As Mark Borges blogged, Goldman Sachs announced last Thursday that its board had decided to implement a say-on-pay advisory vote starting next year (the first U.S. banking institution to so so) and eliminate cash bonuses fro the top 30 executives (and use clawbacks on the shares given as bonuses, which must be held five years).
This announcement was made before yesterday’s stern warning from President Obama to the banking industry’s fat cats, some of whom couldn’t attend the meeting due to fog. This skeptical skit is pretty funny.
Below are some thoughts on Goldman’s pay plan from RiskMetrics’ Ted Allen:
After negotiations with investors, Goldman Sachs Group has agreed to hold an annual advisory vote on executive compensation in 2010 and adopt bonus-deferral provisions.
Under the new policies announced Dec. 10, the financial company’s 30-person management committee will receive all of their discretionary compensation in the form of “shares at risk” that may not be sold for five years. Those shares would be an “enhanced” clawback policy in the event that “an employee engaged in materially improper risk analysis or failed sufficiently to raise concerns about risks.” In a press release, the company said the new policy “is intended to ensure that our employees are accountable for the future impact of their decisions, to reinforce the importance of risk controls to the firm and to make clear that our compensation practices do not reward taking excessive risk.”
“The measures that we are announcing today reflect the compensation principles that we articulated at our shareholders’ meeting in May. We believe our compensation policies are the strongest in our industry and ensure that compensation accurately reflects the firm’s performance and incentivizes behavior that is in the public’s and our shareholders’ best interests,” CEO Lloyd C. Blankfein said in the press release. “In addition, by subjecting our compensation principles and executive compensation to a shareholder advisory vote, we are further strengthening our dialogue with shareholders on the important issue of compensation.”
In response to Goldman’s decision, Walden Asset Management and Connecticut’s state pension fund plan to withdraw the “say on pay” proposal they filed for the company’s 2010 meeting. In 2008, a Walden-Connecticut advisory vote proposal received 45.5 percent support at Goldman.
“As Congress considers whether to require all public companies to have an annual shareholder advisory vote on executive compensation, Goldman Sachs’ action today is a tremendous step that demonstrates its support of this important corporate governance reform,” Connecticut State Treasurer Denise Nappier said in a Dec. 10 press release.
The Goldman press release did not specify the frequency of the advisory vote after 2010. That issue may become moot; proponents expect that Congress will pass legislation soon that would require marketwide annual votes starting in 2011.
Goldman received 97.9 percent support for its pay practices this past May when it held an advisory vote that was required for all companies participating in the U.S. government’s Troubled Asset Relief Program (TARP). After exiting TARP, Goldman was criticized by investors over its plan to pay more than $20 billion in year-end bonuses. A coalition of religious investors filed a pay disparity proposal at the firm in October.
Goldman is the first U.S.-based banking company to agree to hold an advisory vote, and the firm appears to be the first to adopt a bonus-deferral policy. Swiss banks UBS and Credit Suisse previously adopted deferral provisions, and French bankers agreed in late August to do so. In late September, Britain’s five largest financial firms endorsed the Group of 20’s principles on compensation, which call for deferring at least 40 percent of variable pay and a deferral period of at least three years.
In addition to Goldman Sachs, at least 31 U.S. firms have agreed to conduct voluntary shareholder votes on compensation, according to RiskMetrics Group data.
On Friday, the House of Representatives – by a vote of 223-202 – passed the “Wall Street Reform and Consumer Protection Act of 2009” (it appears that this will be referred to as the “Wall Street Reform Bill”). As I’ve blogged, this bill consolidates and revises numerous reform bills that have been introduced in the House this Fall (eg. Title I contains what was the Financial Stability and Improvement Act of 2009). As of the start of last week, there were 238 amendments offered to this bill. As noted on page 2 of this House “highlights,” the bill includes a mandatory say-on-pay provision as well as a provision requiring a vote on golden parachutes.
I’m not convinced I’ve seen a final copy of the bill actually passed since so many amendments were at play. I believe its changed since this version that was floated heading into last week – but that old version is what is linked to from this press release announcing the passage of the bill. [I’ll blog if a newer version becomes available].
With all of the wild gyrations in the stock market lately, we couldn’t help but wonder what this might mean for the future of stock options. Options have already experienced a decline in popularity in recent years thanks to the onerous expensing issues of FAS 123(R), as well as their lack of “line-of-sight” motivational impact on company operational goals, but if you throw into the works the wrenches of white-hot executive pay scrutiny, significantly declined capital markets, as well as significant increases in volatility and Black-Scholes values, you have a potent witch’s brew indeed.
Not being able to let this unique executive pay situation go untouched, Veritas ran some quick calculations of volatility for the Dow 30 stocks – read about these calculations in this article.
Recently, Cisco shareholders narrowly supported a say-on-pay proposal by a majority. In this podcast, Julie Tanner of Christian Brothers Investment Services discusses the recent Cisco vote on say-on-pay and other CBIS activities, including:
– What were the results of your say-on-pay proposal on Cisco’s ballot? How did that compare to last year?
