareholder votes on equity plans, advisory votes have been deemed a “routine” matter, and thus brokers are permitted by New York Stock Exchange rules to cast uninstructed client votes in support of the management proposals. At many companies, broker votes can account for more than 15% of the votes.
AFSCME’s Richard Ferlauto, an annual vote proponent, also pointed out that many activist investors were more focused this year on submitting shareholder proposals to establish advisory votes. Another significant factor was that institutional investors did not learn of the mandatory TARP votes until late February after U.S. Senator Christopher Dodd inserted that requirement in economic stimulus legislation and prodded the SEC to require advisory votes during the 2009 proxy season. “The vote legislation was enacted late so many investors did not have voting guidelines in place,” Ferlauto said.
Tim Smith of Walden Asset Management, another prominent advocate of annual “say on pay” votes, said investors will have more lead time next year to dissect pay packages. He attributed this year’s generally high TARP votes to the fact that many financial firms “cut back pay dramatically” during the economic crisis. He also observed that significant “against” votes will be rare, as most companies should receive overwhelming support during advisory votes when there are no “red flags” over their pay practices.
Recalling the experience of the United Kingdom and other markets, Ferlauto said: “It will take some time for shareholders to figure out how to use this new tool.”
In Britain, advisory votes have been held since 2003, but remuneration report rejections were quite rare until this year, when reports were voted down at Royal Bank of Scotland, Royal Dutch Shell, and three other firms. In Australia, many companies have improved their pay practices since advisory votes were first held in 2005, so the average opposition vote (which include abstentions) at S&P/ASX 200 companies has increased slightly from 10.6% to 12.9%, according to RiskMetrics data. At the same time, investors have become more willing to reject reports in cases of excessive pay practices. The first majority “against” vote at an S&P/ASX 200 firm didn’t occur until 2007, while eight reports were rejected during Australia’s most recent proxy season in late 2008.
Possible Reasons for Low Votes
During this year’s U.S. proxy season, investors also expressed significant reservations over the compensation practices at two TARP firms, MB Financial (60.8% support) and Berkshire Hills Bancorp (61.6%), as well as Motorola (63.8% approval), which held its first voluntary pay vote this year.
At Arkansas-based Bank of the Ozarks, where there was just 59% support, the company increased the CEO’s salary during the most recent fiscal year, offered discretionary bonuses to executives, and paid for an executive assistant who performed personal duties for the CEO and his wife.
At Massachusetts-based Berkshire, the board lowered the performance thresholds in December 2008, which triggered bonus payouts for the named executive officers in January. Another potential concern for investors is that the company uses a one-year performance period and adjusted earnings per share for both its short-term and long-term incentive programs.
At Chicago-based MB Financial, the CEO’s employment agreement, which was revised in 2008, provides for automatic vesting of equity and supplemental retirement credits upon a change in control. The CEO also is entitled to up to 10 years of guaranteed retirement contributions (at 20% of salary). The company also agreed to provide tax gross-ups to executives for their change-in-control payments.
Illinois-based Motorola, which plans to split into two public companies, now has two co-CEOs after recruiting Sanjay Jha to join the firm. Both executives have been granted various perks, including personal use of the company aircraft, with the company paying the taxes on the perks. The 2008 employment contracts with Jha and co-CEO Gregory Brown provide for compensation in excess of 3,257 percent and 401 percent, respectively, of the company’s peer group median.
Last week, I blogged about US District Court Judge Jed Rakoff’s refusal – with a stinging rebuke to both the SEC and Bank of America – to approve a $33 million settlement between the SEC and BofA over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed. I noted how the SEC had limited options because it argued before Rakoff that that there was insufficient evidence to charge individuals – and that the SEC’s best bet may be to dismiss the case and file an administrative claim that wouldn’t be heard in federal court.
Well, what do I know. Yesterday, the SEC filed a case management plan in Rakoff’s court and issued a statement that it would proceed “vigorously” to pursue its case against Bank of America, including:
“As we alleged in our complaint last month, Bank of America did not provide investors with complete and accurate information about the bonuses to be paid by Merrill Lynch to employees. We believe that this disclosure failure violated the federal securities laws.
We firmly believe that the settlement we submitted to the court was reasonable, appropriate and in the public interest. As we consider our legal options with respect to the court’s ruling, we will vigorously pursue our charges against Bank of America and take steps to prove our case in court. We will use the additional discovery available in the litigation to further pursue the facts and determine whether to seek the court’s permission to bring additional charges in this case.
In deciding how to proceed, we will, as always, be guided by what the facts warrant and the law permits.”
