With Aflac’s annual meeting results now in, “say on pay” is in the news. Here are five items to consider:
1. Aflac’s Pay Package Gets 93% Support – As noted in this NY Times article, Aflac’s meeting on Monday was uneventful with the company’s executive pay package getting overwhelming support.
2. RiskMetrics’ Aflac Report – ISS kindly has given us permission to post its analysis of Aflac’s “say on proposal.” It is interesting comparing that to the PIRC report that I posted last week.
3. Shareholders Not Supporting “Say on Pay” As Much This Year – As noted in this Washington Post article, the level of support for “say on pay” proposals is down this year compared to last year (bearing in mind that last year’s levels were remarkable for a “first year” type of proposal). So far, only proposals at Apple and Lexmark have garnered majority support.
Compare the Washington Post’s conclusions with those of ISS from this article. Here is an excerpt: “This year, pay vote proposals have averaged 42.1 percent support at 21 companies so far. That is in line with results for calendar 2007, when 52 such proposals received 42.5 percent average support. Surprisingly, however, the measure received less support at a number of financial companies this season, including Citigroup, Morgan Stanley, Wachovia and Merrill Lynch, where many observers expected the measure would fare better than last year given investor anger over subprime-related losses.”
As noted in the ISS piece, I’m also hearing that levels of support for proposals generally are down. I’m not sure of the reason, although some claim it’s partly due to the lower level of retail holders voting under e-proxy (I’m not sure I buy that given that relatively few companies are doing e-proxy).
4. Two More Companies Agree to “Say on Pay” – Littlefield and MBIA have joined the group of companies that have agreed to allow their shareholders to vote on executive pay, bringing the total number to seven. MBIA’s vote will occur in 2009 and Littlefield’s vote is in a few weeks, where its shareholders will vote on two management resolutions that ask shareholders whether the total compensation received by the CEO, president, and directors in 2007 “is within 20 percent of an acceptable amount,” according to its proxy statement. Hat tip to this ISS article for uncovering these two!
5. RiskMetrics’ Own “Say on Pay” Proposals – A few weeks ago, RiskMetrics Group filed its first proxy statement and it includes three separate resolutions for shareholder approval, which may become the model for future “say on pay” proposals. These three proposals are: (1) the company’s overall executive compensation philosophy; (2) whether the board executed these principles appropriately in making its 2007 compensation decisions; and (3) the board’s application of its compensation philosophy and policies to the company’s 2008 performance objectives.
Canada Revises Its Executive Compensation Proposals
Recently, the Canadian Securities Adminstrators re-published their executive compensation disclosure proposals. The original proposals were made a year ago – and interestingly, many Canadian companies have already voluntarily changed their disclosures to match the proposals. Here is a memo explaining how the proposals have changed.
While the compensation consultant is not bound by an official code of professional conduct like an accountant or lawyer, a high standard of professionalism demands that consultants serve as more than a source of black-and-white answers or even a voice independent of management.
Unlike the oversight provided by the audit committee, most decisions made by the compensation committee are not right nor wrong – but primarily matters of judgment and degree. When appropriate, the consultant must also function as a brake on the decision-making process.
Committees are well served by a consultant who will take the initiative to say to members, “There are some important issues here that you’re overlooking and should be considered before you make a decision.” It is the consultant’s duty to try to persuade members to factor in new information when needed, even if doing so may end up increasing costs or result in a delay, but to do so without being rigid or demanding.
For example, if management and the committee are overly focused on how increased earnings should be reflected in pay levels, the consultant may need to point out that the organization’s return on capital employed ranks at the bottom of its industry. So yes, the compensation consultant can serve as a “reality check” for its client.
According to a new study by our firm of Fortune Magazine’s Top 300 publicly-traded companies, a majority of 2007 proxy disclosures on annual and long-term incentive plans were inconsistent and incomplete when disclosing incentive performance metrics.
