Personally, I’ve come to despise AIG and think that company has risen above the fray to be the poster child of this credit crunch. It’s the “Enron” of this half of the decade. It’s not just that AIG already has stuck out it’s hand for $150 billion of taxpayer money – or even the eye-popping junkets that its employees recently enjoyed.
It’s the continued poor “tone at the top” of senior management, who claim that the company is in trouble due to the government’s onerous terms. There hasn’t been any acceptance of accountability for the mess they’re in (although the compensation of the top 70 officers has been further reined in under new bailout terms with the government, primarily a limit on golden parachutes and bonus pool size has been frozen). And I don’t think I’m alone – see this recent Floyd Norris’ column about the arrogance of AIG. And you should have heard Lou Dobbs last night, whoa boy.
Anyways, check out this recent Washington Post article. Now, AIG has quietly disclosed that it’s paying $503 million of deferred compensation out early in an effort to retain 6200 employees (14 deferred compensation program were terminated; payments will be made in early ’09). My gut reaction was that this will not sit well with the general public (even though the purpose of deferred compensation typically is to defer taxes, not to retain employees) – and that many of these employees will simply take the money and run since there are no strings attached (and they may not want to continue to sully their reputation by staying at AIG if they have any chance of leaving this new “Enron”).
One helpful consultant explains what’s really going on. Most deferrals are paid upon termination of employment. So, if you were worried about the company cratering, you would be motivated to quit to secure your deferred compensation balance ASAP. So AIG’s actions likely are an attempt to stop good employees from leaving. That makes sense (although I don’t think it will work – I still think AIG employees that will take the money and run).
Another consulting friend raises this potential question that someone might ask: Were the deferred monies earned as a result of incentives based on “excessive risk” that has led to the current situation? If so, should some – or all – of that money be clawed back before it is paid out under the Treasury’s agreement with AIG? This is said without intimate familiarity with AIG, it’s plans or the agreement with Treasury – maybe the deferred money is not entirely derivived from incentives (an unlikely event).
It will be interesting to see how the AIG saga continues to play out – because I doubt this is the end of it…
Note that these 14 deferred compensation plans are not related to last month’s agreement with New York Attorney General Andrew Cuomo to not distribute $600 million from other deferred-compensation and bonus pools that AIG maintains.
Last week, I blogged over on TheCorporateCounsel.net about how some financial institutions participating in the Treasury’s TARP Capital Purchase Program might be changing their “double triggers” to single for their change of control arrangements. I clarified that blog right after it got pushed to those that have signed up for that feature (if you want to be added, just input your email address to the left of this blog or send me an email) that no bank has yet disclosed that it has taken such action (at least, as far as I know). Rather, I have been hearing that through the grapevine. So it’s hearsay at this point (a good thing because hopefully anyone thinking about it will now be enlightened).
I have also heard that some advisors are saying that (despite some apparently contradictory guidance in Q-11 of Treasury’s interim final rule release for participants in the CPP) that a move to pure “single triggers” is not required based on Q&A-16 in the IRS notice regarding the Section 162(m) and Section 280G provisions of the EESA and Section 302(e)(C)(i) of EESA itself.
In other words, some advisors are interpreting Q-11 to say that “double triggers” (or severance payments upon terminations after a change of control) may be prohibited parachute payments, even if the Treasury no longer holds any equity or debt in a company it once invested in. So some companies have been thinking that while they would have to ask executives to cut back on their “termination without cause” protection to comply with the Treasury’s program, they could modify their double trigger to make it a single trigger.
The thinking apparently is that if there is no requirement for a “termination of employment” in connection with the change of control payment, then it could never be a prohibited golden parachute. In response, tax lawyers and consultants have been pointing to Q&A-16 and Section 302(e)(C)(i) of EESA to say that a payment that is a parachute payment under the traditional 280G analysis – on account of a change of control without regard to the new Section 280G(e) – is not subject to the new prohibitions in 280G(e) and therefore not prohibited by the CPP. Clear as mud?
Even though Treasury might not particularly care if SEOs get prohibited parachute payments in connection with – and particularly, after – a change of control in which Treasury has been bought out (in the case of equity) or paid off (in the case of debt), I imagine investors certainly will care, as well as those in Congress who approved the $700 billion blank check to Treasury…
Corp Fin’s New Bag of Tricks: E-mail Your Questions!
Yesterday, Corp Fin posted this overview of its policy offices, including some organization chart information. My guess is the SEC will have trouble keeping that updated, as we have found maintaining our own “Corp Fin Org Chart” challenging ourselves – but we do keep it updated!
The big news is that these policy offices – including all your favorites like Chief Counsel’s and Chief Accountant’s – will now accept interpretive queries in writing via this online form.
