I hope everyone is having a relaxing & carefree summer. Live it up, because – as Meredith blogged a few weeks ago on TheCorporateCounsel.net – things are gonna get real on the SEC rulemaking front this fall (or maybe even yet this summer! Who knows!). One of the items in the “proposed rule” stage that the Commission has been signaling may arrive sooner rather than later is “Human Capital Management Disclosure.” We expect the SEC to propose more prescriptive line-item disclosures than what is currently required under the principles-based rule that was modernized a few years ago.
There’s speculation that the proposal will require disaggregated financial reporting and/or tabular disclosure for human capital matters. That’s based in part on calls from the “Human Capital Management Coalition,” which submitted an SEC rulemaking petition last summer. A new 18-page overview from Schroders, CalPERS and the University of Oxford implies that investor interest in this info is still alive and well. Not only is this overview very thorough, but this press release also links to 5 separate reports that dive into the specific issues of measuring safety risks and other topics.
The report takes a stab at translating “human capital” into quantitative (and qualitative) measures that can guide investor engagements on productivity and profitability – i.e., info these investors want you to provide. It also characterizes the HCMC’s call for standardized reporting as being a more balanced approach than many of the other frameworks that are circulating on this topic. The report says that as it stands right now, The HCMC supports mandatory reporting of the following “foundational” disclosures:
1. how many workers (including employees and independent contractors) the company uses to accomplish its strategy;
2. total cost of the workforce, presented in a way that evidences a discernible through-line from the company’s audited financial reports to issuer disclosures;
3. turnover, including management’s actions to attract and retain workers and how changes in the ability to attract and retain workers affects the company’s performance and strategy; and
4. diversity data, including diversity by seniority, sufficient to understand the company’s efforts to access and develop new sources of human capital and any strengths or weaknesses in its ability to do so.
But wait, there’s more. Beyond the Human Capital Management Coalition, you might recall that last year the FASB moved forward with considering an income statement reporting requirement for employee compensation. This Journal of Accountancy article says that FASB tentatively approved that project earlier this year and might issue an exposure draft in July that elaborates and seeks comment on disaggregated line items. This summary from January shows an example of what it could look like.
We’ll be discussing what you need to do about “human capital management” oversight & disclosure at our upcoming “Proxy Disclosure & 20th Annual Executive Compensation Conferences” – which are coming up virtually September 20th – 22nd. Hear what you need to do about these disclosure initiatives (including the SEC’s proposal, if it’s issued by then), and how to balance the information demands with the new risks arising from the SCOTUS’s recent affirmative action decision.
We’ve got a terrific lineup of speakers who will be delivering practical takeaways & action items – essential info for all of us who are grappling with the SEC’s ambitious regulatory agenda. Here’s the 3-day, action-packed agenda for both Conferences, which are bundled together (here’s the agenda specifically for the Executive Compensation Conference). Make yourself look good by getting insights direct from the experts! And for the lawyers out there, get CLE credit while you’re at it!
The Conferences are virtual, September 20th – 22nd. You can also add registration for our “2nd Annual Practical ESG Conference” that’s happening virtually on September 19th, for an additional discount. Register online by credit card – or by emailing sales@ccrcorp.com. Or, call 1.800.737.1271.
This 6-page memo from Compensation Advisory Partners CAP’s looks at pay practices for CFOs, based on 2022 compensation actions among 175 companies with median revenue of $13 billion. The memo also looks at how CFO compensation compares to CEO compensation. Here are a few key takeaways:
– Base Salary: More CFOs and CEOs received increases in 2022 compared to 2021, with the median increase above 2021 increases
– LTI Awards: LTI awards were up in 2022, though not by as much as in 2021, which may reflect continued strong economic conditions at the time of grants in early 2022
– Bonuses: Weaker financial performance in 2022, compared to strong performance in 2021, resulted in lower bonus payouts
– Pay Mix: The mix of equity vehicles remained roughly consistent with prior year practices, as companies have implemented plans emphasizing performance- and time-based stock, partially driven by proxy advisor pressure for long-term incentives to be comprised of at least 50% at-risk performance-based pay
– Total Direct Compensation: TDC increased in 2022, driven by higher salaries and long-term incentive awards. Median TDC increased approximately 5% for CFOs and and 2% for CEOs
CAP offers this summary & prediction:
2022 was a mixed performance year, with operating profit up approximately 7% at median while 2022 TSR at median was -9.2%. Actual bonus payouts declined from all-time highs in 2021, but still remain above target, generally reflecting financial performance improvement following a very strong performance year in 2021. Actual total direct compensation was up slightly though grew at a slower rate than we have seen on average. Target total compensation continues to grow incrementally each year, with higher salaries and target incentives awarded.
