We have posted the transcript from our recent webcast: “The Latest Compensation Disclosures: A Proxy Season Post-Mortem.”
A Preliminary Postseason Report
Whew, the proxy season is over. And it’s now fair to ask: just how wild and crazy was this proxy season? Given all the coming reforms, probably not as crazy as next year’s proxy season will be – but it certainly was’t dull. You can read details about how the various proposals were supported in RiskMetrics’ new “Preliminary Postseason Report.”
Regarding one of the hottest topics, as of June 1, “say-on-pay” shareholder proposals averaged 46.7% support, representing an increase of over 5% from 2008. The 2009 figure is based on preliminary or final voting results for 50 of the 85 proposals voted so far this year. Meanwhile, RiskMetrics is tracking 18 majority votes in favor of the resolution as of June 1st, compared with 11 in all of 2008. Proposals at another five companies received between 49 and 49.9% support.
It’s Time to Weigh In: RiskMetrics Launches Annual Policy Formulation Process
Last week, RiskMetrics kicked off its annual global policy formulation process by inviting comments in its 2010 proxy voting policy survey. This year’s policy formulation process will include more outreach to investment industry groups as well as expanded outreach to the global corporate community.
Given that these comments could influence RiskMetrics’ views – and given that RiskMetrics’ views will be more important than ever given regulatory reform, say-on-pay, proxy access, etc. – you should take advantage of this opportunity. The survey period ends July 31st – and will be followed by an open comment period in October after RiskMetrics publishes its draft policies. Don’t wait for this 2nd comment period to weigh in – it’s better to influence the policies now before the train gets rolling…
With the SEC’s goal to have new executive compensation disclosure rules in place before next proxy season – combined with the real likelihood of say-on-pay legislation and the loss of broker nonvotes for director elections – our the “4th Annual Proxy Disclosure Conference” (whose pricing is combined with the “6th Annual Executive Compensation Conference”) will be more important than ever. Here is the agenda.
Early Bird Expires This Friday: These Conferences will be held at the San Francisco Hilton and via Live Nationwide Video Webcast on November 9-10th. Take advantage of reduced rates that will expire this Friday, June 26th by registering now. These rates will not be extended – there will be no early bird discounts after Friday!
Broc’s recent observation about how “lawyers have long ago given up…” is searing in its accuracy and something I’ve watched with pain over the years as an executive and lawyer. The profession itself has absolutely no insight into the phenomenon. To be balanced, however, I’d have to say that the cultural norms the profession rushed to embrace are no worse than those embraced by many other institutions in our society.
The accumulation of wealth issue is an interesting one, and here there’s an issue that’s troubling well beyond the empirical and logical infirmities of the claim that someone so rich (and, under this hypothesis, relatively unmotivated by the satisfaction of accomplishment and contribution) will somehow magically be energized by even more money he or she doesn’t need. That issue is whether such accumulations of wealth (which in financial services were widespread) were an actual contributor to the crisis in ways that went beyond the perverse incentives built into the structures that produced those payouts.
If you have in the bank more than you and your family will ever need under the most lavish of standards, does that incentivize reckless gambling (with corporate assets) to satisfy non-economic desires such as the desire to be big and command immense resources? Predating the current crisis, one thinks of the contrast between the empirical research on the consequences of acquisitions and the glee with which such transactions are pursued. In the context of the current crisis, it would seem that some of the key decisions must have been driven by a desire to be big and not lose ground (measured in size, not long-term profitability) to the competition.
I also wonder whether such accumulations create an outlook of superiority, entitlement, and invincibility that impairs objective assessment of risks, and disables the type of empathetic outlook that might otherwise have caused one to consider the possible consequences to those still dependent on our economic engines.
Keep in mind, I’m not calling for use of accumulated wealth as a marker for recklessness or bad character. I wonder, however, whether single-minded pursuit of such lavish packages by those with no rational need for them (especially where the collateral damage, such as loss of governmental or public goodwill, is foreseeably significant) should be a marker for potentially harmful proclivities. With the benefit of hindsight, the evidence in favor of that proposition is not inconsequential.
As this Reuters article pointed out, many companies have voluntarily implemented some form of clawback policies ahead of possible new laws that may mandate them. The article notes “Overall, 64.2 percent of the largest 95 publicly held companies in the Fortune 100 had disclosed clawback policies as of this year, up from 42.1 percent in 2007 and 17.6 percent in 2006, according to the study from pay research firm Equilar.”
