The typical performance-based LTIP runs three years, with performance being measured at the end of the period. A three-year time frame encourages a longer-term performance focus as well as retention. However, a three-year term requires the ability to identify longer-term goals with some precision, a process that is usually fairly standard for large, stable or mature organizations.
The situation is different for smaller firms, high-growth companies and those likely to experience a major organizational change in the near future such as a sale or acquisition. Faced with uncertainty about their long-range performance, they are likely to be more comfortable adopting a shorter horizon that allows them to pinpoint the kind of realistic and predictable goals most likely to drive executive behavior.
As a way to add the long-term performance perspective favored by investors and encourage retention, those companies may incorporate a vesting period after the performance period is completed. Typically, companies in this situation might opt for a one-year performance period but also encourage a longer-term perspective through the use of graded vesting over the next two years.
As you have read, Dick Grasso won his case against the New York Attorney General a few weeks back. But if you read the media reports closely, you will notice he won on a technicality – he won because the NYSE changed its “form” since the lawsuit was filed, from a non-for-profit to a public company (a dissenting judge argues that NYSE still has a non-profit subsidiary, and thus is still subject to the New York non-profit rules).
Thus, according to the New York State Supreme Court’s decision, the Attorney General didn’t have the authority to challenge his compensation anymore, and Dick gets to keep his money without any adjudication of whether the amount was reasonable, whether he breached his fiduciary duties, or whether he (or anyone else) ever did anything wrong or improper in connection with his compensation. So although Dick’s been saying he was “vindicated,” it’s hardly so.
So what does this mean for you? It reminds us that a proper clawback can save a company the embarrassment of a lengthy court battle – and many millions of dollars (reportedly, the Grasso lawsuit cost the NYSE more than $70 million in legal fees). It’s time for you to go back and read our Winter 2008 issue of Compensation Standards to learn the “Ten Steps to a Clawback Provision with “Teeth.”
We are pleased to note a recent pair of reports from The Corporate Library that note the trend of clawback usage on the rise; one report noting the upward trend generally (13% of companies surveyed have them now, up from a handful a few years ago) and one report noting how clawbacks are more common at larger companies.
The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices
We have posted the transcript from our recent CompensationStandards.com webcast: “The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices.”
John Wilcox on “Say on Pay” as a Listing Standard
My good friend John Wilcox and I have been corresponding on “say on pay” and he’s given me permission to post his following thoughts on the topic. John recently left his job as TIAA-CREF’s SVP and Head of Corporate Governance (although he remains a senior advisor to TIAA-CREF) to become Chairman of Sodali. John constantly travels around the globe and is an intense student of governance frameworks used in other countries:
I agree that federal legislation or SEC rulemaking would probably not be the best way to implement an advisory vote on executive compensation. Nevertheless, I think the advisory vote would work best if it were applicable to all companies, rather than just to the few who act voluntarily. The best means to achieve universality without becoming prescriptive would probably be for the New York Stock Exchange and Nasdaq to adopt a listing standard calling for an advisory vote.
For example, a shareholder vote is now mandated for equity compensation under NYSE Rule 303A.08, “Shareholder Approval of Equity Compensation Plans.” The rule is straightforward. It reads as follows: “Shareholders must be given the opportunity to vote on all equity compensation plans and material revisions thereof . . . .”
If this approach were applied to an advisory vote, it would be minimally invasive and would permit a range of proposal formats. The rule might be entitled “Shareholder Advisory Vote on Compensation Disclosure,” and might read as follows: “Shareholders must be given the opportunity to cast a non-binding advisory vote on compensation plans disclosed in the proxy statement.”
A rule stated in such simple terms would enable companies to customize their advisory vote proposals to suit their circumstances. My belief is that companies drafting compensation disclosures with a view to a “pass/fail” advisory vote would try harder to achieve clarity and to highlight features of concern to shareholders, such as strategic links to performance and the creation of long-term value. Experience with mandatory votes under NYSE Rule 303A.08 demonstrates that companies are capable of making a good case for equity compensation when a vote is required.
