WTW recently conducted a study of incentive structures and strategies companies use to retain key employees during an acquisition. The survey of approximately 160 respondents provides useful benchmarking information to shape retention programs more effectively. Here are some key takeaways from this release comparing the results to WTW’s 2020 study:
– Overall, retention pool size continues to decline, with nearly 70% of respondents that track and set aside a retention pool reporting that the retention pool was less than 2% of the purchase price for the acquired company. In a similar vein, fewer companies reported retention pools above 5% of the purchase price, compared to three years earlier.
– Companies also shortened the length of retention periods for top executives between 2020 and 2023. […] In 2020, two-thirds of companies that participated in WTW’s retention study reported retention timelines of two or more years for senior executives. Currently, fewer than 30% of participants reported structuring retention periods to last longer than two years, with the median lying between 13 months and 18 months. Shorter retention periods may reflect pressure to retain employees for only as long as necessary during the transition, which may cut costs for retention packages.
– The study also makes clear that performance pay is climbing, and the focus is shifting from cash bonuses alone to a mix of cash, stock options, RSUs and other awards that account for measurable metrics of success for the target or combined companies. This move toward performance pay almost certainly reflects the character of the purchasing companies. More than 70% of respondent buyers were publicly traded companies, with 66% of the acquired companies held privately.
I blogged earlier this year that for 2024 pay vs. performance disclosures, the Corp Fin Staff expects that you’ve digested the feedback and guidance that it issued last year in the form of comment letters and manyCDIs. While I am very grateful for all of that helpful guidance, I also was very happy to see this Skadden memo, which provides a concise & timely list of the common mistakes that the Staff will be watching for this year:
1. Failing to describe the relationship between CAP and: (a) TSR, (b) net income and (c) the company-selected measure (CSM).
2. Failing to include the tabular list.
3. Including multiple CSMs or failing to include the CSM in the tabular list.
4. Failing to provide a GAAP reconciliation for non-GAAP CSMs.
5. Using a TSR peer group that does not match either the industry group in the company’s 10-K performance graph or the compensation peer group disclosed in the Compensation Discussion and Analysis (CD&A).
6. Failing to include or identify all NEOs who served each year.
7. Using partial-year compensation (e.g., only including compensation for the time served as an NEO during a given year).
8. Valuing awards that vest during the year based on a year-over-year change, rather than valuing them as of the date of vesting.
Recently, As You Sow, Si2 and Proxy Impact released the 20th Anniversary Edition of their “Proxy Preview” report – which tracks the number, topics and outcomes for “ESG” proposals in the current season and as compared to prior years. Of the 527 proposals that are captured in the report for the 2024 proxy season, only a handful directly relate to executive compensation. Within that small group, the proposals focus on tying pay to climate-based goals. Here’s an excerpt:
As companies have begun to take seriously the bottom-line impacts of climate change risk management and diversity considerations in human capital management, they have started to tie executive pay to specific corporate goals on these issues. Shareholder resolutions asking for these links have never received spectacular votes, but companies are taking action anyway. This year there are a few variations from As You Sow and state pension funds, at electric utilities and a couple of industrial companies, but all five are about climate change:
• As You Sow wants Cummins and General Electric to disclose a plan “to link executive compensation to 1.5-degree C-aligned greenhouse gas emissions reductions across the Company’s full value chain.” A similar proposal at Cummins last year earned 15.1 percent support, although the 2024 resolved clause is more general; the supporting statement has similar very specific suggestions, though, which As You Sow says are needed because the company claims CEO pay is linked to climate change but does not explain how.
In addition, compensation committees should continue to track “human capital” proposals. The report has a few takeaways on that topic:
– “Fair pay” & “working conditions” proposals continue to diminish. Only 41 resolutions are in play this year on the topics of gender/racial pay gaps, health & safety audits, workplace bias and paid sick leave – down from a high of 74 two years ago.
– “Living wages” proposals are emerging – this is the new twist on the general topic of “decent work,” with 7 new resolutions this year requesting policies designed to pay a living wage or to disclose information needed to assess the company’s compliance with international human rights standards.