Surprisingly, many top U.S. publicly traded companies failed to disclose or explain their incentive performance metrics. Our study of 2007 proxies of nearly 300 companies revealed only 16% (46) of the companies provided complete metric and payout information for short-term incentive plans (STIP), while 19% did not provide any STIP metric values. 65% (190) of the companies had long-term incentive plans (LTIP), and of those, only 46% (88) included a reasonably complete set of metric values and corresponding payout percentages.
– TSR and EPS were the two most commonly used long-term incentive measures
– Income/profit measures and EPS were the most commonly used short-term incentive measures
– Most companies with long-term incentive plans had either one (60%) or two (32%) performance measures
– Short-term incentive plans usually included multiple performance measures
Relative performance measures to their peer groups were rarely found in short-term incentive plans (8%)
– 43% of companies with a long-term incentive plan used a relative measure
– 50% of long-term incentive plans with a relative performance measure used a total shareholder return measure with the target set at the 50th percentile of a peer group
– In all, two-thirds of companies with relative performance measures used total shareholder return
– For companies using the 50th percentile as target for a relative performance measure, over half (57%) set threshold performance at the 25th percentile
– For short- and long-term incentive plans, threshold payouts were frequently set at 0%, 25% or 50% percentile of target
– Maximum payouts were usually capped at 150% or 200% of target bonus
When reading through the Don Delves post from a few days ago, I thought about an interesting academic research paper I read recently. The paper – “The Role and Effect of Compensation Consultants on CEO Pay” -is by Brian Cadman, Mary Ellen Carter and Stephen Hillegeist. The paper uses a sample of 880 firms, and attempts to quantify the degree to which consultant conflicts of interest have an effect on CEO pay levels. Specifically, they talk about “rent extraction”, the idea that consultants with broader relationships tend to recommend higher CEO pay levels.
In reading the paper, I thought there were two interesting findings. First, the presence of a compensation consultant (ANY consultant; conflicted or not) was correlated with higher compensation for the firm’s CEO. While this may say more about the firms that don’t hire a consultant than it says about those that do, it is still somewhat troubling.
However, the authors were not able to find “widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary.” This is inconsistent with the findings of the Waxman committee, though the authors of this study did not have the same information available to them (the last time I checked, academics do not yet have subpoena powers). As a result, the authors had to use proxies to determine whether conflicts of interest are likely to exist.
My view is that independence is a lot more about the individual consultants providing services than it is about the firms they work for. If the sophisticated analysis from this paper was combined with the data available to Congress, perhaps the issue of consultant conflicts could be put to bed and we could all move on to talking about something else.
Last Thursday, Connecticut Treasurer Denise Nappier issued a press release stating that four companies have recently agreed to their requests for information – which were posed in the guise of shareholder proposals – on one of two issues:
– Consultant independence – specifically, how much the executive pay consultant is paid for non executive pay work, and
– The reason for the perceived pay inequity between the CEO and the other named executives.
Let’s address these issues one at a time:
1. Consultant Independence: It is certainly true that consulting firms that perform large amounts of non-executive pay work for management will have a difficult time giving independent advice on executive pay to the board – especially if that advice might not please management. However, that does not mean that non-independent consultants give bad advice. Nor does it mean that independent consultants give better advice. Some of the best consultants work for non-independent firms and there are a few independents who are not the sharpest tools in the shed.
Nappier states that, now that all of a consultant’s fees are disclosed, “Shareholders will finally have the information they need to make an informed decision on whether the company’s compensation policies and practices adhere to high standards of professional ethics and best practices.” This is a non-sequitur. Independence or non-independence (and disclosure thereof) does not equate to “high standards of professional ethics and best practices”. If Arthur Andersen had disclosed all of its fees received from Enron, would that have made their advice any more ethical?
The point here is that consultant independence, while an important issue, is a bit of a red herring. The main problem our industry (compensation consulting) suffers from is not a lack of independence, but a lack of standards. Despite Jesse’s work on Compensationstandards.com, there is no agreed on set of principles and standards defining what constitutes “high standards of professional ethics and best practices” in executive compensation design and practice, or in corporate governance over executive pay.