As part of it’s announcement, as noted in this Washington Post article, the SEC intends to broaden its investigation into alleged wrongdoing at the company and may seek additional charges as it prepares for the trial…
Late Friday, Microsoft announced that its board authorized moving forward with a triennial say on pay approach starting with this year’s meeting, being held on November 19th. On the “Microsoft on the Issues” Blog, the company’s General Counsel and Deputy General Counsel provide more background on the issue and details of the plan adopted.
You may recall that the Carpenters Union had been pushing this triennial alternative (as noted in this blog) – but that it had more recently withdrawn the proposals it had submitted to 20 companies on the topic in the wake of the House considering but rejecting the idea when it passed a say-on-pay bill in early August. Maybe Microsoft’s action will provide some momentum towards the idea, although it could be too late as the Senate plans to consider a bill in the coming months…
Yesterday, pay czar Ken Feinberg spoke at a FDIC conference on executive compensation here in DC (this Reuters’ article reports he has 8 speaking gigs before his end of October deadline) and, according to this BNET article, he said he would issue his blueprint for the top 25 employees at financial institutions receiving TARP funds within the next 30 days.
Here is a notable excerpt from the article:
Feinberg suggested the rules he lays out for these companies should serve as a precedent for the entire financial industry, said Jaret Seiberg, a policy analyst with Concept Capital’s Washington Research Group who attended the event. But how broadly the rules are applied is up to officials with the Federal Reserve and SEC, Feinberg noted.
A Light-Hearted Look at Harvard
Harvard has become well-known for its “Corporate Governance Blog,” founded by outspoken pay critic, Professor Lucian Bebchuk (the blog mostly has devolved into law firms posting the text of their firm memos unfortunately). That’s why I had a light-hearted Friday chuckle when a friend forwarded something called “The Daily Stat” which provides stats regarding “Which CEOs Took a Base Pay Cut?”
The stats only consider base salaries. Anyone remotely familiar with the topic of executive compensation recognizes that base salary is just a drop in the bucket of an executive’s pay package and that’s been the case for a few decades. Incentive compensation dwarfs salaries – and even bonuses, retirement pay or even perks can exceed salary amounts. Just so much misinformation out there about exec pay…
Now that we have seen the SEC’s proposals and Congress’ say-on-pay legislation – that will force you to radically change your executive compensation disclosures and practices before next proxy season – we are wrapping up the ’10 version of Lynn, Borges & Romanek’s “Executive Compensation Disclosure Treatise and Reporting Guide,” which we will deliver to subscribers in early October.
Act Now for $100 (Or More) Discount: To obtain this hard-copy ’10 Treatise when its printed in October (as well as get online access to the ’09 version right now on CompensationDisclosure.com, as well as the valuable quarterly “Proxy Disclosure Updates”), you need to try a no-risk trial to the Lynn, Borges & Romanek’s “Executive Compensation Service” now.
If you order by October 1st, you can take advantage of a $100 or more discount. The many of you that currently subscribe can renew by October 1st to also receive this discount. Get the new Treatise hot off the press when it comes out in a few weeks!
– Jim Reda and David Schmidt, James F. Reda & Associates
There have been substantial changes reported by companies in their 2009 proxy statements following an unprecedented drop in stock prices. In our recent study of 200 of the largest companies (by market capitalization) that comprise the S&P 500 Stock Index we reviewed “forward looking” statements with regard to changes in 2009.
Surprisingly, 70 percent of companies reported changes to their 2009 executive compensation programs. These range from “minor changes” relating to salaries to “major changes” relating to short and long-term incentive programs. We also reviewed changes to severance, retirement and perquisites programs. In our study, we reviewed each proxy statement for a description of prospective changes for 2009 in response to the economic downturn and increased shareholder scrutiny.
Executive compensation program changes reported for 2009 appear to be primarily related to the stock price drop from December 31, 2007 to February 28, 2009. The greater the drop in stock price, the more likely it is that a company reported a change to their program. This relationship also applies to each element of compensation.
To assist in our study, we categorized changes as “minor” or “major”. Minor changes are related to adverse salary changes. Major changes primarily relate to short- and long-term incentive plans, but we have also included changes to severance, retirement and perquisite programs in this category as well.
In general, incentive plans have changed as follows:
– A shift away from long-term incentives to include more focus on short-term incentive plans;
– Short-term incentive (“STI”) plan performance measures shifted to profit and cash flow from capital efficiency and non-financial performance goals;
– Long-term incentive plan performance measures shifted to capital efficiency, cash flow and total shareholder return; and
– Companies are increasing their emphasis on time-vested restricted stock (“RS”) and restricted stock units (“RSUs”).
