Last week, at the same Council of Institutional Investors meeting where Chair Schapiro laid out the SEC’s new regulatory agenda, Goldman Sachs CEO Lloyd Blankfein called for changes to the compensation model on Wall Street. As noted in this story appearing in the LA Times, Blankfein faced some angry protestors while delivering his address – certainly a sign of these times of extraordinary public anger.
Blankfein noted that compensation decisions must be made in the context a multi-year evaluation of risk to get a full picture of an individual’s decisions, and that performance should not be judged in isolation. Among the specific guidelines that he suggested are:
1. Compensation should include salary and deferred compensation, which is “appropriately discretionary” because it is based on performance over the year.
2. The proportion of equity comprising and individual’s compensation should increase significantly as total compensation increases.
3. Senior employees should get most of their compensation in deferred equity, while junior people should get most of their compensation in cash.
4. Individual performance should be evaluated over time to avoid excessive risk taking and to allow for a clawback effect.
5. Equity awards should be subject to future delivery and/or deferred exercise over at least a three-year period.
6. Senior executive officers should retain the bulk of their equity until they retire, and equity should not be accelerated once someone leaves the firm.
Recently, Moody’s issued a report entitled “Executive Compensation: What to Watch in 2009.” The report is not earth-shattering and finds the following:
– Pay-related changes will put new incentives in place for management and affect employee recruitment and retention efforts that could have significant future implications for bondholders.
– Analysts expect pay-related scrutiny to be focused most heavily on firms most closely associated with the credit crisis, including those receiving government assistance, those who have exhibited poor pay practices in prior years, or both.
– Expected key compensation changes include: a reduction or elimination of 2008 bonuses; changes to performance targets and metrics used in both short and long-term incentive plans; modifications to equity-based incentive plans; and other changes resulting primarily from shareholder pressure.
– Given the focus on pay, the pressures on various pay elements – in particular on variable compensation, which represents roughly 85% of typical CEO pay – and the reduced likelihood of near-term stock market recovery, we expect median CEO total pay to decline for the 2008 fiscal year and possibly again in 2009.
– There are both benefits and potential risks stemming from the pay changes, including those applicable to TARP firms under the Stimulus Act; potential credit implications are unknown at this time since pay is very much contextual and must be analyzed on a case-by-case basis.
Compensation Arrangements in a Down Market
We have posted the transcript from our recent webcast: “Compensation Arrangements in a Down Market.”
We haven’t heard much about backdated options lately. That’s why I found Bud Crystal’s recent report so interesting, given that he contends that “Opportunistically-Timed Options Are Alive and Well.”
Here is a recent report from Frederic W. Cook & Co. entitled “The 2008 Top 250 Report Prevalence of Long-Term and Stock-Based Grant Practices for Executives at the 250 Largest Companies.” Key findings from the report include the following:
– Stock option usage continues to decline, although options remain the single most common long-term incentive vehicle.
– Stock options are being replaced primarily by full-value shares that are earned by continued service and achievement of performance contingencies (performance shares).
– Full value shares with performance contingencies (performance shares) are now as common as full-value shares that vest by continued service alone (restricted stock).
– Long-term performance awards (performance shares and performance units) are now almost as common as stock options and represent nearly as much of CEO’s total long-term incentive values as stock options.
– Imposing performance requirements on the vesting of stock options increased in 2007, although most other stock option design variations (reloads, discounts, and tandem grants) disappeared in practice.
– Median CEO long-term incentive values continued to increase, but 75th percentile values leveled off.
– The prevalence of stock ownership guidelines for executives continues to increase with approaches combining mandatory share ownership and retention ratios showing the fastest growth.
Here is a follow-up on Broc’s recent blog. In thinking about these issues, I think you also have to look at the composition of boards. Most companies, rightly, want to have CEOs, COOs, Presidents, etc. on their boards who can bring real world experience to deal with business issues – strategic planning, evolving markets, business restructurings, etc.
The issue that creates from a compensation point-of-view is obvious. And while compensation is important, clearly some of these other factors have an exponentially larger impact on value creation/loss for shareholders. One suggestion might be to require essentially a separate “board” to deal with compensation that draws on a broader universe of participants (and also includes some of the directors from the “real” board to provide the required insight vis-a-vis the other factors).
With no fanfare, RiskMetrics recently issued this new paper – “Evaluating U.S. Company Management Say-on-Pay Proposals” – which lays out the four steps that RMG uses to analyze a proposal (including nine questions that it will ask itself) placed on the ballot by management. This is an important document considering RiskMetrics’ role in the voting process. We have posted it in our “Say-on-Pay” Practice Area.
