I recently blogged about Part 1 and Part 2 of a three-part series on clawback policies by WTW. In Part 3, WTW focuses on whether and how companies should prepare in advance to ensure they have the ability to clawback compensation from officers if the need arises.
First, the article notes that companies should not expect to be able to rely on the rule’s “impractical” exception as shareholders, proxy advisors and the press will expect companies to have a mechanism in place to ensure that earned compensation is within reach in the event of a future restatement. This is easier for current officers, of course, for whom future pay provides a ready source of funds but, to move quickly in the event of a restatement, WTW suggests companies consider adopting a policy identifying compensation sources to be pursued first in the event of a clawback—such as shares held pursuant to stock ownership guidelines.
Former officers present the greater challenge. Here’s an excerpt from the article:
Once an officer departs, the company often does not have access to a ready source of funds to effectuate a clawback within its direct reach. There are exceptions: When options remain outstanding, full-value shares are not settled until a later date (e.g., the end of a performance period) or when existing deferral arrangements delay payment until some future date. But we expect that most companies will have to confront the obvious question about whether they should defer a portion of officer compensation for a period sufficient to facilitate a clawback in the event the officer terminates employment.
Companies wishing to adopt this approach must resolve certain issues first. The predominant one is that current officers can become former officers very quickly, and often no compensation is available to defer once they leave. For example, if annual bonuses have a “must be present to win” provision so that payment happens only for a current employee, no funds will be available for a departing officer who leaves before that date or if that office leaves on that date when the bonus is paid. Similar rules apply for most, but not all, long-term incentive plans.
The article goes on to identify other challenges presented by a mandatory deferral, including 409A and how to compute an appropriate deferral amount. Many companies may choose not to implement a policy ranking compensation or a mandatory deferral program, but, at a minimum, compensation committees should be considering these options and weighing in on how far the company should go to ensure compensation can be clawed back.
This Glass Lewis blog highlights a potential use case for CEO pay ratio disclosure—to gauge a company’s human capital management practices. Since it allows companies to use various methodologies to identify the median employee, the rule’s flexibility has resulted in limited comparability of the data across companies, but Glass Lewis has identified helpful takeaways by considering year-over-year changes. As an example, the blog cites one company whose NEO base salaries increased by 50%—for which the company cited a challenging recruiting environment and inflationary pressures—while compensation for rank-and-file employees, which was evident in the pay ratio disclosure, only increased 6%.
This is a good reminder that CEO pay ratio can’t be a fill-in-the-blanks exercise every year, even though it has largely failed to be the controversial, headline grabbing disclosure some expected years ago. Think about how your numbers have changed year-over-year and how investors will react to this year’s data. If there are any anomalies or surprises, make sure to address them with contextual disclosure.
BlackRock recently released this investment stewardship announcement, which complements its global incentives commentary by outlining factors that US companies may (should?!) consider when designing executive compensation programs. Directors and others who set compensation will appreciate the high level approach BlackRock has taken here. The announcement specifically avoids providing prescriptive guidance on executive compensation construction, which BlackRock believes boards are in the best position to design. Instead, BlackRock encourages compensation committees of US companies to consider the following factors:
– How the balance between retentive and motivational components in compensation program design promotes long-term performance
– How the compensation program rewards long-term financial value creation, sustained across the duration of the program’s performance period
– How pay underpins strategy, with clear disclosure of the rationale for the selected performance metrics
– How resilient the pay program may be across dynamic market environments and the business cycle
– How the committee might responsibly use discretion to reinforce alignment of pay program outcomes with long-term shareholders’ interests
– How to provide sufficient disclosure in unusual situations such as executive transitions and newly public companies
In this uncertain environment, BlackRock expresses concerns about the resilience of executive compensation programs and suggests that companies may have overly relied on performance awards since 2020. Here is an excerpt:
We believe over-indexing executive pay to performance-levered awards increases the potential for a perceived need for special awards and award modifications, especially in tumultuous business environments. Since 2020, the business environment has been challenging for many companies and as a result, many performance awards have not paid out under the formulas within the plan design. Similarly, many options grants are underwater. We have noted that some boards have used discretion, special awards, and/or award modifications to increase the compensation likely to be realized by executives. In essence, these committees seem to be, at least in part, rewarding executives for expended effort rather than for realized results aligned with returns to long-term shareholders.
We ask that companies consider and explain how their executive compensation program is resilient and, thus, will deliver reasonable pay outcomes across a broad range of business outcomes and market environments. In this context, resilient means that programs will provide sufficient retentive impact without intervention when market conditions are difficult, motivate appropriate risk behaviors by executives, reward performance when conditions are more favorable, and adequately reflect the financial performance that shareholders are experiencing.