I think it is unwise to argue that an advisory vote applied universally would be overly burdensome to shareholders. Shareholders must already shoulder the burden of reading dense and opaque compensation disclosures. Complaining about this responsibility surely does not serve the cause of transparency and good corporate governance, nor does it inspire confidence in the diligence of shareholders. Instead, shareholders should be pressuring companies to improve the quality of their disclosure, to provide summaries and to explain how pay and performance are linked. Incidentally, I have never heard shareholders complain about the burden of disclosure and voting rights on equity compensation plans under NYSE Rule 303A.08.
A fair argument can be made that CD&As are too complicated and the links between compensation and value creation are not clearly articulated, thereby creating an unacceptable burden on shareholders to digest and make sense of the data. If this is true, it is company executives, boards and compensation committees – not shareholders – who should be accountable. Simplification, clarification and better explanation of how compensation drives performance should be the responsibility of companies, not shareholders.
Shareholders have to read and evaluate compensation disclosures. However, if a company’s compensation narrative is not clear and convincing, shareholders should send the drafters back to the drawing board. An effective way to do this would be through an advisory vote.
If we see the advisory vote as the means to push for better compensation practices and clearer disclosure, rather than a means to punish companies, the concerns of both companies and shareholders are largely eliminated.
After the IRS’s recent and unanticipated 162(m) PLR (200804004) and Revenue Ruling 2008-13 on bonus payments in a termination context, a new (more normal) ruling dealing with “officer” status came as a bit of a relief. As most compensation practitioners know, Section 162(m) of the IRC is a provision that provides for a $1 million limit on non-performance based compensation that a public company can deduct for its named executive officers.
The goal then is to structure covered executive compensation agreements to provide for “good” performance based compensation. That was the problem with the IRS’s recent 162(m) foray – which took the position that full bonus payments made upon an involuntary termination were not performance based. Of course, Section 162(m) also has strict “procedural” requirements, apart from tying “good” compensation to performance. One such requirement is the provision mandating that objective performance goals be established by a committee of two or more independent “outside” directors.
Dealing With “Interim” Officer Status
In Revenue Ruling 2008-32, dated June 16, 2008, the IRS addressed the issue of who qualifies as an “outside” director. The facts of the ruling are as follows: Public Company X’s chief executive officer (CEO) unexpectedly resigned in January 2008. In response, the Board of Directors of Company X appointed Director A to serve as “interim CEO” while the Board conducted a search for a permanent replacement CEO. The service agreement between Company X and Director A did not limit Director A’s authority as interim CEO, was for an indefinite duration, and provided for termination of service upon selection of a permanent CEO. On February 1, 2008, the Compensation Committee of Company X approved, and the Board of Directors ratified, a compensation plan for the period during which Director A served as interim CEO.
The plan provided for a base salary of $1 million, as well as participation in Company X’s executive bonus plan. On December 11, 2008, after Director A served as an interim CEO for almost a year, Company X announced that Employee F was selected as Company X’s new CEO. Director A received final, prorated compensation for services as interim CEO on December 29, 2008. Following December 29, 2008, Director A did not receive compensation from Company X, directly or indirectly, in any capacity other than as a director. In January 2009, Director A was appointed to the Compensation Committee of Company X. Director A had not served on the Compensation Committee before.
162(m) and “Outside” Director Status: The Ground Rules
The issue before the IRS was whether Director A would qualify as an “outside” director for 2009 and subsequent years under Section 162(m)(4)(C)(i), after having served as an “interim CEO.” Under Section 1.162-27(e)(3)(i) of the 162(m) regulations, an individual is an outside director if the director:
– Is not a current employee of the publicly held corporation;
– Is not a former employee of the publicly held corporation who receives compensation for prior services (other than benefits under a tax-qualified retirement plan) during the taxable year;
– Has not been an officer of the publicly held corporation; and
– Does not receive remuneration from the publicly held corporation, either directly or indirectly, in any capacity other than as a director.