This is not an April Fool’s joke. Yesterday, the Chicago Tribune ran this article about a lawsuit brought against McDonald’s by a former Senior Director of Compensation who balked against signing a subcertification related to the company’s disclosure of executive compensation. The company denies the allegations. I’m pretty sure this is the first whistleblower suit related to executive compensation disclosure.
The complaint was filed in US District Court for Northern Illinois – and includes allegations of (as noted in this blog):
– Setting up a reimbursement/repayment scheme to avoid disclosing golf club memberships for the regional President stationed in Hong Kong;
– Mislabeling the outgoing CEO as a “transitional officer” so he could keep his health and other benefits, and so the millions paid to him after his last day of work for McDonald’s could be called salary and incentive pay, rather than severance; and
– Implementing a shareholder-mandated 2.99X cap on executive severance agreements with loopholes large enough to render the cap meaningless.
We’ll be closely following this development since the topic is “near and dear” to many of our members…
We just posted the registration form for our popular conferences – “Tackling Your 2010 Compensation Disclosures: The 4th Annual Proxy Disclosure Conference” & “6th Annual Executive Compensation Conference” – to be held November 9-10th in San Francisco and via Live Nationwide Video Webcast. Here is the agenda for the Proxy Disclosure Conference (we’ll be posting the agenda for the Executive Compensation Conference in the near future).
Special “Half-Off” Early Bird Rates – Act by April 24th: We know that many of you are hurting in ways that we all never dreamed of – and going to a Conference is the last thing on your mind. But with huge changes afoot for executive compensation and the related disclosures, we are doing our part to help you address all these critical changes—and avoid costly pitfalls—by offering a “half-off” early bird discount rate so that you can attend these critical conferences (both of the Conferences are bundled together with a single price). So register by April 24th to obtain 50% off.
“Books & Records” Being Used to Check Compensation Committees
As noted in this NY Times’ article from Sunday, the Louisiana Municipal Police Employee Retirement System is using a books & records demand at Chesapeake Energy to determine whether the board met its fiduciary duties in approving a $75 million bonus, as part of a renegotiated employment contract with the CEO.
The CEO had lost 94% of his holdings in the company due to a margin call (when the company’s stock dropped 60%) – and he had an existing 5-year contract struck in ’07 that had not yet run its course when this new one was renegotiated. The books & records demand was the first step used in the Disney case a few years back.
A few weeks ago, the UK’s regulator – the Financial Services Authority – published a draft “Code of Practice on Remuneration Policies.” It is proposed that the Code will be relevant to all FSA-regulated firms, not just banks, and will relate to the remuneration of all employees. It would therefore apply to the UK FSA-authorised entities of non-UK firms operating in the UK.
The Code comprises one general principle and 10 specific principles and develops ideas first set out in a “Dear CEO” letter sent last year by the FSA to the CEOs of many banks. Although it is not clear when the final Code will formally become part of FSA regulation, it is expected to be in the near term.
Learn more in our “International” Practice Area about this development.
French Parliament Toughens Tax/Social Security Treatment of Golden Parachutes
This recent Latham & Watkins memo explains the new French changes to the social security treatment of indemnities, including golden parachutes, paid to a manager due to the forced termination of duties, as well as the new tax treatment of certain golden parachutes at the level of the paying company.
Fueled by the anger over the AIG bonuses, the focus now is on bonuses generally. As we all know, a focus on a single pay element doesn’t really make sense as the totality of the pay package is what really matters. But the public (and most of the media, Congress, etc.) isn’t used to dissecting complex executive pay packages.
Anyways, companies may now be moved to rename their “bonuses” as something else due to their stigma, as noted in this NY Times article yesterday. And the concept of retention bonuses may need to be reconsidered, as there clearly have been some abuses in this area. I agree that retention bonuses make sense in particular circumstances – and can even be critical to save a company from imploding. But – like everything in life – sometimes there are mistakes and even purely abusive situations.
Occasionally, it’s also hard to make retention bonuses sound “right” to the masses, even though it makes sense for the company. Perhaps some of the AIG bonuses fall into that category as I read this resignation letter from one of the AIG Financial Product Unit executives. Notice the letter has over 900 reader comments.
As a sidenote, the reality is that the economic downturn has forced many companies to cut executive bonuses, as noted in this Watson Wyatt report.