The accounting industry lacked standards in the 1950s and 1960s and the FASB was formed. Perhaps we need a similar industry principles setting body for executive pay. If we don’t do it, the government will, and they won’t do it well.
2. Pay Inequity: In her release, Nappier offers a very coherent argument for why we should care about pay equity or inequity. She states that when the CEO is paid three times or more the pay of the next highest paid executive, that may be a sign of inadequate succession planning. Based on my experience, that is probably true. If there is even one likely internal candidate, the company will often have to pay him or her 50% to 60% of the CEO’s pay. I think Nappier may be on to something here.
We recently updated our piece on this site – “Possible Roles of Independent Consultant to the Board Compensation Committee” – to flesh out a few more responsibilities that our firm typically fulfills for our clients, as well as list seven responsibilities that our firm expects from our client’s compensation committee, board and management. We have posted this revised document in the form of a sample agreement with a client. Let us know what you think.
With a down market, the number of companies asking what to do with their underwater options naturally increases. Looking into the crystal ball, I think it is fair to say that re-pricings will be very rare; none of my clients would even consider it (they would do cash SARs if they did not have shares).
I have had a few conversations about surrendering underwater option shares for no or nominal consideration. Participants would not be promised any replacement grant, but the shares added back to the kitty would be eligible for recycling (it appears that their plan allows an “add-back” for the surrendered options).
Some companies have accelerated their normal grant dates to try and put some incentives in place to support the needed turnaround (and take advantage of the current, low price). Some companies have granted restricted stock with continued service vesting provisions to promote retention and conserve shares. Some companies have awarded deferred cash to promote retention (in some cases, the stock is so volatile that employees prefer cash).
Also important, Risk Metrics/ISS’ allowable limits have dropped significantly the last few years, so getting a new plan or the refueling an existing plan approved by shareholders is viewed as a real challenge for underperforming companies. The bottom line is that I expect to see the use of more cash, despite the potential for liability accounting (in some cases, liability accounting is not all bad, as the charge to earnings is ultimately conditioned on what the employee realizes in value. So, a cash SAR that produces no value and ultimately results in no accounting cost; unlike a stock option, where you take the charge regardless of the value – or lack thereof – realized by the employee).
Section 162(m) of the Internal Revenue Code, the so-called “million dollar cap,” has been a failed tax law. It has been a cause of escalation in executive pay over time, rather than the deterrent it was intended to be.
When it was passed into law in 1993, it no doubt helped put performance on the table and stimulated an interest in the role of performance in executive pay. However, over time I have seen little practical impact on incentive plan design or incentive payout levels, and no end to the creative methods used to skirt (sorry, comply) with its requirements.
For most companies, Section 162(m) has resulted in creation of an additional faux incentive plan, with objective performance standards set at levels not easily missed, and handsomely rewarded when attained. The faux plan is the “umbrella” under which the actual bonus can still operate, usually unchanged. Discretion is maintained in determining payments in the actual plan, along with the tax deduction for the discretionary payment itself, so long as the actual payment does not exceed the outsized reward determined in the objective faux formula.
162(m) intended to penalize companies that exercised discretion in determining executive bonuses by ultimately making the bonus payment non-deductible. I believe that some discretion in determining executive annual incentives is necessary and a responsibility of management and Compensation Committees to exercise. And I think they should be accountable for this exercise of discretion, but accountable to shareholders, not the IRS.
The advent of the new proxy disclosure rules and the SEC staff’s push to have companies disclose how they exercise discretion and what factors they considered in determining executive bonuses now provides a process of public disclosure and accountability for the exercise of discretion in executive incentives. Today, 162(m) looms more as a potential “gotcha” if companies are forthright in their CD&A in disclosure of their exercise of discretion.