In This Case: Disqualifying “Regular and Continued” Officer Status
Not surprisingly, in the ruling, the IRS relied on the definition of “officer” in the 162(m) regulations. That provision provides that “officer means an administrative executive who is or was in regular and continued service . . . The determination of whether an individual is or was an officer is based on all of the facts and circumstances in the particular case, including without limitation the source of the individual’s authority, the term for which the individual is elected or appointed, and the nature and extent of the individual’s duties.”
In this case, the IRS highlighted certain facts:
– Director A was not employed as CEO for a special and single transaction;
– Director A was in regular and continued service from January 7, 2008 through December 11, 2008;
– Director A was hired for an indefinite period; and
– Director A did not merely have the title of officer, but had full authority to serve as CEO.
Under the facts before it, the IRS determined that Director A was an officer of Company X and thus not an “outside” director for purposes of Section 162(m). Thus, Director A’s officership status tainted any chance of subsequent appointment to the Compensation Committee. He may as well wear a scarlet letter on his chest, at least for compensation purposes. The bottom line is that once a bona fide officer of the issuer, the individual is forever barred from qualifying as an “outside” director, absent a successor situation (of the sort described below).
Planning Around Disqualifying “Officer” Status
Is there any good news in this revenue ruling? Consistent with the 162(m) regulations that define “officer,” a one-time, short-term, limited role as officer should not taint the individual in question. Section 1.162-27(e)(3)(vii) provides that an “officer” means an “administrative executive who is or was in regular and continued service.” So there is some wiggle room in structuring interim officership status so as not to constitute regular and continued service. Working off the factors in the revenue ruling and regulations – what if we structured the interim CEO position for a finite period, to handle specific matters and with limited authority?
On a related note, practitioners should also remember that there is a well developed line of private letter rulings that say officership in one entity does not necessarily disqualify the individual from “outside” director status in the new entity. For example, in PLR 200423012, Director served as secretary of Corporation Y from Year a to Year c. In Year d, Corporation Y merged into Corporation X. Director served on the Board of Directors of Corporation X. Director received no remuneration from Corporation X except in his capacity as director. The IRS ruled that Director qualified as an “outside” director of Corporation X, notwithstanding prior offcership status at Corporation Y.
There are also situations where the individual in question served as officer, but only in a limited ministerial capacity. These facts alone did not preclude the IRS from ruling that the individual qualified as an “outside” director. For example, in PLR 9732011, Corporation A proposed that Director B serve as the second “outside” director on its Compensation Committee. Corporation A had been a publicly held corporation since Year Y. Director B was not a current or former employee of Corporation A and did not receive any compensation from Corporation A other than in his capacity as a board member. Director B had served as the corporate secretary for Corporation A since Year Z. Corporation A represented that Director B’s functions as corporate secretary were limited to attendance at board and shareholder meetings and that Director B’s duties were ministerial in nature, with secretarial duties performed by the assistant secretaries.
As stated above, Section 1.162-27(e)(3)(vii) of the 162(m) regulations provides that the determination of whether an individual is or was an officer is based on all the “facts and circumstances” in the particular case, including the “nature and extent of the individual’s duties.” Therefore, in this case, the IRS ruled that Director B qualified as an “outside” director because the nature and extent of his duties as an officer were strictly ministerial and “ceremonial” in nature.
Finally, a “tainted” former officer who continues to serve as a director may still be able to observe Compensation Committee activity in the context of a non-voting role. In PLR 9811029, the IRS allowed a stock option plan approved by a Compensation Committee which included “inside” directors, as well as two “outside” directors, to qualify for “good” 162(m) treatment, based on the fact that the “inside” directors would abstain or recuse themselves. The IRS ruled that after giving effect to the abstention or recusal of the “inside” directors, the corporation had a subcommittee of, at a minimum, two “outside” directors, and complied with Section 162(m).
– Michael Album, Partner, Proskauer Rose; Morgan Gold, a summer associate from Fordham University School of Law assisted on this blog posting.