– How does Christian Brothers select which companies to which it will submit shareholder proposals?
– What types of proposals has Christian Brothers submitted for the 2010 proxy season?
– Does Christian Brothers engage with companies before – or after – it submits shareholder proposals?
Just a few moments ago, the SEC issued a notice that it will hold an open Commission meeting next Wednesday, 12/16 to consider adoption of its executive compensation and other corporate governance proposals. It’s unknown at this time whether they will apply to the upcoming proxy season.
In the UK, the final Walker Review recommendations were recently issued. This is a sweeping governance reform of the United Kingdom’s financial industry, including strengthening the role of non-executive directors and giving them new responsibilities to monitor risk and compensation. Here’s an excerpt from a recent RiskMetrics’ newsletter:
The review’s more than three dozen recommendations remain largely unchanged from a draft released in July for public comment, which prompted a broad spectrum of financial market participants, including institutional investors, remuneration consultants, shareholder associations, and bank representatives to weigh in on the proposed guidance.
However, many of the recommendations, particularly those regarding remuneration, have been re-worded to be less prescriptive in nature. Britain’s Financial Services Authority has taken a similar approach with respect to its own remuneration code, which will take effect next year. A primary example of this is the definition of “high end” employees, who fall under a variety of Walker recommendations, which are now defined as those who perform a “significant influence function,” rather than meeting a certain pay level threshold. Still, other defined elements, such as the level of bonus deferral, have remained untouched.
A key element of better executive compensation practices is whether an employer has a clawback policy which enables the employer to recoup incentive compensation from an employee under certain circumstances. Typically, a clawback may apply if an employee has committed an egregious act or if there is a restatement of the financial results from which the incentive compensation payment was derived. To the delight of corporate governance reform advocates, many public companies have voluntarily adopted clawback policies.
The federal government has also increasingly mandated the clawback of incentive compensation. The Sarbanes-Oxley Act of 2002 and the American Recovery and Reinvestment Act of 2009 each compel a clawback of incentive compensation paid to certain enumerated employees if the employer has a financial accounting restatement. Even more recently, in October 2009, the Federal Reserve Board of Governors proposed guidance that would generally compel banks under its supervision to delay the actual payout of an incentive award to an employee until significantly beyond the end of the applicable performance period. This proposed guidance would require that any such payments should be decreased for actual losses or other aspects of performance that become clear only during the deferral period.
The California Supreme Court recently rendered a decision in the Schachter v. Citigroup case which dealt with incentive compensation. The ruling itself was not all that surprising – but the court’s opinion did indirectly highlight a potential pitfall for clawbacks. In Citigroup, the employer maintained a program whereby an employee could voluntarily elect to reduce his/her salary by a stated percentage and in exchange receive restricted shares (at a discount) that would vest over time. The restricted shares would be forfeited without consideration if the employee resigned employment prior to vesting. However, if the company terminated the employee’s employment without cause prior to vesting, then the employee would receive a cash payment equal to the amount of the foregone salary as consideration for the forfeited shares.
A former employee, who had resigned his employment, filed suit challenging the compensation arrangement. He argued that he should have received his foregone salary after his resignation on the theory that various California labor code statutes generally prohibiting the disgorgement or nonpayment of wages were violated. The California Supreme Court disagreed and ruled that, as is typically the case with unvested equity compensation arrangements, failure to satisfy the vesting conditions meant that the incentive compensation was not earned and that the employee was not deprived of any wages.
However, the court’s opinion took notice of the differing consequences for the incentive compensation depending on whether the employer or employee had initiated termination of employment. The court noted that payment of the incentive compensation if the employer was the initiating party to terminate employment was consistent with “contract law principles prohibiting efforts by one party to a contract to prevent completion by the other party.” The court further noted that an employee may be able to recover at least a pro-rata share of a potential bonus if the employee’s employment is terminated by the employer without a valid cause prior to completion of the terms of the bonus agreement. In addition to the applicable California labor code statutes, as support the court cited California state regulatory agency opinions and state appellate law decisions.
The point is that state laws, regulations and/or agency decisions could potentially impede the ability of an employer to recoup or delay/deprive an employee from receiving incentive compensation. For example, California Labor Code Section 221 specifically states “It shall be unlawful for any employer to collect or receive from an employee any part of wages theretofore paid by said employer to said employee.” If a clawback was implemented to comply with a specific federal law, then such clawback may be better able to withstand a challenge under state law by virtue of federal law pre-emption.
But what if the clawback was being voluntarily implemented by the employer purely as a matter of good corporate governance? In such case, the clawback could be vulnerable to being invalidated based on state laws that protect an employee’s rights to compensation particularly if the employee was not culpable and/or if the employee could argue that the incentive compensation was already “earned” (or paid) under applicable state law.
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).