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.
Broc recently asked me whether I thought companies are making any changes to their annual incentive plans in light of today’s adverse economic circumstances. Indeed, there are plenty of recent stories about companies doing just that. And according to news reports, these adjustments really frustrate shareholders.
Adjustments or plan changes regularly happen on the downside, and rarely, if ever, on the upside. When things are going well, CEO’s and other executives earn a lot of money. Some deserved – and some because of their good luck (think housing boom). When the company’s fortunes turn south, and shareholders take the hit, executive pay often stays close to their high levels.
You hear the executives say, “our most talented people will leave” or “they will not be motivated” or “we need to keep them focused, or else things will be even worse.” While this may be true in limited situations, that is why there are retirement programs, TVRS awards, base salary and other arrangements to provide some level of pay certainty and help to ensure retention.
I remember a client with an uncapped bonus having a windfall year, and the CEO voluntarily agreeing to reduce the bonuses from 400% of target to 225%. He said he wanted to save it for a rainy day when the company was not performing so well against its goals. This is rare, and requires having leadership trump immediate gratification and greed.
Undoubtably, some will also argue that given the short tenure of CEOs and other senior level executives, they have to try and grab every buck they can since they only have 3-5 years to make it. Life can be tough!