Some investors view CEO succession planning as the Board’s most important responsibility. In fact, in its voting guidelines for 2024 annual meetings, BlackRock called out that it might vote against the members of the responsible committee where there is significant concern on this topic. We’ve noted that a number of companies include succession-related metrics to compensation programs to incentivize planning. This Directors & Boards article shares a reminder that it also may be appropriate for compensation committees to pay a premium to up-and-coming internal candidates who might otherwise be recruited away. Here’s an excerpt:
Ensure compensation supports succession plans. Over the past decade, compensation committees increasingly have broader responsibilities and, in many cases, that includes oversight of executive succession. It is important for the committee to consider succession plans when weighing executive pay decisions. For example, if an executive is one of the candidates to succeed the CEO, it is likely appropriate to pay that executive at a premium to market for their current role. The committee should also review retention handcuffs for talent that is most critical for succession planning.
One retention risk approach to consider is conducting a “next job” analysis. This analysis considers what a current executive could potentially be paid if they left their current company for a higher-level position at another company. For example, knowing how much the head of a large business unit could make as a CEO of a smaller stand-alone company can give an important frame of reference for retention risk. While ISS and Glass Lewis may be critical of special retention awards, the greater risk to the company may be losing essential talent because there was not enough retention “glue” holding them in place.
Even if the proxy advisors aren’t thrilled, retention awards may draw relatively less ire if they are granted only to executives other than the CEO, and you may be able to get shareholders on board if they are framed as an element of succession planning. If you’re not sure what to say about succession planning, you’re not alone – check out Meredith’s blog on TheCorporateCounsel.net about the significant variations in discussing the elements of this process.
In the latest 20-minute episode of the “Pay & Proxy Podcast,” Meredith interviewed Paul Hodgson of ESGAUGE (Paul is also a freelance writer and researcher for ICCR and Ceres). Meredith and Paul elaborated on themes from Paul’s recent article on impact of Elon Musk’s 2018 compensation package on benchmarking & the market for CEO pay. Specifically, the podcast covers:
1. Overview of the equity award and legal challenges in Tornetta v. Musk
2. How Delaware boards need to be thinking about director independence when setting compensation, especially for potential controlling shareholders and “superstar CEOs”
3. Process takeaways for compensation committees from the Tornetta v. Musk decision
4. The importance of shareholder outreach and necessary disclosures when seeking majority of the minority shareholder approval
Last fall, Liz shared that more than 70% of S&P 1500 CEOs achieved target or above-target payouts for annual incentives in 2022, according to an analysis from ISS-Corporate. In that analysis, ICS questioned whether terminology commonly used by companies in CD&A — stating that target goals are intended to be “rigorous” — is accurate when targets are consistently achieved. The report suggested a “best practice” payout range is 50-60%.
This recent report by Compensation Advisory Partners, which analyzed annual incentive plan payouts over the past ten years of 120 large U.S. public companies with a median revenue of $43 billion, further supports this 70% statistic.
Based on our analysis of actual incentive payouts over the past ten years, the degree of difficulty, or “stretch”, embedded in annual performance goals translates to:
– A 95 percent chance of achieving at least Threshold performance
– A 70 percent chance of achieving at least Target performance
– A 5 percent chance of achieving Maximum performance
Not surprisingly, 2020 and 2021 were outliers:
In most of the years reviewed in our study, between 60 percent and 80 percent of companies paid bonuses at target or above. There were two exceptions: 2020, when only 55 percent of companies paid bonuses at target or above, and 2021, when 89 percent of companies paid bonuses at target or above.
In 2020, bonuses were generally down due to the unanticipated impact of the COVID-19 pandemic on financial results, while in 2021 bonuses increased due to a faster than expected rebound for most companies. In 2022, we saw a return to more typical payout distributions with 65 percent of companies paying bonuses at target or above.
With the macroeconomic environment still highly uncertain, the report notes that “companies can use design strategies to help reduce volatility in their plan payouts, including setting wider ranges around target to recognize the challenges of setting performance goals in an uncertain environment, using non-financial goals to tie annual incentive payouts to other markers of company progress, and adding relative measures, which will allow for relevant comparisons even if the overall market is affected by macroeconomic challenges.” On the use of non-financial goals, some had speculated that the Dodd-Frank clawback rules may also cause companies to include more strategic or operational goals in their plans. Whatever the reason, an increasing number of companies in this study are taking that approach (separate from ESG goals):
57 percent of companies in our current study use strategic or nonfinancial goals, an increase from 38 percent in 2020. These metrics incentivize behaviors that contribute to long-term success but may not be captured by short-term financial performance results. Specific strategic or nonfinancial metrics vary by industry and company – for example, pharmaceutical companies often use pipeline metrics and oil and gas companies often use safety and environmental metrics.