CalPERS, which due to its position as the largest public pension fund in the US is an influential investor at many public companies, articulated priorities for the current proxy season as part of a recent Investment Committee meeting. Executive pay remains a priority for this proxy season. Specifically, CalPERS will focus on engagement on relative underperformers with continual higher relative pay. The pension fund will continue to withhold votes from directors at companies with poor pay practices. The “Proxy Voting & Corporate Engagement Update” presented at last month’s Investment Committee meeting shares these results on executive pay votes over the past two years:
– Voted “against” 49% of management say-on-pay proposals versus 55% “against” in 2021
– Voted “against” 1,289 Compensation Committee members in 2022 versus 3,079 in 2021
Although that’s still a lot of “against” votes, at least there was as year-over-year improvement, from the corporate perspective.
Meanwhile, BlackRock – the world’s largest asset manager – has said in its Investment Stewardship team’s engagement priorities that it will want to talk with compensation committee member(s) if it identifies “apparent misalignments” between executive pay & performance or has other concerns about a company’s compensation policies. BlackRock will also vote against both say-on-pay and compensation committee members if say-on-pay is on the ballot and it concludes a company has failed to align pay with performance. That’s consistent with the voting guidelines announced in December.
From the folks who brought you the say-on-pay tracker and other tools, the team at Farient Advisors has now announced the launch of “PVP Tracker” – which can help you stay on top of how S&P 500 competitors and peers are sharing data. Here’s more detail:
Included in our newly launched PvP Tracker™ is coverage of both qualitative and quantitative elements. On the qualitative side, the PvP Tracker™ summarizes trends in peer group selection, the “most important” performance measures, and the formats employed when describing the relationships between CAP and measures of financial performance, among other elements.
Here are a couple of early findings that the real-time data reveals:
– When companies reference the relationship between CAP and performance measures, they most commonly (55% of S&P 500 companies) disclose those relationships in a graphic format only. Another 34% of companies use a combination of graphs and narrative. A slim minority (11%) of S&P 500 companies disclose these relationships in a strictly narrative format. Thus, a visual representation is the preferred approach either because it helps to better show the connection between pay and performance, or because no additional narrative is needed to satisfy SEC reporting requirements.
– In terms of the “most important” company-selected metric (CSM), Farient’s PvP Tracker™ finds that a majority (54%) of companies are choosing an earnings metric, such as operating profit or EPS, followed by returns (15%) and cash flow (13%). Of course, CSM trends vary by industry—for instance, 37% of companies in the financial sector select a returns measure as their CSM.
You can sort the data by industry to show comparisons of CAP to SCT compensation and to explore disclosure trends. It’s a very handy tool for anyone tasked with benchmarking – or just curious about how these disclosures are shaping up.
Coming off a year of record say-on-pay failures in 2022, companies have focused on disclosing “responsiveness” to investor feedback in proxy statements and engagement conversations. That can be done by disclosing the number or percentage of significant shareholders that the company met with and changes to executive pay programs that were made year-over-year to address previous investor concerns.
We are very early in the season – but these efforts appear to be paying off. According to this new Semler Brossy memo (with data from Proxy Insight), say-on-pay votes are tracking higher this year, and the “failure” rate is tracking lower than last year. Here’s more detail:
– Average Say on Pay support for the Russell 3000 (92.2%) is 170 basis points higher than the average support at this time last year. More companies are receiving greater than 90% support (76%) than at this time last year (71%).
– The failure rate for the Russell 3000 (0.7%) is 140 basis points lower than at this time last year (2.1%). Only one Russell 3000 company has failed so far this year.
– The current S&P 500 average vote result of 88.8% is 160 basis points higher than last year’s average at this time.
– Average Say on Pay support for the S&P 500 (88.8%) is 340 basis points lower than the Russell 3000 average – however, only 34 S&P 500 companies have held a Say on Pay vote thus far in 2023.
Semler Brossy notes that proxy advisors remain influential – the average vote result for Russell 3000 companies that receive an ISS “against” recommendation is 19% lower than at companies where ISS recommended “for” the proposal. So far this year, ISS has been recommending in favor of more say-on-pay proposals than last year.
Speaking of proxy advisors, remember that if you receive less than 70% support (ISS) or 80% support (Glass Lewis), and aren’t sufficiently “responsive,” the proxy advisors may recommend against reelection of compensation committee members or the entire board in subsequent years. The “Say-on-Pay Solicitation Strategies” chapter of Lynn & Borges’ Executive Compensation Disclosure Treatise also explains that you need to be wary of “cautionary” support. That can turn into an “against” vote the following year, especially if there is tepid performance on TSR or other metrics in the proxy advisor’s model. For that reason, you may want to consider disclosing responsiveness even to “cautionary” feedback.
Here’s an optimistic update that Dave shared on TheCorporateCounsel.net last week:
As John recently noted, the timing of the SEC’s approval of exchange listing standards implementing Rule 10D-1 could be upon us sooner rather than later. That outcome could prompt a flurry of activity as issuers seek to implement compliant clawback policies within the 60-day window mandated by the SEC.