Recently, I attended a clawbacks seminar hosted by the Institutional Investor Educational Foundation and took in a panel of of Nell Minow of The Corporate Library; Bill Patterson of CtW Investments; Jay Eisenhofer of Grant & Eisenhofer; and Steven Caponi of Blank Rome.
In addition to notes in this report, here are some worthy gems from the panel:
– Nell: “Pay is not just both a symptom of bad corporate governance and bad economic judgment, it’s also the disease. Pay that is out of whack with performance is the single most important indicator of a bad board – and my company rates boards of directors – but it’s also the single biggest risk factor that you can have in a company.”
– Bill: “Last week, Target had their annual meeting in Minneapolis and you all are aware that they were under attack by Bill Ackman of Pershing Square. The board of directors rallied to their own defense before the meeting and they visited CALPers and ISS – but once it became clear Ackman wasn’t going to win, they didn’t bother to show up – so they introduced the board with a slide show. And this is a shameful statement.”
– Jay: “Look, I think it’s very important that we keep in mind that there is a direct connection between some of the compensation abuses that we’ve seen in compensation systems as we’ve seen them and the financial problems that we have had recently. And I think it’s extremely important we draw that line clearly because it’s not just a question of companies with lax compensation policies – somehow or other are at risk of having problems because it indicates a lax attitude on the part of boards or officers. It’s much more fundamental than that.
There is study after study – by people who have absolutely no axe to grind on these issues – that have demonstrated that the way in which compensation systems are designed has a direct influence on the behavior of the officers of a corporation in terms of whether or not they are going to be more prone to manipulation of financial results, whether or not they are going to be more prone to enter into speculative transactions, whether or not they are going to enter into transactions and foster corporate behavior that encourages short-term results at the expense of long-term gains, short-term inflated results at the expense of long-term gains and that’s the academic research.”
– Steve: “There’s a big distinction between what seems like a good, reasonable compensation system at the time you set it. Most people are given their salary when they are hired, not when they quit or when they are fired versus what you do after the fact. And I think that’s really where the issue lies. You should look at these companies and say in 2004 and 2005 when individuals were making insane amounts of money for the companies, for the stockholders, for the people in this room, were they entitled to be compensated? Everyone at the time said, ‘yes.’ What they didn’t anticipate were the unanticipated consequences.
We’re all suffering from that. So, you now go back and say, ‘well, gee, like us, you didn’t understand so, therefore, you’ve got to give the money back.’ My back intuitively stiffens when someone talks about boardrooms and compensation and injustice out there somehow doesn’t seem to sit right with me. I’m not sure why. It’s not supposed to be a squishy thing. It is supposed to be more metric.”
Needless to say, I disagreed with what Steve said here. Most compensation arrangements for senior managers today are fluid or squishy – meaning that the ultimate amounts paid are not known until well after certain barriers are cleared. For the payouts related to options, it may be as long as ten years from the date of grant that the ultimate value is known. So the idea that there might be adjustments to pay later on is not a foreign concept.
And even if that concept wasn’t already mainstream, I didn’t find his arguments against adjustments persuasive. If a company allegedly hits certain performance targets that trigger a payout – but then it’s found that the company really didn’t hit those targets, I never heard a valid justification for why an executive should get to keep the money. It certainly doesn’t seem right from a fairness perspective. And allowing executives to keep money under these circumstances would certainly seem to incentivize them to ensure they “met” targets – even when they didn’t…
At the end of May, the SEC Staff surprised the corporate community with a new interpretation – in the form of CDI 120.05 – that entirely changes how the “Grants of Plan-Based Awards Table” is to show the Grant Date Fair Value of performance plan share plans in column (l). As we explain in this memo, we think the SEC’s action is misguided – and we hope it can be reconsidered in light of the anticipated broader review of disclosure that SEC Chair Shapiro has planned. Let us know what you think.
Recently, I blogged about five reasons why I thought annual ratification of compensation consultants was a bad idea. I must have been persuasive because my anonymous poll in that blog resulted in 90.6% agreeing with me – while 6.3% said it was a good idea (with 3.1% unsure). Bear in mind that most consultants read this blog so there could be some bias.