Wow! It will be interesting to see if the volume of queries changes at all – my guess is it will go up, which will be a bummer for the Staff. But on the plus side from the Staff’s perspective, the queries will likely be couched more clearly when reduced to writing. Having worked myself in Chief Counsel’s office, it can be difficult to try to answer a question posed over the phone, particularly if the questioner is strangely vague or inexperienced (or drunk, but that’s a long story).
With the recent record vote of 67% support on a say-on-pay proposal at Sun Microsystems – and the high likelihood of Congress adopting mandatory say-on-pay for the 2010 proxy season – yesterday’s RiskMetrics’ “Say on Pay” webcast was interesting. So far this year, “say on pay” proposals have received majority support at 11 companies (up from 8 last year) – and 12 companies have agreed to conduct advisory votes voluntarily.
1. Schering-Plough’s New Survey – Not much new was imparted during the webcast – which was comforting in itself to hear. To me, the most interesting part of the webcast was the discussion over Schering-Plough’s unique plan to survey investors on pay practices. One panelist didn’t think a survey goes far enough (ie. not transparent enough) because the shareholder feedback only goes to the board and not other shareholders. One liked it, so long as the design of the survey was sound – and it was paired with a say-on-pay vote.
Personally, I like the idea of it – but I’m afraid the reality is that most investors don’t have the time to fill out surveys for all their portfolio companies – nor have the expertise to provide advice on compensation practices. Similar issues that arise for say-on-pay itself. It will be interesting to see how many do indeed respond to Schering-Plough.
2. Will Boards Know What an Advisory Vote Means – It sounded like the Center for Executive Compensation’s principal argument against say-on-pay is that a board wouldn’t know what a majority vote “against” would mean – and that a majority vote “for” would mean that the company wouldn’t have to worry about the structure of their pay packages (as many of you know, the “Center” is run by a group of HR professionals).
I’d look elsewhere for more cogent arguments as the other panelists were quick to make these appropriate points. If a company gets a majority vote on any proposal, it’s the job of the board to reach out to the company’s biggest shareholders and find out the true meaning of the vote. And if the board doesn’t reach out, not only will it find itself in deeper waters – but shareholders likely will speak up and tell you (directly, through the media or just voting no on the board in the following year per ISS guidelines).
On the flip side, if say-on-pay is mandatory, I’d bet that companies will work hard to refine their compensation arrangements to fall within the parameters of the major proxy advisory groups and shareholders before they put them up for a vote. So there would be dialogue about pay packages that received majority support – it would just take place before the annual meeting of shareholders. This is what happens in the United Kingdom today.
My own take on this argument is that it’s true that a majority vote “against” a company’s pay arrangements might mean something else other than dissatisfaction over pay. Today, some shareholders use the tactic of submitting proposals they don’t care about in an effort of getting a board to the table on another issue. But by engaging with the company’s major shareholders, the board will find out what shareholders want. In a nutshell, that’s what say-on-pay is all about – getting boards to do their jobs and represent shareholders.
Anyways, my own views on say-on-pay remain the same. I’m on the fence and can see the pros and cons (although my list of those are different from some others). But views on the topic don’t seem to matter much these days – it sure looks like Congress intends to adopt say-on-pay in the very near future…
Recently, I answered five questions posed to me in this USA Today article:
Q: Are business people and employees still angry about the financial debacle and rising pay to executives — especially on Wall Street?
A: The outrage is at the highest levels I’ve ever seen. There are too many non-performing CEOs whose pay does not conform to reality. Twenty years ago, CEO pay was 250 times higher than rank-and-file pay. Today, it’s 600 times, even as the country slides into a recession. Executives shouldn’t recklessly gamble with everyone’s money, then be allowed to paddle away. That’s flat-out wrong. In the words of Tony Soprano, you get paid when we get paid, you get out when we get out.
Q: Given the $700 billion financial system bailout plan, will executive pay level off or keep growing?
A: Pay won’t necessarily continue rising. People realize that trees can’t keep growing into the sky. I think pay will more closely match performance, and there will be an appropriate balance to executives’ pay and the interest of shareholders. I will say as long as there are guaranteed golden parachutes that allow executives to bail out of a crashing company while shareholders and employees go down, there will be no reform in executive pay.
Q: Is the bailout plan’s limits on executive pay for companies that receive money a wise or dumb move?
A: Congress can’t regulate this stuff. It’s too complex. The imposition of unspecified pay limits really is a mistake.
Q: Who bears responsibility for too-high executive pay?
A: It’s easy to point fingers and vilify CEOs. For every bad CEO, there are 99 good ones. Microsoft, Berkshire Hathaway, General Electric, Procter & Gamble — all are companies that clearly practice pay for performance. We need to look around ourselves to find the responsible parties, and it’s a combination: business people, boards of directors, Congress, institutional investors, mutual funds, the media — and let’s not forget executive pay consultants.