Encourage legislators who have spoken out against Section 162(m), to take the difficult political steps needed to remove this particular cap and help shareholders get the type of disclosure they deserve. You can contact:
Watson Wyatt just completed our second annual proxy survey – here is the related press release – and discovered more U.S. companies have disclosed the specific goals used in their executive compensation plans in their 2008 proxies than in 2007, although roughly one-third still do not provide this information. We found that more than two-thirds (68 percent) of the 75 large, publicly traded companies studied disclosed the actual goals on which they based rewards under their 2007 annual incentive plans, up from 54 percent that disclosed goals last year.
Additionally, 57 percent included the goals for long-term incentive plans, compared with 45 percent one year ago. Of those that did not disclose actual goals, only 19 percent stated affirmatively that disclosing them would result in competitive harm.
We have found this to be a positive step and one that will make it easier for shareholder to determine if pay programs are rewarding executives for maximizing shareholder value. It appears the SEC’s goal is permit shareholders to figure out if goals are too easy or too hard and if executives are focused on the right things. Having the specific financial goals disclosed – for example, earnings per share growth of 10 percent – is one way shareholders can make a reasonable determination if their company follows its pay-for-performance philosophy.”
Despite the progress in goal disclosure, we also found that slightly more than half (56 percent) of CDAs provided a detailed description of how total pay earned during 2007 tied to company performance. Even fewer (36 percent) provided an analysis of how well the company performed versus its industry peers. The SEC had requested companies provide this type of analysis in the proxies for 2008. We recall John White’s statement from last year’s Proxy Disclosure Conference, “Stated simply – Where’s the analysis?”
Our view has been that most companies have a positive pay-for-performance story to share, yet our survey found very few who have taken the opportunity to tell it. We only found 4 percent of proxies included an executive summary that describes how the company did versus peers, how pay was reflective of company performances and how pay compared to that of peers.
We were please to see companies taking steps to reduce some of the less shareholder-friendly or non-core elements of compensation such as executive pensions and severance. Only one of the 11 percent of companies who changed executive pensions increase benefits for the executives, with the others having frozen accruals or reducing benefits for new hires. And all 24 percent of companies that made changes to their severance or change-in-control programs reduced the potential payments to executives.
We think this approach of revisiting the appropriateness of existing severance and change-in-control provisions helps them put more emphasis on maintaining core pay programs that are well aligned with corporate performance.
Selection of appropriate peer companies is one of the most important decisions that a compensation committee makes. If the peer group is flawed, then the competitive analysis is likely to be flawed as well, and the rest of the decisions made by the committee are suspect as a result.
By way of example, the recent Congressional hearing into severance pay practices at several high-profile financial firms uncovered some interesting information about the conversations between the compensation committee of Countrywide Financial Corporation and various consultants regarding the construction of the company’s peer group. At one point during the process, there was a suggestion to eliminate three smaller banks from the peer group (SunTrust Banks, BB&T Corporation, and Fifth Third Bancorp) and replace them with Bank of America Corporation, Merrill Lynch, and Goldman Sachs. When looked on the basis of assets, the three smaller banks were in fact modestly smaller, with assets ranging from 60% to 100% of the assets of Countrywide.
On the other hand, the three suggested replacements ranged from about 4-7 times Countrywide in asset size. In terms of market capitalization, all three of the smaller banks were very close to Countrywide in terms of market capitalization at the time, while the market capitalization of the suggested replacements ranged from 3 to 9 times Countrywide. And the pay practices were quite different as well—CEO total compensation at the three replacement companies at the time averaged more than $25 million, while CEO total compensation at the three banks that were to be excluded from the analysis averaged about $3.5 million.
It seems possible that the modified group was chosen based on the pay practices for the CEO as opposed to factors such as industry segment, size, performance, market capitalization, etc. However, peer group suggestions such as those made in this case are often justified on the basis of statements like “we need to be able to compete with these kinds of companies for the world-class talent necessary to drive our business forward.” While these statements are true in the abstract, the new approach to disclosure makes it even easier to pick a group that is biased toward high payers. Any CEO—even those that do not set out intentionally to bias the peer group—may have information about each company’s pay practices in their head as they define the appropriate group with the consultant and the compensation committee. When discussing two companies that are similar, arguing for the one with higher pay might be too tempting to avoid.