Specifically, a substantial majority (70 percent) of companies that filed proxy statements disclosed changes to their executive compensation programs effective in 2009 that will impact pay levels reported in next year’s proxy. Highlights of the changes are as follows:
– Base Salary: Eliminated merit increases for 2009 (43 percent) and froze or reduced base salaries for 2009 (13 percent);
– Short Term Incentives: Adjusted short-term incentive program (e.g., move to discretionary plans, changes to Pay for Performance Curve- the relationship between threshold, target or maximum performance levels and the corresponding threshold, target or maximum payout levels).
– Long Term Incentives: Adjusted long-term incentive grants (e.g., awarding the same number of shares regardless of value, decreasing the value of awards, changing the mix of award types, and changes to Pay for Performance Curve) (39 percent); and
– Other Elements of Compensation: Changed various other elements of compensation (e.g., modifying change-in-control (“CIC”) benefits, eliminating tax gross-ups on perquisites, reducing retirement benefits) (15 percent). Modified CEO’s change-in-control benefits (e.g., reducing the severance multiple) (4 percent).
In summary, our findings show:
(i) Greater focus on short-term cash flow results which is counter to the direction suggested by the U.S. Treasury, academics and other expert advisers regarding ways to mitigate risk, which is to encourage a long-term perspective by subjecting more compensation to stock price risk; and
(ii) More reliance on restricted stock and restricted stock units which is not performance-based as it vests simply with the passage of time.
We suggest that companies consider:
(a) Rebalancing their short- and long-term incentive target opportunity levels which may result in (x) a reduction of STI levels, or (y) a combination of reduction of STI levels and a slight increase in LTI levels;
(b) Change the LTI mix away from restricted stock (or units) to a more performance-based award program; and
(c) Revise the pay for performance curves for both short- and long-term incentive plans by reducing maximum payout levels.
These changes collectively will better align corporate risk, corporate performance and executive pay.
Yesterday, in a sternly-worded 12-page order, US District Court Judge Jed Rakoff’s refused to approve a $33 million settlement between the SEC and Bank of America over allegations of misleading proxy materials because the bonus obligations due to Merrill Lynch employees were not fully disclosed. As this Bloomberg article notes, even though a February 1st trial is scheduled, the SEC has limited options now because it argued before Rakoff that that there was insufficient evidence to charge individuals. The SEC’s best bet may be to dismiss the case and file an administrative claim that wouldn’t be heard in federal court.
The following excerpt from this NY Times article gives you a sense of how Judge Rakoff felt about the settlement:
He accused the S.E.C. of failing in its role as Wall Street’s top cop by going too easy on one of the biggest banks it regulates. And he accused executives of the Bank of America of failing to take responsibility for actions that blindsided its shareholders and the taxpayers who bailed out the bank at the height of the crisis.
The sharply worded ruling, which invoked justice and morality, seemed to speak not only to the controversial deal, but also to the anger across the nation over the excesses that led to the financial crisis, and the lax regulation in Washington that permitted those excesses to flourish.
Implicit in the judge’s remarks were broader questions on the anniversary of one of the most tumultuous weeks in Wall Street’s history: What do the giants of finance owe their shareholders and the investing public? And who will adequately oversee these behemoths?
As the drama of this case continues to unfold, Bank of America awaits the findings of NY Attorney General Andrew Cuomo as some expect him to file a complaint charging individuals at Bank of America in connection with the disclosure of Merrill Lynch bonuses in the near future.
Obama Speaks on Lehman’s Collapse Anniversary: Latest Timetable for Congressional Reform
Yesterday, President Obama was also stern as he delivered a speech near Wall Street in which he talked about the need for financial reform. As noted in this NY Times article, the window for true reform is quickly closing as the stock market climbs every day. Below is an excerpt from that article about the possible timeline for Congress taking legislative action:
Senior Congressional Democrats had originally planned to have the House complete its work on the financial overhaul before turning to the more recalcitrant Senate. But the tighter time schedule has forced lawmakers to rethink that approach.
Later this week, Barney Frank, Democrat of Massachusetts and the chairman of the House Financial Services Committee, is expected to announce a series of hearings for the coming days before his committee marks up legislation in October. Aides say he is hoping to get legislation to the floor by the end of next month or beginning of November.
There is less certainty in the Senate, where Christopher J. Dodd, Democrat of Connecticut and the chairman of the Senate Banking Committee, has been working to put together a package that could withstand the threat of a filibuster.