Seyfarth just released its Human Capital Disclosure Report — now in its third year. Based on a review of HCM disclosures of 200 companies in 2023 10-Ks, the report provides the following general trends — although it also recognized that the disclosures continued to vary widely from company to company:
We saw an increase in the number of HCM disclosures we reviewed specifically referencing culture up an average of 82.5% across industries.
Despite recent Supreme Court decisions raising issues about factoring race into college admissions decisions, we continued to see most HCM disclosures include reference to DEI efforts with 93.5% of the HCM disclosures we reviewed across industries including references to DEI principles. The number of companies including more detailed statistics related to diversity and year-over-year comparisons continued to increase with the number of companies that included demographics reporting increasing to 60.5% across industries (up from 44% in 2021).
While not at the same level of DEI references, we saw consistent numbers in the references to pay equity reviews in the HCM disclosures we reviewed—with 28.5% across all categories mentioning pay equity efforts—and most industries reflecting the same or increased references to pay equity reviews.
Perhaps not surprisingly, many of the HCM disclosures we reviewed focused on recruitment and retention efforts as a critical part of their HCM strategy. As part of that effort, employee benefits continue to play a front and center role. In addition to the compensation element, which is impacted by the pay equity analyses noted above, we saw many references to the importance of the company’s employee benefits package. These references often included mention of standard employee benefit programs, such as retirement plans and medical benefits, but many also referenced additional benefits offerings, such as mental health and well-being benefits, mindfulness tools, caregiver (caring for infants as well as disabled or elderly family members), and family planning and fertility benefits.
We also saw many HCM disclosures focus on employee engagement, noting engagement surveys, and other ways to assist employees with their professional development and general education. Many disclosures referenced remote and hybrid work options reflecting a continued desire for flexibility within the workforce. Companies also seemed focused on developing their talent pipeline, as another tool for retention and health of the business. We saw references to a variety of course offerings and programs, including traditional coursework from universities (some virtual) as well as mentorship and sponsorship programs. We also noted references to more discreet topics such as mindfulness, financial literacy, and English as a Second Language courses.
[T]he number of references to board level oversight of human capital issues in the HCM disclosures we reviewed (regardless of industry) continued to increase with an average of 45.5% reporting board oversight in this area, up from 25% in 2021 and 42% in 2022.
This Compensia Thoughtful Pay Alert discusses trends and key practices among companies in the technology industry that award executives PSUs with a relative TSR metric. The use of relative TSR remains popular (approximately 64% of the covered technology companies granted PSUs with a relative TSR metric), with some companies (particularly in the software space) making some improvements in program design to strengthen pay and performance alignment.
Where both relative TSR and financial metrics are weighted components of the plan formula (85% of the companies including both types of metrics), TSR accounts for, on average, 45% of the payout.
The other 15% of companies use relative TSR results as a modifier to adjust payouts determined using financial or absolute stock price metrics, generally +/- 25 percentage points. No company eliminated a relative TSR metric for the current year, while 10 companies introduced relative TSR PSUs for the first time.
The alert highlights these design improvements:
– Bar raised on performance levels required for target and maximum payouts (i.e., above 50th percentile at target and above 75th percentile at max)
– Payout caps added for negative absolute TSR (nearly 50% of companies)
– Adjustment in measurement approaches
On measurement approaches, the alert says percentile rank remains the most common (at 70%), but “more companies are questioning the impact of using a percentile rank approach on the plan outcomes” since select indices are “becoming increasingly weighted toward a small group of highly-valued companies (i.e., top 10 constituents represent 30% of the S&P 500; Apple, Microsoft, Amazon, NVIDIA, Alphabet and Meta represent 40% of the NASDAQ).” This is causing an uptick in companies considering or implementing a Percentage Points vs. Index approach (25%) or Points vs. Median approach (5%). The alert reviews the advantages and disadvantages of each approach.
In early 2023, the SEC announced the adoption of rules implementing a T+1 settlement system. The transition to the shorter settlement cycle will occur on May 28, 2024. Nasdaq and NYSE recently published alerts about this transition and its impact on distributions of cash, stock or warrants — in particular, NYSE reminded listed issuers to avoid consummation of corporate actions during this transition, to the extent practicable.
With this transition around the corner, this Morgan Lewis blog discusses the implications for stock plan professionals, noting that “employers will have one less day to calculate the withholdings owed with respect to employees’ equity compensation and deposit those withholdings with the IRS and state tax authorities.”
