One of the beauties of having so many experts participating on one blog is the dialouge it will create among them, as well as with their audience. For example, George Ince of Davis Polk & Wardwell notes: Peter Hursh’s blog on the “bottom’s up” technique of establishing director pay is a useful starting point – but I would suggest that it undervalues the director’s services since I think there should be some additional pay for directors to account for their fiduciary duties and potential liability and exposure in performing the role of a
director, which are not present for the other types of advisors he uses for the fee measurement.
More Performance Target Disclosure Stats
Back in early April, Equilar released a study regarding how many of the Fortune 100 disclosure their performance targets (compare the stats in Watson Wyatt’s survey, noted on April 10th in this blog):
– From 2006 to 2007, the prevalence of Fortune 100 companies disclosing actual performance targets for their executives under all types of compensation plans increased from 55.8% to 66.4%.
– Among Fortune 100 companies with annual bonus plans for executives, 68.3% disclosed the actual performance targets which must be achieved to generate payouts. Last year, 44.4% of Fortune 100 companies with such plans provided a comparable level of detail.
– The study also finds that 81.0% of awards which measure short-term performance, benchmark results solely against internal company goals. Conversely, 60.9% of long-term performance awards use relative measures as a component in determining payouts.
I’m often asked by directors of smaller publicly-traded, or even private companies whether I think their pay for board service is competitive. Most directors, like your boss and your spouse, are of course overworked and underpaid.
I respond by taking them through what I call the “bottom’s up approach” to setting pay for directors. I ask the director to estimate the number of hours he or she spends each year on different board activities – – mosty, participating at board meetings, at committee meetings, at a board retreat, on conference calls, and in individual meetings, as well as in preparing for these sessions (although I tell them to exclude travel time). Say that serving as a director of ABC Company takes about 100 hours per year. Then I ask the individual: what is the average hourly rate of the senior outside advisors to the Company and its Board – – that is, its attorneys, accountants, business consultants, marketing specialists, etc.
The answer is often, for smaller companies, about $350-$400/hour. Then I say, “Well, for you that’s 100 hours times $350-$400/hour, or $35,000 – $40,000 per year as an independent contractor – – i.e., as a non-employee director of ABC. How does that compare to the sum of your retainer, meeting fees and annualized stock opportunity?” The answer, in every case I’ve had so far, is that what the inquiring director is getting paid – – usually about half in cash retainers and meeting fees, and half in stock – – is very close to the bottoms-up answer. My experience is that (i) this reassures the director that his or her pay is fair and (ii) once an individual thinks that the pay for his or her job is fair – – and this is especially true for outside directors – – then that person does the job for other reasons.
Recently, we issued this “Early 50 Filers” report, which analyzes executive compensation disclosures by 50 companies that filed proxy statements early in 2008 and that had two years of experience under the SEC’s expanded reporting rules. The data covers disclosures related to: corporate performance metrics; benchmarking practices; consultant independence; corporate governance; readability; and length.
For purposes of having a little fun – and putting aside the fact that NBA players are paid based due to business decisions just like any other decision to invest in an asset to earn more (which is very different from the process by which CEO pay is set – check out my recent article that imagines if NBA players were paid like high-performing executives. I use the article to make some points about how properly designed pay packages would result in more pay-for-performance.
Interesting article from the Washington Post last week speculating on what the future may hold for “Say on Pay” votes in light of a fairly low success rate this season. Some pundits speculate having a simple “yes” or “no” vote on pay packages is too much of a blunt instrument – and suggest these votes may need to be retooled to focus more clearly on the elements of the pay package.
From our perspective, when advising clients to do a better job in their CD&A explaining how their program accomplishes their goal of “pay for performance,” we suggest they be mindful of a future that could involve “Say on Pay.” Our point to them is: Why wait until the vote is pending to make your arguments to shareholders? Why not be doing the analysis every year to prove the point?
Of course, performing an analysis of how the pay your executives ultimately earn stacks up to that of your peers – and then comparing what your executive’s earn versus how the company performed versus peers – is time-consuming and may yield an answer the client might not like. But without doing the analysis, in our view, it is impossible to make a statement that your plan pays for performance.