2023 continues to be a dynamic environment due to uncertainty around interest rates, equity market performance and global economic growth. For 2023, we expect to see pay changes in the single digits as Compensation Committees and management teams consider performance and retention when making their pay decisions.
With pay versus performance disclosures creating a shiny new number to analyze – “compensation actually paid” – lots of data folks are excitedly slicing & dicing the figures to find out “what these disclosures tell us.” But do the PvP disclosures really tell compensation committees – or shareholders – anything that they don’t already know using the sophisticated models that they’ve developed over the past decade?
This Semler Brossy memo says that at the very least, CAP won’t be a good substitute for holistic, time-tested approaches to assessing the link between pay & performance. Here’s the intro:
The commonly accepted view is that CAP directionally represents the change in equity holding power for an executive in a given year. However, CAP values are highly dependent on pay design, the timing of pay increases for an individual executive, stock price at the end of fiscal years, and other factors that are not immediately apparent when reviewing the disclosure. As a result, companies with similar total shareholder return (“TSR”) performance over a defined timeframe can have divergent PvP outcomes that can be difficult to reconcile without a deeper understanding of the CAP methodology’s idiosyncrasies.
The disclosure sheds light on specific elements of pay and performance but is not a substitute for time-tested approaches to assess a pay program’s efficacy and alignment with performance over a multi-year time horizon. Board compensation committees should continue to rely on more robust benchmarking and outcome-based analyses to assess pay programs. Competitive pay benchmarking, incentive goal rigor analyses, and more traditional realizable pay analyses provide a more exhaustive set of tools to calibrate and assess pay and performance.
The memo articulates 7 factors and 3 real-world case studies to illustrate that although CAP and the related PvP disclosures can be a helpful “back-of-the-envelope” snapshot of changes in executives’ equity holding power in a given year, the data isn’t all that valuable for assessing pay-for-performance.
HR leaders may have previously considered their value-add to be limited to their efforts to attract, motivate, and retain talent, while their other responsibilities — like external reporting — are important but secondary. This Equity Methods blog highlights that this mindset has been changing, and needs to change, given the increasing importance of non-financial data (especially in the proxy and sustainability report) to investors’ buy, sell, and ballot decisions.
The blog specifically highlights the importance placed on executive compensation data, pay equity and representation information and CD&A storytelling, but emphasizes that this list isn’t exclusive and investors rely on many other types of non-financial data. This data impacts the company and its equity value through say-on-pay votes, director elections, the growth of ESG funds, public and employee perception and the risk/cost of activism.
What does this mean for HR leaders? That companies need to enhance their processes and procedures around this data. Here are the suggestions from the blog:
1. Set up a system of controls. In keeping with how Sarbanes-Oxley mandated internal control procedures and an audit of the system of internal control over financial reporting, we suggest voluntarily implementing rigorous controls around all non-financial calculations taking place. This means procedure documents, control totals tests over the data, trending and fluxes to validate numerical reliability, and clear review responsibilities.
2. Leverage calculation best practices. While some non-financial calculations are black and white, others are laden with assumptions. Unfortunately, there are no rigorous standards governing calculation methodologies as we have in accounting via generally accepted accounting principles (GAAP). The limited materials made available by the Sustainability Accounting Standards Board and others do not, for example, prescribe specific approaches for complex topics.
Complex areas where we see significant divergence in methodologies include pay equity, employee engagement results, how to cut and stratify representation data, and advanced pay calculations like the new pay vs. performance disclosure in the proxy.
Our advice is to leverage your external vendors. For example, in addition to seeing a wide breadth of situations and using this experience to inform best practices, we also keep tabs of trends in litigation. Until a standard-setter gives us the equivalent of GAAP in the non-financial space, we think there’s value in monitoring what techniques do and don’t hold up in litigation.
3. Conduct at least two dry runs before going live on a new externally reported metric. In addition to working out process kinks, these dry runs also let you conduct the critical exercise of trending the results and performing root cause analysis on the variance drivers. Imagine disclosing a pay equity result that shows no gender pay gap and then a year later you disclose a 3% gap.