Okay, so after reading Frank Glassner’s blog that tells me, contrary to everything I learned in school, that you can take it with you, and highlights pay excesses that are guaranteed to make some shareholders’ a bit crazed about executive pay, allow me to weigh in on whether it’s a great idea to allow shareholders to have a direct “say-on-pay” for public company executives.
I say that, despite some of the excesses that are out there—including compensation continuing beyond the grave—Frank’s blog may indicate why “say-on-pay” is unnecessary.
Current Status of Say-on-Pay
First, what’s going on with “say-on-pay”? Is it the NEXT BIG THING or just a passing fancy? According to Brian Foley, managing director of Brian T. Foley & Co., White Plains, NY, who spoke at the recent ALI-ABA Executive Compensation Conference in NY last month, not only is it not a passing fancy it’s likely to become law.
Both major party candidates, Senators McCain and Obama, have come out publicly in favor of “say-on-pay” votes by shareholders. Obama sponsored S. 1181, a counterpart bill to Rep. Barney Frank’s (D-Mass) H.R. 1257, which mandates a non-binding, advisory vote on executive pay packages.
On June 10th, Senator McCain decried the “extravagant” pay and severance arrangements offered to executives and promised to force companies to seek shareholder approval of their executive-pay plans. “Under my reforms,” he is reported to have told a small business group, “all aspects of a CEO’s pay, including any severance arrangements, must be approved by shareholders.”
Will this become law or is it just great sound-bites for the campaign trail? Who knows. I for one have long since given up handicapping anything in D.C. The odds aren’t there.
Analyzing “Say-on-Pay”
The more important question, it seems to me, is whether say-on-pay is necessary or even a good idea? I say “no” on both counts.
Is say-on-pay necessary? Read Frank Glassner’s blog. One take away from his blog is something we all know: compensation is becoming much more transparent. Everyone is reading these proxies and openly criticizing the more egregious practices. This may be viewed as a good thing and shows that the new rules appear to be serving their stated purpose.
And shareholders of public companies already have a say-on-pay in a number of significant ways. First, all major exchanges require shareholder votes for equity plans (where most of the real money is) and any significant changes to those plans. Code Sections 422 and 162(m) require shareholder approval of plans that grant incentive stock options or may pay certain officers of public companies over a $1M annually, respectively.
Third, and most importantly, Shareholders can “vote the rascals out” if they think their directors are paving the streets with gold.
Sophisticated shareholders can and should read carefully the information required in the company’s proxy statement as part of the Compensation Discussion and Analysis. This will give them the fully story on compensation, including, of course, big pay packages that executives can figuratively take to the grave.
Just as importantly but often overlooked: if they read the CD&A thoughtfully, they will discern the arduous process employed by thoughtful compensation committee members as they attempt to figure out the “right” amount to pay their executives. While its currently in vogue for some shareholders and advisory groups to claim that compensation committee members are not doing their jobs, as a veteran of many compensation committee meetings, I can report that nothing is further from the truth. Shareholders who read the CD&A should question the wisdom of replacing the thoughtful process engaged in by committed individuals with the democratic process.
While some proponents of say-on-pay call voting directors out the “nuclear option” it is a very real option and not at all “nuclear.” What’s nuclear about exercising your voting right as a shareholder?
Besides being unnecessary, it’s not even a very a good idea. Say-on-pay—even the non-binding variety most often touted by proponents and approved by Apple and others – can not be in the long-term interest of successful public companies.
Not a Good Idea – and Not in Long-Term Interests of Shareholders
Why? Because it seriously blurs the line between those who are charged with running a company and those who are investors. A profit-making enterprise is not a direct democracy and treating it like one will set us off on a ridiculous downward slope. If “say-on-pay” initiatives pass, what’s next?
– “Say-on-way,” in which shareholders provide advisory votes on capital budgets and strategic planning?
– “Say-on-stay,” in which shareholders hold a referendum on who is to be hired and fired? Brilliant. Perhaps then candidates for positions in public companies will run campaigns for their positions. Position statements can be prepared. Polling can be done. Debates between leading candidates for CEO can be held. Professionally prepared commercials can be streamed to desk-tops of shareholders around the globe, ending with the would-be-CEO asserting that he is “Bill Carsonand he approves this message.” Imagine the ruckus when a minor (not leading candidate) demands his right to openly debate for the position of CEO of General Motors or Exxon.