In a recent symposium we attended on the issue of “Say on Pay,” each of the proxy advisory firms who spoke on this issue acknowledged their “yes” or “no” recommendations would be based on many different factors, the most predominant of which will be . . . wait for it . . . pay for performance. There is still time for companies themselves to help define what this means, and by doing so in their CD&As, perhaps Corporate America can drive the definitions rather than the advisory services.
Let’s not forget, both Barack Obama and Hillary Clinton have proposed legislation to mandate a non-binding “Say on Pay” vote, so this issue will continue to be debated throughout the upcoming election season – and perhaps beyond that.
A recent consulting assignment highlighted the need to push back when faulty thinking threatens not only outcome but the process of executive pay determination. A CEO pushing for a renewal of his expiring 3-year contract felt ‘under-optioned” due to an odd history of Board decisions. He was requesting a 3-year front-loaded option grant and a fixed 3-year deal with all options vesting during that period. He hit a stalemate with the CC who felt something wasn’t right about his request and needed an independent viewpoint.
The outcome was one that satisfied all parties: an option grant 3x the normal number of shares in annual grant but with a 25% premium price and vesting consistent with a series of three annual grants (11-22-33-22-11%) rather than the company’s standard 3 x 33% vesting. He gets the advantage of the front-loaded grant only if the company outperforms.
The process of getting to this point was difficult. We emphasized a scenario-based tally sheet and analysis to refocus the CC and the CEO from the new option grant potential gains to the total gains from previous options plus the new one. This changed both parties’ thinking from the vesting-date based analysis to the post-vesting “tail” value of the options.
We all face the inertia of the old-school notion that “pay is annual” (reinforced by the SEC and financial reporting cycles) and that “value ends at vesting or expected life” (reinforced by FAS123R). I frequently emphasize the idea of “checkerboard pay” – every year looks different – and the cumulative uneven value of those patterns must be understood. Even more important now that the mix of SO, RS, Cash LTI, etc changes year to year and the pressure to retain options and/or shares has become an element of the pay package. The only way to understand the cumulative effects of decisions is looking back multi-year and looking forward multi-year.
With this client, I had to politely ignore both the Committee’s and CEO’s instructions to omit the previous option grants on the tally sheet because they were “irrelevant” – I guess that’s a little compensation consultant civil disobedience. When they saw the numbers with stock price projections, however, it changed everyone’s attitude and they requested that we show additional future years in the projection. Suddenly we weren’t talking about $2mm vs. $4mm but about $16mm vs. $18mm, and then $26mm vs. $30mm.
We had to emphasize a number of concepts to the Compensation Committee including:
– Truncation of option value is voluntary, not built into the option other than the term itself which is rarely a constraint. Vesting doesn’t end value accumulation, exercise only ends the tax-withheld part of value accumulation, and employment termination only affects the unvested AND unprotected (unaccelerated) part of value accumulation.
– Stock price projections are estimates, but better estimates than Black-Scholes values, and emphasize the “shareholder value commission” aspect of equity-based pay. If the projections are wrong the pay is self-correcting. The dollar value projections have to be accompanied by percent-of-outstanding analyses.
– We never, ever, ever, use accounting numbers in pay analysis. Options aren’t worth less because you paid an actuary to reduce your BS assumptions (pardon my acronym). RSUs are not worth face value at grant, they’re worth more. Conversely, performance shares are not worth the maximum payout just because you’re accruing that so you can reverse some of the expense later when EPS needs a boost. The complexity of LTI numbers require some thoughtful analysis, not FAS123R adherence.
– Despite the best efforts of “free agent” negotiators’ mentality, executive work is not professional sports and no one ever had to retire early from a knee injury sustained on a conference call with analysts. Let the sports analogy go. Shareholders should expect, and reward, continued performance-positive employment. And someone quitting at age 50 is not “retiring” they are quitting.
And yes, I’m still their consultant. Neither the CEO nor the CC fired me because I said “no”. But if they do, that’s fine too.
I recently wrote an article – “Long-Term Compensation Planning for High-Potential Employees” – whose theme is that a longer term view of rewards, focused on wealth accumulation, will be the competitive advantage companies need in competing for key or high potential talent for the future. In other words, simply providing competitive pay will not provide a sufficient advantage, and companies cannot continue to bid up wages for skills in short supply. I also observe and read that the talent management strategy of most big companies is shifting back to an internal strategy (make vs. buy). With this shift comes the opportunity to again look at levels of pay, and especially wealth accumulation, longer term. Let me know what you think.
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