In the furious activity over the past few days, it’s easy to understand why many in Congress have demanded new measures for restraints on executive pay. The measures would give regulators the authority to prohibit “inappropriate” or “risky” compensation practices for banks or other regulated financial institutions. From a perception standpoint, this opens the door for overall government regulation of executive compensation.
Representative Spencer Bachus III (R – Alabama) stated that “doing something about executive compensation would be very popular with the American people”. No surprise here – in the eyes of the American public, many of the same executives whose compensation is to be “restrained”, are those currently leading the effort to get the diversified financial industry sector back on its feet, and, in their eyes, are the very same “masters of the universe” whose greed and myopia brought the sector, and, subsequently our country, to its knees in the first place.
Nonetheless, the decision of Congress last week to impose some form of still unspecified executive pay limits, is a mistake.
At this very moment, it’s a valiant struggle for many of you to keep a straight face when reading the words “talent”, “banking”, “auto industry”, and “Wall Street” in the same sentence. And yet, precisely because Wall Street, banking, automobile manufacturing, and many other industry sectors are currently a trainwreck, Corporate America will desperately need scores of simply brilliant, hard working executives and key employees, if it is to return to a state of financial health that benefits the rest of the economy.
The sort of sums that would satisfy Congress as “executive pay caps” may be far above the income levels of average Americans, but if artificial caps are put into place, there will be no surer way of driving American industry sectors offshore, or into other forms of private ownership where they will be beyond the gaze of regulators. Besides, if ever there was a time when executive pay in financial services, maufacturing, and in general industry overall is likely to be depressed by the market, it is now. The past financial bubble didn’t only inflate asset and stock prices, but, as a result of often flawed executive pay plan design that was largely equity-based, it also inflated pay. Now that bubble has burst in an unprecedented and ugly way, and millions of people want work.
As in the past, U.S. politicians have a lamentable record of intervening in setting executive pay. Too soon we forget that in the early years of the Clinton administration, Congress imposed IRS 162(m), a salary cap of $1 million, beyond which companies faced a tax penalty for any pay above the cap that wasn’t “performance-based”.
Executive pay rose as CEOs beneath the cap, realized that they might be “underpaid”, and another set of executives gained from an outpouring of creativity, as companies, with a great deal of help from (mea culpa) executive pay consultants invented myriad types of short- and long-term incentive plans get around the limit. This not only complicated an already confusing situation, it also made it harder for shareholders to know who was getting what, when, and most importantly, why.
If the “deja vu all over again” foolishness of Congress trying to set and regulate executive pay levels is an old lesson, the financial crisis is teaching some new lessons to shareholders. Forget the conventional wisdom that paying executives large grants of stock options or restricted stock in their own companies ensures “skin in the game”, thus driving sensible risk-taking and maximum shareholder value decision-making. In the collapses of Lehman Brothers and Bear Stearns, senior management didn’t just take reckless gambles with other people’s money. Dick Fuld and Jimmy Cayne took reckless gambles with their own, still failed to do the right things, consequently ended up losing everyone’s money, as well as most of their own fortunes. Public company shareholders, institutional investors, and watchdogs should remember that loading up top executives with shares can certainly be an aid to corporate governance, but not a substitute for it.
For executives and employees alike, the tales of Lehman Brothers, Washington Mutual, Merrill-Lynch, AIG, Countrywide, and other catastrophic corporate failures, especially after meltdowns of the past like Enron, Tyco, Global Crossing, the whole “.com bust”, etc., is a reminder of the danger of having too much capital tied up in the company where you work. Additionally, it clearly magnifies the need for a “balanced portfolio” of well designed executive pay vehicles that are both operationally and market driven. Many more truly talented executives and key employees will now demand their short- and long-term incentives in cash, and, perhaps ask for even more shares. That surely will have an effect on the way that companies recruit key employees and on equity-based executive pay in general. And, hopefully, the concept that forcing significant equity-based stakes on executives in their own companies as a means to stop bad decision making has finally been put to rest.
A strong message to Congress – the design and payout structure of executive pay programs is far more important than the amount — especially in troubled industry sectors. For Wall Street and banking, and financial services industry executives, foolish short-term risk-taking could be discouraged by matching the timing and payout of executive compensation to the achievement of performance metrics for the companies and portfolios they are responsible for. And, if we’re going to collect “bailout capital” from the taxpayers, we ought to insure that there is adequate return on invested capital to them, as well as any of our stakeholders, and link those successes directly to executive pay – without guarantees of wealth in spite of failure at the detriment of both employees and shareholders.