Proponents on say-on-pay want to ignore the slippery slope argument, but offer no real response as to how say-on-pay is any different than having a direct, advisory say on any other aspect of the operation of a public company.
This blurring of the lines between shareholders and the boards they elect will not lead to better run companies–it will lead to companies that better run.
– Peter Marathas, Partner, Proskauer Rose (Boston)
We just had our monthly call among global benefits attorneys, and I heard that the European Union is hotly debating the regulation of executive compensation. Apparently, the impetus comes from the financial services sector, in response to the subprime meltdown. In the U.S., executive pay seems more broadly in the public crosshairs – with the legislative proposals focused on public companies (in the form of non-binding “Say on Pay” votes by shareholders to approve or disapprove of disclosed executive compensation), and on private companies (regarding the timing of taxation for equity-based compensation provided through private equity, aka hedge funds).
Although an election year would not seem likely to bring consensus for any law, I would not be surprised to see traction for ones such as these that ostensibly clamp down on executive pay. We saw this in 2004 when IRC Section 409A passed . . . in part because it was politically incorrect to defend executive pay. The question should be: will the U.S. be better off in the long-term if the legislation being proposed winds up passing?
“Say on pay” strikes me as warranting broad-based opposition from corporate America, if only to avoid the slippery slope of having shareholders vote on any front page issue of the day. Executive pay may be the cause celebre this year, but next year it could be outsourcing or right-sizing, or any number of emotion-laden issues. Boards of directors are elected to decide these hard issues, and it seems to me that full disclosure ought to suffice to enable shareholders to voice and express there interests. Say on pay is mere opportunistic piling on, in my view. As a result, if the legislation gets momentum, I’d hope voices of reason emerge to objectively assess its implications.
Mike Kesner’s recent posts on relative performance measures and peer group selection led to a spate of emails among our consultants at Watson Wyatt. Yes Broc, folks do read this blog! Here is our collective group-think, as articulated by Michael Marino, one of our consultants who focuses his practice in these areas:
Relative performance measures give the appearance of objectivity and simplicity but are very difficult to implement correctly for two reasons:
1. Identifying performance peers is a significant challenge and many firms underestimate this challenge.
2. Metric definitions can vary significantly and they are often adjusted from GAAP accounting to reflect specific factors unique to a particular company.
Peer Group Challenges: Business economics are often very different within a single sector or industry and executive performance peer groups often do not reflect these economics. For example, in the petrochemicals industry, upstream, midstream, downstream and fully integrated companies will have very different business economics. It is difficult to find two or three companies that have highly comparable businesses in any sector, let alone 10 or more, which is a common number for relative performance assessment.
Investment bankers and investment managers understand the limitations of peer groups as a valuation method. This is why they rely on multiple valuation approaches to assess business value. Executive performance assessments should recognize this limitation and should be more robust than simply measuring relative performance (see solution below).
Accounting and Financial Reporting Challenges: Financial metric definitions are often inconsistent between companies and they are often measured on a non-GAAP basis. It is very difficult and sometimes impossible to put companies on equal footing if a company uses a non-GAAP measure for incentive compensation purposes. In many cases, the non-GAAP measures reflect adjustments aimed at removing accounting distortions to better focus on business operations.
Consider also the effect of acquisitions on business performance and relative comparisons. Acquisitions can boost revenue growth and reduce return measures in the short-term thereby distorting performance in the short-term when the benefits of the acquisition are still uncertain.
One Solution: We recommend that our clients counterbalance absolute and relative goals in incentive plan design. Consider measuring absolute financial performance and relative financial performance on the same measure (e.g., absolute EPS and relative EPS) Companies should also consider balancing absolute financial performance with relative stock price performance or TSR. This way, operating performance is viewed in the context of the market’s expectations for future financial performance.