I also received a lot of member feedback via email, all of them agreeing with me in one form or another. Here is one that I thought was particularly persuasive:
“I absolutely agree with your notion that this is a bad idea. In fact, it could backfire and result in the kind of entrenched relationships and stale program design that the proposers are likely trying to undo. My sense is that companies are fairly reluctant to switch auditing firms in part because they worry about the potential questions it raises for shareholders over what “disagreements” might have existed.
Would we really want compensation committees to feel the same kind of reluctance? While there would certainly be some professional advantages to having more “sticky” client relationships, knowing that our clients have relatively low “switching costs” helps keep us all on our toes – which is a good thing for our clients and the state of the industry.”
Wednesday marked a significant day in the ongoing involvement of the US government in executive compensation, as Treasury Secretary Geithner outlined a series of broad-based principles that companies – particularly financial institutions – should consider in connection with the design and implementation of their executive compensation programs. Secretary Geithner’s statements followed a meeting involving SEC Chairman Schapiro, Federal Reserve Governor Dan Tarullo and several compensation experts. We have begun posting memos regarding this development in a new “Treasury Guidance” Practice Area.
The principles that Secretary Geithner outlined should come as no surprise to those who have been reading our publications over the last several years. The principles draw on best practices that we have seen developing in the marketplace over time, and for the most part can be universally applied. (Nothing in Geithner’s comments seemed to indicate that the guidance was limited strictly to financial institutions, but banks will see these standards in more concrete terms as they are worked into the supervisory process of bank regulators.)
Here are the principles:
1. Compensation plans should properly measure and reward performance – Incentive compensation plans should be tied to performance in the sense of long-term value creation, which could be accomplished by using a wide range of internal and external metrics (and not just the company’s stock price), including metrics that distinguish the company’s performance from its peers.
2. Compensation should be structured to account for the time horizon of risk – Continuing the theme of aligning pay with long-term value creation, the principles encourage conditioning compensation on longer-term performance and thereby obviating the need for specific clawbacks, while encouraging the holding of equity awards for longer periods.
3. Compensation practices should be aligned with sound risk management – As we have heard repeatedly since the financial crisis, compensation committees are encouraged to conduct and publish risk assessments of compensation plans in order to “ensure that they do not encourage imprudent risk taking.”
4. Golden parachutes and supplemental retirement packages should be reevaluated – Companies should reexamine the extent to which golden parachutes and supplemental retirement packages are aligned with shareholder interests, whether they incentive performance and whether they result in value to executives even when shareholders lose value.
5. Promotion of transparency and accountability in the compensation-setting process – Citing the lack of independence of compensation committees and the lack of clarity in disclosures (including the lack of a true “walkaway” number for top executives), two legislative initiatives are proposed.
The first legislative initiative outlined yesterday is a push for an advisory vote on executive compensation, which goes beyond the previously introduced legislation and the pending Shareholder Bill of Rights, in that it would require a vote on executive compensation as disclosed in the proxy statement (including the CD&A and the compensation tables) and a vote targeting the compensation reported for each of the named executive officers. Similar to the prior proposals, a non-binding vote on golden parachutes would also be required in merger proxies.
The second legislative initiative coming out of the announcement is a new framework for compensation committees that would be analogous to the audit committee provisions of the Sarbanes-Oxley Act. Under SEC-mandated listing standards, the compensation committee members would be subject to the higher independence standards applicable to audit committee members, the compensation committee would get resources to hire and oversee its own advisors and independence standards would be prescribed for outside compensations consultants and outside counsel. This initiative comes as somewhat of a surprise to me, because while compensation consultant conflicts have been a concern, I have not heard much in the post-Sarbanes-Oxley era about concerns that compensation committees lack sufficient independence.
Chairman Schapiro also released a statement on Wednesday, reiterating the rulemaking efforts under consideration on executive pay and corporate governance. Proposals are expected on these in the next several weeks. Not to be outdone, Congressman Barney Frank issued a statement, generally supporting Secretary Geithner’s principles (except for the compensation committee proposal), but also indicating that Congress should go further and “adopt legislation that mandates that the SEC adopt appropriate rules that embody these principles.”
Treasury Issues Much-Anticipated Rules Implementing TARP Exec Comp Restrictions
We also saw the Treasury announce that it had finally published interim final rules implementing the executive compensation provisions from the Recovery Act. The lack of guidance had created difficulties for financial institutions participating in the TARP program, since they were not sure what to do with their compensation programs in the absence of greater clarity in how the legislation was to be applied.