In the case of stock option exercises or vesting/settlement of other stock awards, the stock will need to be delivered to employees’ brokerage accounts no later than one day after the DWAC date. Accordingly, employers will need to make payroll deposits by the second business day after the DWAC date instead of the third business day.
See the blog for a detailed discussion of the required timing of these deposits and the consequences of doing so after the deadline. Here’s the example it provides:
For example, assume that an RSU vests on a Monday, July 1, and the DWAC is that day. The new settlement date is July 2 and the payroll tax deposits are due July 3. But assume that the employer is unaware of the settlement date change and does not make its deposits until July 9 (after the long holiday weekend).
These deposits are now six days late, and the deposit penalty would be 5% of all the late deposits. If these deposits were made on July 8 the penalty would be only 2%, but under either scenario it is clear that the reduction of the settlement date (and therefore the liability date) by one day can significantly impact an employer’s penalty exposure.
The takeaway?
To avoid potential deposit penalties, whether employers make their own payroll tax deposits or hire a third-party payroll service provider to make deposits, employers should check to be sure that their scheduled dates of deposit for equity compensation are accelerated to accommodate the new T+1 rule.
A U.S. district court recently ruled in favor of Apple to dismiss a case that alleged ’34 Act and fiduciary duty violations relating to proxy statement disclosures about executive compensation, say-on-pay, and director elections. Bloomberg reported on the case when it was filed last year and this win.
Specifically, the plaintiff (a pension fund affiliated with the International Brotherhood of Teamsters) alleged that the company’s proxy misled investors by understating the value of equity awards in the CD&A. The plaintiff took issue with the fact that the number of RSUs granted to executives was calculated with the very common approach of dividing the target grant value by the closing stock price on the date of grant. So, the CD&A disclosed a “target value” of awards based on those figures.
The plaintiff said that the compensation committee should have used a Monte Carlo simulation to value the awards, which would have shown a higher value of compensation in the proxy disclosure, and which allegedly impacted the voting outcome. Here’s more detail from the opinion:
At the core of the Complaint is Plaintiff’s assertion that the amount of executive compensation disclosed in the compensation-narrative section of the 2023 Proxy Statement understates the actual compensation as disclosed in the compensation-tables section of the 2023 Proxy Statement. According to Plaintiff, “to accurately determine the grant date fair value of performance-based compensation that are based on [relative shareholder return], one needs to employ a somewhat complicated analytical derivative pricing model such as a Monte Carlo simulation. Here Apple did so for purposes of reporting the NEOs[‘] compensation in 2022 and 2023, but it failed to use such a model when awarding the performance-based RSUs.”
As a result, Plaintiff contends, “the 2021-2022 compensation actually cost Apple $31,707,610 more than the amounts disclosed in the 2023 Proxy Statement, and . . . Apple’s representations were materially false because they grossly understated the known costs of this compensation.
The court said that the plaintiff’s Section 14(a) complaint came up short in a couple of ways. First, the plaintiff didn’t adequately plead “loss causation” – because the advisory nature of the say-on-pay vote meant that the proxy statement hadn’t caused any injury, and the compensation information was not an essential link to director election decisions. On the substantive disclosure, the opinion says:
As another court noted in a previous executive-compensation-related suit against Apple brought under Section 14(a), there is no SEC rule requiring that a specific method for determining executive compensation be used, so long as the chosen method is disclosed. That principle applies here.
The Complaint effectively admits (by pasting excerpts of Apple’s disclosures in support of its claims) that Apple did precisely what Section 14a) and SEC rules require – presented its compensation process and methods through detailed compensation tables. [The Complaint says] “the proper way to determine the Grant Date Fair Values of performance-based equity compensation . . . is to use a sophisticated model such as a Monte Carlo simulation. Apple used such a model when accounting for these performance-based shares as demonstrated by the Grants of Plan-Based Awards Tables in its 2022 and 2023 Proxy Statements.”
Plaintiff does not allege that Apple was required to disclose anything more. That the compensation tables are in gray type and not graphically designed in color like the narrative section is inconsequential.
Overall, the dismissal of this complaint (with prejudice) is good news for companies. But as always, there are procedural nuances and specific facts that could have affected the outcome, particularly with respect to the fiduciary duty claims.
That means that this ruling may not entirely deter plaintiffs from bringing claims against other companies on similar grounds, if they find a good target. It’s another reminder that your executive compensation disclosures are being closely scrutinized and can be fodder for litigation – even if you did everything correctly. Stay safe out there!