– Ira Kay and Steve Seelig, Watson Wyatt Worldwide
I just added ten executive compensation lawyers to the mix of this new – and popular blog. With the group of bloggers now comprising of twenty compensation consultants and these ten lawyers, I have renamed the blog: “The Advisor’s Blog.” For those who haven’t, you should input your email address on the left side of this blog – so you can be alerted when a new entry is made.
Mark Borges struck “Gold, Jerry, Gold” in his analysis recently of the new Item 402 interps in his “Proxy Disclosure Blog.” Meanwhile, Mike Melbinger continues to deliver on his “Melbinger’s Compensation Blog,” last week covering a new IRS revenue ruling on Section 162(m).
In-House Counsel’s Role in CEO Pay Setting Process
In this podcast, James Williams, General Counsel of Liquidity Services, provides insights into the role of in-house counsel in the executive compensation setting process, including:
– How much of your time do you spend on compensation-related issues?
– What is your role in scheduling, attending and preparing for compensation committee meetings?
– Where do you think you add the most value in the process?
– How do you handle the tricky issues of supporting the board as well as supporting senior management?
The Latest Compensation Disclosures: A Proxy Season Post-Mortem
We have posted the transcript from the popular webcast: “The Latest Compensation Disclosures: A Proxy Season Post-Mortem.”
With the 409A documentary compliance deadline fast approaching (December 31, 2008), companies are under the gun to complete the arduous process of identifying and analyzing all arrangements (written and unwritten) that might possibly entail “deferred compensation” as expansively defined under Section 409A. There are many rocks to look under! Don’t overlook some of the less obvious sources, such as:
– informal offer letters to employees that may promise severance pay, equity grants or accelerations, post-termination health insurance, continuation of other employee benefits, or reimbursements of various types
– “informal” bonus arrangements that may need to be reduced to writing and contain a payment deadline to assure the availability of the short-term deferral exemption
– stock unit awards or performance shares (as opposed to restricted stock grants), which are not categorically exempt from 409A but can often be drafted to comply with 409A or meet the short-term deferral exemption
– reimbursement arrangements, which turn up in all types of unexpected contexts – such as, to list just a few: (a) an agreement to reimburse the expenses of an employee for cooperating with the company after employment as to lingering litigation matters, (b) agreements to reimburse legal expenses incurred by an employee in seeking to enforce an agreement with the company, or (c) even a monthly car allowance or payment of club dues
– (to get a bit more exotic) reverse back-to-back payment triggers for compensation to employees of hedge fund managers (i.e., where the hedge fund manager, as service provider to the hedge fund, gets paid upon termination of the hedge fund and uses that event as a trigger to make payments of deferred compensation to the employees of the hedge fund manager). This is the inverse of the “back-to-back arrangements” that are explicitly permitted (if drafted correctly) under Treas. Reg. §1.409A-3(i)(6).
The best time to start the 409A documentation process is several months ago. The second best time is TODAY. Remember that even after you identify the documentary “fixes” needed to comply with or be exempt from 409A, you must leave time to:
– organize the whole story for presentation to the Board or Compensation Committee for consideration and approval where required
– explain the ramifications of 409A to employees who have contractual arrangements that are implicated and outline any choices such person may have (such as whether or not to agree to a change in the “good reason” definition in order to avoid a six-month delay in payment)
– allow service providers to consult their own counsel for advice, where they are being asked to consent to changes to an agreement.
The one-year reprieve we got last October doesn’t seem as long as it once did.
In recent days, we have been inundated with sensational coverage of lucrative benefit packages to be paid to the estates of senior executives upon their death. These so-called “golden coffins” are generally contractually stipulated arrangements that range from salary continuation and life insurance payments to accelerated vesting of equity, often a big-ticket item for long-tenured executives, and (believe it or not) even post-mortem car allowance payments.
The discovery of these spectacular death benefits may be front page news, but their existence dates back to prehistoric corporate times. The recent changes in SEC disclosure rules on executive pay have forced companies to very publicly reveal the outsized deathbed gifts being lavished on top of the giant salaries, as well as panoply of expensive and often embarrassing perks.