On Monday, April 3rd, a group of law firms submitted letters to the SEC responding to the requests for comments on the NYSE and Nasdaq clawback proposals, asking that the SEC not approve the adoption and effectiveness of the listing standards earlier than November 28, 2023. The letters outlined the many challenges that issuers are facing in determining how to implement a compliant clawback policy, on top of having to address other recent SEC rules changes such as the pay versus performance disclosure requirements and the Rule 10b5-1 amendments. The letters also note that adoption of a clawback policy would require board approval, and issuers would therefore be forced to hastily convene board meetings for such purpose given the uncertainty associated with the effective date of the listing standards and the subsequent short compliance period.
We can only hope that the SEC will carefully consider these comments when determining the timing for approval of the final listing standards.
In addition to the letter signed by 39 law firms to urge a reasonable effective date for the Dodd-Frank clawback listing standards, the following groups have also submitted comments:
– CII – expressing concern over the lack of investor participation in the NYSE’s proposed delisting procedures for companies that fail to comply, which differs from the Nasdaq approach
– Trade Group Coalition (American Securities Association, Business Roundtable, Center On Executive Compensation, National Association of Manufacturers, U.S. Chamber of Commerce) – also urging a longer lead time
Dave noted that one of the key questions as you look to comply with these new rules is whether to adopt a new standalone policy or try to integrate the Dodd-Frank clawback requirements into your existing policy. We’re continuing to share practical information about the Dodd-Frank clawback requirement in our “Clawbacks” Practice Area.
We’ll also be sharing key action items at our “20th Annual Executive Compensation Conference” this September. Although we all hope the approval of these rules occurs no earlier than November, with delisting on the line, it’s not a topic you can ignore. The Conference agenda is filled with other essential info as well – 19 panels over the course of three days for our combined “Proxy Disclosure & 20th Annual Executive Compensation Conferences.” Register now to get the “early bird” rate before it expires – you can sign up online using the “Conferences” drop-down menu, email sales@ccrcorp.com or call 800.737.1271.
We have posted the transcript for our recent webcast “The Top Compensation Consultants Speak” in which Blair Jones of Semler Brossy, Ira Kay of Pay Governance and Jan Koors of Pearl Meyer shared their insights on these topics:
– Early Trends in Pay vs. Performance Disclosures
– Clawback Policies: Strategic Views
– 10b5-1 Plans and Practices
– Compensation Committee Role in Human Capital Management
– Compensation Committee Role in ESG; Trends in Non-Financial Incentive Metrics
– Director Compensation Trends
During the webcast, Ira Kay described a soon-to-be released Pay Governance study that used PVP data by 50 large S&P 500 companies that filed their proxies on or before March 10, 2023 to calculate the level of alignment of “compensation actually paid” with TSR, relative TSR, GAAP net income, and the company selected measure. The study, which has now been released, concluded that the vast majority of companies have directionally aligned changes in CAP and cumulative TSR and argues that these findings support shareholders’ consistently strong support for say-on-pay proposals.
Check out this post from Farient Advisors for a helpful table summarizing institutional investor policies on ESG in compensation plans. The policies are categorized by “No Policy,” “Policy Does Not Require ESG” and “Policy Expects/Requires ESG” as described further by this excerpt:
Large investors, in particular, are demanding that companies adopt sustainability strategies and targets, diversify their boards, and disclose ESG information. A more recent development, however, has been the investor’s role in driving the incorporation of stakeholder measures into incentive plans.
While many investors do not have a formal policy on incorporating ESG measures into compensation plans, some of the largest asset managers have released specific policies on their expectations. BlackRock and Vanguard, for example, are pushing companies that use stakeholder measures in incentive plans to prove that they have the same level of goal rigor as that used for other financial and non-financial metrics.
Meanwhile, other global investors such as AllianceBernstein, Legal and General, Allianz, Amundi, and UBS have engagement policies that encourage the adoption of stakeholder incentive measures, and particularly climate measures for companies in certain industries. It should be noted, however, that some of these investors are not asking for a pay connection to all ESG goals. In fact, some investors are making the linkage to only a part of the “E,” such as climate targets.
To stay up to date on constantly evolving expectations and practices, navigate to our “Sustainability Metrics” Practice Area, where we continue to post resources on the latest trends.
I recently blogged about 2022 and 2023 increases in executives’ base salaries given preferences for upfront cash in light of market volatility. This HLS blog from Compensation Advisory Partners reiterates that higher base salary increases and lower bonus payouts are the consistent themes seen in early filings by S&P 1500 companies with fiscal years ending between September 30 and November 30 and gives further detail regarding compensation actions for CEOs and CFOs. Here are some key statistics from the blog:
– Approximately 80% of CEOs and CFOs received salary increases
– Bonuses decreased by 10%, on average, for CEOs while CFOs had an average decrease of 12%
– Grant date fair value of equity awards increased by 17%, on average, for both CEOs and CFOs
– Significant year-over-year changes (+/-25% or more) in total compensation were seen for approximately 40% of CEOs and 33% of CFOs