Congress can certainly ask that financial institutions, or any other business that has accepted bailout funding, to put up more capital if their executive pay structures appear to be dangerously risky. They have to be able to fund bonuses like any other business. That makes far more sense than “capping” executive pay.
In the end, companies, their Boards of Directors, and their shareholders are far better at setting executive pay than government bureaucrats will ever be. There will never be adequate fixes to executive pay in any industry sector – public or private – as long as there are guaranteed “Golden Parachutes”, or any other risk-free contractual provisions that allow executives to bail out of a failing company while both employees and shareholders go down with the ship.
Candidly, what has created the highest degree of recent outrage in executive pay has been the captains of those sinking ships paddling away in their own comfortable lifeboats and thumbing their noses as their employees and shareholders went under.
Recently, Ed Durkin of the United Brotherhood of Carpenters reported that it has withdrawn its proposals for an alternative “triennial” say-on-pay process (the concept is explained in this blog), with the following explanation:
We made a decision that the best course of action to take was to withdraw the triennial pay vote proposal from the companies to which it was submitted. On balance, we felt that it would not be constructive to call the vote on the issue at this subset of companies in light of the status of the legislative process. We had good discussions about the pay vote issue and executive compensation generally with most of the companies, and a number of them offered to lend their voice to the effort to legislatively establish a triennial vote as outlined in the proposal. The Union is continuing to advocate for a triennial vote in Congress, with the recent TARP company say-on-pay votes providing solid evidence of the shortcomings of the say-on-pay vote formulation in HR 3269 (annual vote, vote on overall plan only, applied to all publicly-traded companies).
Following a trend commenced last year by Schering-Plough, industry rivals Lockheed Martin and Northrop Grumman recently posted shareholder surveys regarding executive pay on their websites. The principal idea behind these surveys is to provide a better avenue than say-on-pay for shareholders to weigh in on compensation (egs. shareholders can provide specific comments and the questions are more narrowly focused).
You may recall that I recently conducted a podcast with Susan Wolf of Schering-Plough regarding how the experience worked out for them this past proxy season. Schering-Plough intends to announce the results of its survey sometime during the next few months. Amgen also canvassed shareholders this past proxy season. We have compiled all these surveys in our “Say-on-Pay” Practice Area.
A Comparison of the Surveys
1. Posting Surveys Online – The two newest surveys are posted online – but Schering-Plough mailed their survey as part of their proxy materials (as noted in this press release). Amgen also posted its survey online. It will be interesting to see whether posting surveys increases – or decreases – shareholder participation. My guess is “increase” – but you never know (for example, note how e-proxy has resulted in a decrease in retail votes).
2. Evaluation of CD&A Transparency – To some degree, all of the surveys piggyback on TIAA-CREF’s list of ten questions for evaluating CD&As that was released back in August ’07 (in fact, Amgen’s survey is identical to TIAA-CREF’s survey). All of the surveys ask whether shareholders found their CD&As clear and useful and allow for five types of answers.
3. Tying Pay to Performance – The surveys ask whether shareholders think pay is tied to performance in slightly different ways. Lockheed Martin’s survey asks whether its executive pay as disclosed ties pay to performance and is aligned with shareholder value. Northrop Grumman’s survey asks whether its compensation play is aligned with the long-term creation of shareholder value. Schering-Plough asks whether its executive pay program is tied to performance and then also drills down with questions about specific performance metrics.
4. Does Pay Matter? – Northrop Grumman asks two interesting questions that the others do not: whether the shareholder analyzed the company’s pay policies and practices before becoming a shareholder and whether the company’s compensation plan was a material consideration in becoming a shareholder.
5. Retention and Mix of Equity – Schering-Plough was the only company to ask whether shareholders thought that the company’s pay plan allows it to attract and retain well-qualified executives, as well as ask questions about the mix of equity in both its executive’s and director’s pay.
6. Whether Shareholders Support Pay – Both of the newest surveys – Lockheed Martin and Northrop Grumman – cut to the chase and ask the $64,000 question: whether shareholders support the company’s compensation plan as described in the CD&A.
7. Additional Comments – All of the surveys allow for shareholders to submit their own comments, a smart move since the use of multiple choice answers can be limiting. Amgen’s survey doesn’t even provide an opportunity to select from a multiple choice menu – each question has a text box below it. I think providing multiple choice selections will increase the likelihood of obtaining more responses – as some potential respondents may be daunted by the burden of spending too much time on a survey.
Note that Northrop Grumman decided to also use its survey to solicit feedback on two non-compensation related matters: allowing shareholders to call a special meeting on any issue and if so, what minimum percentage of shares should be the threshold to do so.