These egregious types of executive pay arrangements are yet another example of how times are changing in the world of corporate governance. It also seems that some of the most striking examples in recent media coverage are the result of legacy deals cut many years ago, during the days when smoke-filled rooms may have obscured the objectivity of executive compensation decision making that may very well have been based on well intentioned business or estate planning goals which shaped senior executive employment contracts.
It should be noted that Compensation Design Group, Inc. (CDG) doesn’t often see these types of benefits, nor would we expect to see them in today’s senior executive contracts. In fact, we find ourselves in the midst of an inevitable slow-moving, high inertia trend towards overall belt-tightening of executive contracts. Severance multiples are declining, restrictive covenants are far more common, and compensation arrangements are written to be clearly defined and easily understood. Most importantly, the provisions in fairly designed executive contracts are able to withstand the test of reasonableness necessitated by proxy disclosure, as well as the public outcry of myriad interested parties.
Increasing regulatory oversight, congressional hearings, SEC disclosure, media attention, and rapid changes in corporate governance guidelines, are shining a white-hot spotlight on these types of executive compensation, and, on a go forward basis, directors will need to justify any benefits and perquisites given exclusively to senior management.
Consider Brian L. Roberts, the CEO of Comcast. Should Mr. Roberts be so unfortunate as to die while in office, his life would end, but his salary would continue. In fact, it would continue for five full years after his death, and yes, during that period, he would also collect his annual bonuses.
James M. Bernhard Jr., CEO of the Shaw Group has similar arrangements in his contract. He gets an extra $17 million dollars in exchange for a promise not to compete with the company for a period of two years following termination of employment. The payment is due even if Mr. Bernhard dies while on the job. No one quite knows how he is going to compete from the grave, but if he can do it, he’ll be forever known as “Lucky Jim”.
When XTO Energy CEO, Robert R. Simpson, kicks the bucket he’ll find that his pail is filled with the proceeds from a $3 million dollar insurance policy. It’s a skimpy reward – even for a dead man – but don’t worry about Bob. Had he died on December 31 of last year, he could have also taken a $111 million “bonus” with him to the grave, plus $20.5 million in instantly vested shares, plus – let’s be fair here – $4.4 million in salary. And, if you think you can’t take it with you, Simpson’s death triggers an additional $158,400 payment listed as a “car allowance.”
Hey, fashionable as it may be, you don’t expect the CEO of XTO Energy to drive through the Pearly Gates in a Toyota Prius, do you?
Eugene M. Isenberg, CEO of Nabors Industries, has himself lined up for over $275 million dollars as his last day payday in this world – an amount that is actually more than the entire 2008 first quarter income for Nabors. That pot of gold at the end of the rainbow must be looking pretty good to Isenberg who is 78 years old. The concept of making more than a quarter of a billion dollars simply for giving up breathing must be very attractive. Fortunately, Isenberg received over $500 million in compensation from 1992 to 2007. That probably took the edge off all that heavy breathing he had to do.
Even for an executive pay consultant, there’s a lot not to like about golden coffin deals. Are we outraged by these “bad example” CEOs running amuck while the American economy is running aground, making our jobs as professionals terribly difficult, putting all of the incredibly hard working CEOs and their boards of directors in a bad light, or are we just angry and upset because they make more dead than we ever will when we’re alive?
Defending significant payments to the dead has not been easy for corporate compensation committees – or the boards that they sit on. Most companies defended their golden coffin practices as “an appropriate way to take care of an executive’s family after an unexpected death” however; they also noted that those benefits were “negotiated as part of an executive pay package that has many components”.
Note to our readers: If you earn less than $50 million a year, alive or dead, don’t even try to understand these “executive pay package components.” They’re way beyond you. You probably don’t even understand why it’s necessary to shovel on the six and seven figure golden coffin perks to retain a top executive who is six feet underground. As in “I don’t care if Jim is dead. I don’t want him working for the competition!”