The rules implement and expand on the Recovery Act provisions. Some new provisions that go beyond the statutory requirements include:
– Prohibiting tax gross-ups to senior executive officers and the 20 next most highly compensated employees;
– Requiring additional disclosure of perquisites in excess of $25,000 for employees subject to the bonus restrictions, including a narrative description of, and justification for, the perquisites.
– Requiring a disclosure of the use of compensation consultants, including a discussion of any non-compensation services performed and the use of “benchmarking” procedures.
Is it just me or is it kind of weird that the Treasury is now setting executive compensation disclosure standards for the proxy statement?
In considering an option repricing program, a significant factor for companies to weigh is the advisory services’ positions on repricing, as their support is usually necessary to win shareholder approval. RiskMetrics’s general view is that option repricing is never a good practice. Repricing weakens—and if done on a serial basis, destroys—the incentives that make up the foundation of a stock option program. However, RMG has taken a case-by-case approach in determining whether to support repricings and considers six factors in making its decision (the first two are the most important):
– Value neutrality – is the exchange value-for-value?
– Participation – are executive officers and directors included?
– Rationale – was the sustained stock price decline beyond management’s control?
– Timing – why is the company choosing to conduct a repricing at this particular time?
– Term and vesting of surrendered options – what is the duration, exercise price, and vesting of replacement awards?
– Disposition of cancelled option shares – will cancelled options shares be available for future issuance under the company’s plan(s)?
While these factors create a high burden, there is evidence that RMG does support repricing programs when warranted. For example, in determining whether to support Cardinal Health’s repricing proposal, RMG noted in their report that the program excludes NEOs and directors from participating and that the exchange was value-for-value. Additionally, because the proposed program would recycle surrendered shares by returning them to the pool, RMG conducted a burn-rate analysis and shareholder value transfer analysis on the potential cost of all plans and found the results to be better than industry averages. As a result, RMG considered the repricing program to be “reasonably structured” and recommended a “For” vote. The Special Meeting will be held June 23rd.
For more on repricings, see our “Stock Options” Practice Area. Also note that Panel 7.1 of the “17th Annual NASPP Conference” is a special Double Session entitled “How to Implement Responsible Option Exchange Programs AND Effectively Administering an Option Exchange Program ” devoted to this topic and the panel includes RiskMetrics’ Pat McGurn. Should be a good one…
Tune into our CompensationStandards.com webcast tomorrow – “The Latest Compensation Disclosures: A Proxy Season Post-Mortem” – to hear Dave Lynn, Mark Borges and Ron Mueller analyze how the executive compensation disclosures looked during this proxy season.
In his “Proxy Disclosure Blog” last night, Mark does a great job of summarizing the recent news that Treasury may finally be issuing its executive compensation guidance this week – and that it may apply to all financial institutions, not just TARP participants. Mark also raises some good questions, such as whether the new “pay czar” will be responsible for interpreting ARRA guidance or whether it will be Treasury or someone else. Chaos reigns supreme.
Coming Soon: SEC’s New Executive Compensation Rules
As noted in this WSJ article, the SEC intends to roll out new proposals to change its executive compensation disclosure rules sometime in early July. Mark Borges did a great job of recapping what the proposals will likely look like in his blog.
With the SEC’s goal to have its rule changes effective before next proxy season – combined with the real likelihood of say-on-pay legislation and the loss of broker nonvotes for director elections – our the “4th Annual Proxy Disclosure Conference” (whose pricing is combined with the “6th Annual Executive Compensation Conference”) will be more important than ever.
These Conferences will be held at the San Francisco Hilton and via Live Nationwide Video Webcast on November 9-10th; here is the agenda. And many also attend the NASPP Annual Conference that follows directly thereafter – the full Conference program was justed posted. Take advantage of reduced rates that will expire on June 26th by registering now.
Following up on this blog, the real problem when dealing with performance metrics is the accounting system/GAAP; that is mostly what Fred Whittlesey wrote about. GAAP has left its original roots (i.e. cost accounting) – and is now being used as single comprehensive measure of a business. That goal mostly is a fantasy and so the “books” are largely fiction.
Financial statements should measure only things that can be accurately measured, like cash in and cash out, and other aspects of the disclosure system should address other less precise issues.