The first question everyone will ask is, “What changed and why?” Not only will you want readily available processes on the shelf to identify change drivers, you’ll also want some comfort that the methodology is durable and not overly sensitive to blips in the data. These offline dry runs are critical to gaining that comfort so you can begin disclosing externally.
4. Prepare and execute manager training. Once you begin disclosure, employees will see the information and have questions. These questions may be unexpected or nuanced in a way that the manager may simply not know how to reply.
We suggest drafting manager talking points and FAQs in advance of going live (internally or externally). The informational aids should address disclosures related to representation, pay equity, employee engagement, health and safety, or any other topic where an employee could express concerns or simply seek more detail.
As Dave noted in our recent webcast “Managing the New Buyback Disclosure Rules” on TheCorporateCounsel.net, one of the common criticisms of share repurchases is that they allow executives to manage per-share earnings metrics to achieve objectives under compensation programs. This recent article by Pay Governance analyzes repurchase and incentive compensation data and provides the following key takeaways:
– While most S&P 500 companies conducting buybacks in 2018–2021 did not adjust performance goals or incentive awards to account for the lower share count post-buyback, those conducting the largest buybacks tend to adjust goals or incentive awards to offset for the impact.
– Although the use of per share metrics is common in incentive plans, most of these companies balance per share metrics with other performance categories, reducing the impact buybacks have on incentive payouts.
– Shareholder returns for companies in our sample conducting buybacks are similar to returns for non-buyback companies, thus dispelling the notion that companies conduct buybacks to inflate stock prices to the benefit of management.
– The majority of activist share repurchase demands are successful.
These findings seem reassuring for anyone concerned about the incentives of — or benefits to — corporate insiders when implementing buyback programs but highlight that the board needs to consider the buyback’s expected impact on the company’s executive compensation, decide whether to adjust goals or awards and appropriately document its deliberations. We cover this and many more considerations for buyback programs in our “Stock Repurchases” Practice Area on TheCorporateCounsel.net.
Given the no-fault nature of the clawback requirement, the inclusion of “little r” restatements and the need to clawback pre-tax dollars, one commonly-asked question about the Dodd-Frank clawback rule is whether it’s possible for companies to protect executives against the risk of a clawback through insurance or indemnification. As described in this Aon alert, both are prohibited, which has caused companies to consider their insurance policies. Here’s an excerpt from the alert that addresses how the clawback rule will impact D&O insurance coverage going forward:
The SEC rule is a no-fault policy and does not evaluate misconduct. It explicitly prohibits a public company from not only indemnifying officers in the event the clawback rule is invoked, but also from paying or reimbursing the premium for any such insurance policy on behalf of the executive officers. Any existing insurance coverage that provides indemnity for the return of erroneously awarded compensation in an actual compensation clawback event will no longer be available once the final exchange rules go into effect.
Most market standard Side A Difference-in-Conditions (A/DIC) policies include coverage for “facilitation costs” or costs and expenses associated with the return of amounts incurred or required to be paid pursuant to Section 954 of the Dodd-Frank Act. We expect that Side A/DIC policies and insurers will continue to provide this coverage going forward.
As Ali Nardali of K&L Gates highlighted in a recent podcast, it seems likely that a robust insurance market will develop here, but executives will have to pay their own premiums.
For our second episode of the Pay & Proxy Podcast, Ani Huang, the CEO of the Center On Executive Compensation, a division of HR Policy Association, joins me to discuss the Center’s recently released guide on selecting and evaluating an independent compensation consultant. In this 14-minute podcast, Ani covers the following topics:
– Reasons companies initiate an RFP for a compensation consultant
– Policies regarding evaluating a compensation consultant and running an RFP
– Best practices for the evaluation and RFP process
– Criteria to consider when judging an independent compensation consultant
We’re always looking for new podcast content, so if you have something you’d like to talk about, please reach out to me at mervine@ccrcorp.com.
FW Cook recently released its analysis of the pay vs. performance disclosures filed by the 403 S&P 500 companies that filed proxy statements containing that disclosure through June 1, 2023. Here are some of the highlights:
– The top three most common financial performance measures that companies chose as their Company Selected Measure (CSM) were profit (56%), revenue (17%), and returns (12%)
– A majority of companies included profit (88%), TSR (55%), and revenue (51%) in their Tabular List and only 21% of companies included non-financial performance measures
– Most companies (76%) used their 10-K published industry or line-of-business index as their total shareholder return (TSR) peer group
– Despite three financial performance measures being the minimum requirement, most companies included additional financial performance measures
– Most companies (91%) used graphs/charts as the clear description requirement, and the remaining 9% used a narrative only description
The report also notes that, as expected, the vast majority of companies included their PVP disclosure near the end of the proxy statement, usually following the pay ratio disclosure. Only four companies chose to include the disclosure before the Summary Compensation Table.