By now, I’m sure you’ll agree – it’s definitely time to start holistically reviewing your company’s executive contracts for such provisions.
We could rant and rave over these terrible executive pay provisions, but I have a better idea. The next time you get your annual review, and your supervisor dangles a 4% raise before your red, swollen eyes, ask if you’re worth more to the company dead or alive. Considering the cost of all your shortcomings, company management will probably be glad to double or triple your salary if you add “a quick painless death” to your goals and objectives.
Maybe you really can’t take it with you, but with the pittance they’re paying you to stay, you might as well try.
Allow me to introduce myself – Michael J. Album – a partner at Proskauer Rose practicing executive compensation law in the firm’s Employee Benefits and Executive Compensation Group. This is my first posting on this blog.
Following a tough week on 409A issues, I was having lunch in NYC with Arnold Ross and Norman Ross, principals at The Ross Companies, an exemplary benefits and executive compensation consulting firm. Arnold (father) and Norman (son) have about 65 years of compensation experience between them, and are quite knowledgeable in their chosen field.
During our conversation on compensation injustices, Arnold asked me why vested options generally expire within one year of the death and/or disability of the grantee, or in some cases within 180 days of the event. Norman politely pointed out that there should be no early expiration under such circumstances and the option should continue through to the end of the term. Anything short of a full term would simply be “punitive.”
How Do Companies Handle Death/Disability?
As we know, many companies either allow for a 180-day extension/exercise period or one-year extension/exercise period following the death or disability of the grantee. Some companies do provide for longer exercise periods. Some examples: at Chevron, the effect of death/disability on the expiration date of a stock option depends upon the age and length of service of the employee. Long term Chevron employee (i.e. one whose combined age and service total at least 90 or who is over 65 with at least one year of service) get accelerated vesting and retain the full term to exercise vested options.
Shorter term employees (i.e. those whose combined age and service total at least 75 or who are over 60 with at least one year of service) get pro rata vesting over a three year service period from date of grant and have five years to exercise their vested options or the remainder of the original term, whichever is shorter. All other employees forfeit unvested options at the time of death/disability and have only 180 days or the remainder of the original term (whichever is shorter) to exercise their vested options.
As stated in their 2008 Proxy Statement, Chevron’s policy of full/partial vesting (absent misconduct) is a “reflection of our belief that our equity and benefit programs should be based upon a career employment model ….” (See page 46 of Chevron’s proxy statement.)
At General Motors, vested options remain exercisable for the full remaining term under applicable retirement provisions; outstanding options vest immediately upon death and remain exercisable for three years from the date of death or for the remainder of the original term, whichever is shorter. (See page 48 of GM’s proxy statement).
Why Not Take a More Generous Approach?
The point of the approach taken by Messrs. Ross was this – the executive had assumed the risk of devoting his/her service to the issuer, and the issuer had an option on the executive’s work life – if the executive resigned prior to vesting, he/she suffered the economic risk through forfeiture of unvested options and a limited 90-day exercise period. Death/disability were involuntary events – why deprive the executive’s estate of the upside on the remaining option term?
I responded that the issuer was not an insurer, that it was “unfair” for the disengaged executive (or his/her estate) to benefit from the efforts of the new executives who stepped into handle matters and that the aggregate effect of “dead man”/“dead person” options could eat into available “head room,” making it more difficult to grant new equity to active employees. Companies would also be concerned about the administrative issue of dealing with widows and orphans holding options for the remaining term. Besides, this is the way it has been done for years.
Messrs. Ross shook their heads. Think out of the box. Sure the WSJ had just run an article highlighting criticism of huge cash “severance” payments to dead executives. But this wasn’t cash, this was equity. The number of dying/disabled executives was a limited universe – not likely to really affect available equity. The FAS 123R option expense changes were not going to be increased in any practical sense, since the traditional Black-Scholes “fair market value” pricing model uses company wide historical exercise data – which is not likely to be impacted by a few estates holding options to term.
– Michael Album, Partner, Proskauer Rose; Ishai Mooreville, a summer associate from the University of Michigan Law School assisted on this blog posting.