Q: What’s the easy solution to a complex problem?
A: If we had very clearly defined regulations based on the design of pay plans — rather than on caps and limits on pay — we might go somewhere. Just a few years ago, it was all the rage for companies to peg executives’ pay to earnings per share. Then, all you had to do was to issue and buy back your company stock, and all of a sudden, you were skewing earnings. If a company performs well, you get paid. If it doesn’t perform, you don’t get paid. Hopefully, the financial crisis will teach new lessons to everybody.
– Ed Hauder, Senior Attorney and Consultant, Exequity, LLP
With all the gyrations in the market lately, I couldn’t help but wonder what this might mean for stock options. Yes, stock options have already experienced a bit of a decline in popularity in recent years thanks to FAS 123(R), but will the flight from options increase? (To read a better version of this blog, see this document with four charts added.)
Not being able to let this go, I ran some quick calculations of volatility for the Dow 30 stocks. The results confirmed that volatility had increased dramatically in 2008 (through October 17th) compared to 2007, 38.99% vs. 21.80% (based on a daily volatility calculation using adjusted closing stock prices), an increase of approximately 80%.
To see how this dramatic increase in volatility might impact stock options, I then looked at volatility for the same group of companies over two three-year periods (i) 1/1/2006 to 10/17/2008, and (ii) 1/1/2006 to 12/31/2007. Not surprisingly, the rise in volatility that showed in the year-over-year comparison also echoed in the three-year volatilities, 24.11% vs. 19.84%, an increase of approximately 22%.
So, how might this impact the future use of stock options? Options are going to become more expensive to use and, if the market is in a prolonged bear market (such as that between 1966 and 1982), there may not even be much upside potential. Additionally, the new bailout-related mandates, including admonitions against incentives that encourage “excessive risk,” are also likely to have an adverse impact on the use of stock options.
However, the stock prices themselves will be depressed compared to prior periods, so wouldn’t the impact of increased volatility be offset by the decrease in the stock price? To test that I took the closing median stock price of the Dow 30 companies for each of the 3 year periods, $33.33 for 1/1/2006 to 10/17/2008 and $46.99 for 1/1/2005 to 12/31/2007, and then used the medians of the most recent FAS 123(R) assumptions disclosed by the Dow 30: risk free interest rate of 4.80%, dividend yield of 2.33% and an expected life of 6.0 years, and ran a Black-Scholes model of a “median” stock option for the Dow 30 in each three-year period.
The results confirm that the relative cost of a stock option will increase as a result of the increase in volatility for 2008. The Black-Scholes values were $8.45 (25.36% of face value/median stock price) for the 1/1/2006 to 10/17/2008 period and $10.45 (22.23% of face value/median stock price) for the 2005-2007 period, representing a 14% increase in the percent of face value/median stock price. So, even though the stock price has dropped as has the Black-Scholes value, the FAS 123(R) cost for stock options will represent a larger percent of the stock price.
Is this the death of stock options? Probably not. But, their increased cost, possible limited upside and the new mandate to avoid excessive risk in compensation programs (at least for those companies participating in the financial bailout) will cause a good number of companies to reconsider their use of stock options, and, most likely, many of them will veer further away from stock options and towards full value awards like restricted stock units and performance shares/units. In these challenging times it will be harder to justify leveraged incentives that can result in greater upside potential than is the case for shareholders whose equity participation has come the old fashioned way – by buying full value shares.
A short while ago, Corp Fin Director John White announced he will be leaving the SEC at the end of the year after working at the SEC for nearly three years. I understand that John will return to the law firm for which he spent over 30 years, Cravath Swaine & Moore. Like his predecessor, John has overseen an enormous amount of regulatory change on his watch – and we thank John for all he has done for the corporate community (and for us by speaking out about responsible executive compensation disclosures).
Last Friday, the WSJ ran this front page, top article – entitled “Banks Owe Billions to Executives” – reporting that the big financial institutions getting capital infusions from the Treasury Department owed their senior executives more than $40 billion for past years’ pay and pensions as of the end of 2007.
The article notes that “Few firms report the size of these debts to their executives. (Goldman is an exception.) In most cases, the Journal calculated them by extrapolating from figures that the firms do have to disclose.”
What the WSJ would be surprised to hear is that many companies don’t even report the size of these debts to their own compensation committees and boards – because they don’t conduct a wealth accumulation analysis! In our “Wealth Accumulation Analysis” Practice Area, we have a number of sample tables to help you get started, including this new “Wealth Accumulation/Full Walk Away Amounts Chart” courtesy of Watson Wyatt and Deloitte Consulting.