We have posted the transcript for our recent webcast – “Pay Vs. Performance: Lessons From Season 1” – in which Weil’s Howard Dicker, Freshfields’ Nicole Foster, Aon’s Daniel Kapinos & Mercer’s Carol Silverman shared their insights on these topics:
– Challenges in the First Year & Approaches to Interpretive Questions
– Common Mistakes & Misconceptions
– Most Frequently Used Company-Selected Measures
– Most Frequently Used Company-Selected Measures
– Use & Placement of Supplemental Disclosures
– Recommendations for Shareholder Engagements & Voting Impact
– Longer-Term Impacts on Compensation Programs & Disclosures
Here’s an excerpt from Howard Dicker’s comments on the use and placement of supplemental disclosures:
Now, the PvP rule itself is very clear, that if a company adds more measures to the table (for example, in addition to the CSM), each additional measure must be accompanied by a clear description of the relationship between CAP and such measure across the fiscal years.
What is not in the rule, but is abundantly clear in the SEC’s adopting release, is that any supplemental measures of compensation or financial performance and other supplemental disclosures provided by companies must satisfy three conditions: 1) it must be clearly identified as supplemental; 2) it must not be misleading; and 3) it must not be presented with greater prominence than the required PvP disclosure.
According to the SEC, for example, a company could use a heading in the table indicating that the disclosure is supplemental, or include language in the text of the filing stating that the disclosure is supplemental. The proxy statement of Equinix is an example of a company clearly labeling its supplemental disclosures as supplemental.
Now, I know that the surveys are saying that very few companies use supplemental disclosure; however, based on my own non-scientific sampling, I’m seeing more supplemental disclosures than I expected but I’m not always seeing them labeled as supplemental.
As you may be able to tell, clawback policies are consuming a lot of my brain space right now. Listed companies will need to have a policy in place by December 1st of this year, which will apply to incentive-based compensation received by executive officers on or after the effective date of those rules, which is October 2, 2023.
As Dave blogged earlier this week on TheCorporateCounsel.net, while the requirements for the policy that are dictated by SEC Rule 10D-1 are very specific (and restrictive), the actual implementation of clawback provisions in response to those requirements is proving to be somewhat complex for listed companies. I blogged yesterday about state law contract considerations – and research also shows that, because the decisions that surround implementation of these policies could create unintended consequences down the road, you need to tread carefully.
This Equity Methods blog walks through “readiness steps” – focusing on these broad action items:
3. Documenting a playbook of actions to take in the event a clawback is required
On the step of policy creation, which is where most of us are living right now, the blog covers a few basic decision points (some of which Dave also discussed in his blog earlier this week). Here are some relevant excerpts:
– Single or Dual Policy – We anticipate most companies adopting a two-policy framework in which the Dodd-Frank-mandated clawback will sit next to a broader but more flexible (discretionary) clawback.
– Calculation Methodology – Although we expect the use of an event study to be the de facto standard, our advice is to not commit to a particular calculation methodology for stock price or TSR-based awards. Instead, we suggest drafting the clawback policy to state that the compensation committee will evaluate the facts and circumstances and select a methodology that, in its judgment, yields a reasonable estimate of the accounting restatement’s effect on the stock price or TSR metric.
– Enforcement Method – We think practices will evolve, so we suggest drafting the policy to confer flexibility. We have experience setting up web-based choice platforms and think it may improve the odds of success if participants have multiple repayment options.
The blog goes on to recommend producing “work papers” that sit outside of the policy and give you a playbook to guide decisions that will need to be made quickly if a restatement occurs – similar to what many companies do for cyber incidents and other sensitive events. Check out the chart in the blog for a starting point.
For even more color, Dave, Ron & Mark gave their take on clawback policies (and many other topics) during Tuesday’s webcast on this site. The audio archive for that program is available now – with the clawbacks discussion starting around the 90-minute mark – and the transcript will be posted in the next few weeks. This is also one of the many important areas on which we will be providing practical guidance at our “Proxy Disclosure & 20th Annual Executive Compensation Conference” – coming up virtually September 20th – 22nd. Register now to make sure you have the latest action items before you finalize your policy!