In his “Icahn Report” Blog, Carl Icahn recently threw down the gauntlet and blamed compensation consultants for excessive CEO pay. Here is an excerpt from his blog:
A major reason executive pay packages are ballooning is because of the incestuous relationships between boards and CEOs who conspire to give lucrative pay-and-perk packages to each other. But it is also due to the egregious use of “compensation consultants” that soak up multi-million dollar fees to provide strategic counsel to boards and in addition advise ever higher pay packages to top managers they presume to oversee – whether they perform well or not.
We’re ready to see some responses from those toiling in the fields. I know Carl has missed the mark, how about you?
Recently, Equilar released its latest trend reports regarding stock ownership policies. Below is a summary of the full reports (which can be purchased from Equilar here):
1. Executive Stock Ownership Policies
– The prevalence of Fortune 250 companies with publicly disclosed executive stock ownership policies, including ownership guidelines and/or holding requirements, increased from 80.9% in 2006 to 82.6% in 2007.
– Ownership guidelines remain the most prevalent form of ownership policy, appearing at 78.0% of Fortune 250 companies in 2007. In 2006, 75.5% of companies disclosed guidelines.
– For Fortune 250 companies with ownership guidelines, most choose to define ownership targets as a multiple of base salary. In 2007, 79.8% set their targets in this fashion.
2. Director Stock Ownership Policies
– The prevalence of Fortune 250 companies with publicly disclosed non-employee director stock ownership policies, including ownership guidelines and/or holding requirements, increased from 77.6% in 2006 to 78.9% in 2007.
– Often, ownership guidelines and holding requirements can be used in tandem to promote equity ownership. Among the Fortune 250, the prevalence of companies with both types of policies for non-employee directors increased from 12.8% in 2006 to 16.2% in 2007.
With November just around the corner and, for many companies, perhaps the last compensation committee meeting of the year scheduled in the next two months, it is now critically important to start thinking about your Compensation Discussion & Analysis for the 2009 proxy statement. There is still time for companies and compensation committees to take appropriate actions that can serve as the foundation for the analytical disclosure in the CD&A that the SEC and others expect. Many of these actions were discussed in detail last week at our two conferences, “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference” and the “5th Annual Executive Compensation Conference,” as well as at the “16th Annual NASPP Conference.”
To kick off the CD&A panels at the 3rd Annual Proxy Disclosure Conference, I noted my view that CD&A is really at a crossroads this coming proxy season. In many ways, the 2009 proxy season will likely determine whether CD&A slides into irrelevance like its predecessor, the old Board Compensation Committee Report, or whether it will finally provide the crucial analytical background to the compensation numbers that was intended all along. I don’t think that the possibility for irrelevance is overblown – complaints are surfacing that institutional investors are skipping over CD&A and going straight to the compensation tables, because they are not finding useful information presented in the CD&A. This trend was confirmed by Pat McGurn and others on “The Investors and Proxy Advisors Speak” panel at the 3rd Annual Proxy Disclosure Conference. This trend, in my view, can only lead to trouble, because investors are only getting part of the story if they skip the explanation and rationale that is supposed to be included in the CD&A.
Several factors will certainly contribute to the focus on CD&A in 2009 and beyond. If some form of say-on-pay is enacted and investors are given the opportunity to cast an advisory vote on the CD&A and the other compensation disclosures, then what is said this next proxy season will be an important backdrop for voting decisions, even if mandatory say-on-pay votes don’t occur until 2010. Further, while the recent Emergency Economic Stabilization Act and the TARP program implementing that legislation included executive compensation provisions that are only applicable to participating financial institutions, the existence of these provisions in the federal legislation are reason enough to compel companies to consider taking action now on executive pay concerns – whether analogous to the Act’s provisions or in other areas that remain a significant focus of investor criticism.
As Broc noted in the blog last week, John White’s speech at our 3rd Annual Proxy Disclosure Conference included White’s views on how the executive compensation provisions of the TARP may be instructive for other companies on how they should approach their executive compensation programs. Finally, with 2008 being a year when many companies faced significant challenges given the markets and the economy, all eyes will be on the CD&A in the 2009 proxy to see what compensation committees did do – or did not do – to address executive pay in the face of difficult conditions.
It may be that we now find ourselves at a broader tipping point on executive pay, marked by the recognition of some pay excesses in recent federal legislation and a clearly rising level of anger among investors over how compensation decisions may have contributed to the current situation.
Now it is up to all boards and their advisors to take the public and shareholder anger to heart when making compensation decisions. These developments make this year very different from what we have been dealing with in the past. As a result, disclosures must be different, and the company and compensation committee actions described in those disclosures need to be different. I don’t think that this is a situation where you can just look at the disclosure in a vacuum and try to tweak it here are there – there needs to be some deep consideration in the next two months as to how the compensation policies and decisions are going to be explained to investors in 2009.
For more on John White’s speech and how executive compensation disclosure should be changing in 2009, take a look at Mark Borges’ initial blog and follow-up blog on the 3rd Annual Proxy Disclosure Conference.