The Advisors' Blog

Fortunately, I wasn’t one of the thousands of travelers who were stranded by Southwest’s scheduling meltdown over the holidays, but if I was, questions about the structure of the company’s executive compensation programs wouldn’t have been high on my list of things to worry about. I guess that’s why I’m not a Senator, because those questions featured prominently in a letter that Sen. Alex Padilla (D-Cal.) sent to the airline earlier this month.  Here are the specific inquiries Sen. Padilla made around executive comp issues:

Is executive compensation in any way tied to flight cancellation rates and consumer satisfaction? What is the estimated impact of this holiday season on top Southwest executives’ compensation? Is the company considering any clawbacks of executive bonuses or other compensation based on the failures that occurred during the 2022 holiday travel season?

In hindsight, my failure to consider the possible executive compensation side of the equation just confirms that I’m pretty clueless. The Southwest situation is just another reminder that any highly publicized corporate crisis is going to result in the media and politicians emphasizing the executive comp side of the equation. There’s just too much raw meat there to expect them to resist.

– John Jenkins

Tune in at 2pm Eastern today for the webcast – “The Latest: Your Upcoming Proxy Disclosures” – to hear Mark Borges of Compensia and CompensationStandards.com, Alan Dye of Hogan Lovells and Section16.net, Dave Lynn of Morrison Foerster and TheCorporateCounsel.net, and Ron Mueller of Gibson Dunn discuss all the latest issues to consider as you prepare your upcoming proxy disclosures – including how to present newly required pay vs. performance data. Understand what to expect for the upcoming proxy season, so that you can prepare your directors and C-suite – and handle the challenges that 2023 will throw your way.

We are making this CompensationStandards.com webcast available on TheCorporateCounsel.net as a bonus to members – it will air on both sites. And because there is so much to cover, we have allotted extra time for this program! It’s scheduled to run for 90 minutes.

If you attend the live version of this 90-minute program, CLE credit will be available. You just need to fill out this form to submit your state and license number and complete the prompts during the program. All credits are pending state approval.

Members of CompensationStandards.com are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, try a no-risk trial now. Our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. If you have any questions, email sales@ccrcorp.com – or call us at 800.737.1271.

– John Jenkins

This recent article from Directors & Boards highlights anticipated compensation committee priorities for 2023. This excerpt says that one of those priorities is ensuring that incentive comp programs are designed to be recession-proof:

With the prospect of a downturn coming in 2023, compensation committees will have to ensure incentive plan goals are challenging while also ensuring those goals are achievable in a potential downturn. Approaches committees can consider include widening performance ranges around the plan, incorporating relative performance measurement into the plan and adding greater discretion, particularly for short-term incentive plans.

In order to mitigate shareholder concerns, it is better to build any adjustments into the plan design rather than make after-the-fact adjustments for the benefit of management. For example, it is better to widen the performance range at the beginning of the year than to make an adjustment at the end of the year to allow for management incentives when the management team failed to achieve the short-term incentive plan threshold level of performance.

The article also flags ensuring that executives have appropriate equity incentives, addressing new regulatory requirements and dealing with a challenging shareholder environment as other committee priorities for the coming year.

– John Jenkins

We’ve posted the transcript for our recent webcast – “SEC Clawback Rules: What to Do Now.”  Our panelists covered a variety of topics associated with the looming clawback listing standards.  Here’s an excerpt from Ariane Andrade’s review of the disclosure requirements that will come into play once an issuer has adopted a compliant clawback policy:

The disclosure requirements affect the annual report on Form 10-K and proxy and information statements where the issuer has to report the information that’s required by Item 402 of Regulation S-K. The new rule requires that the exchange listing standards include a requirement that listed issuers have to disclose their policies. We would expect that a failure to comply would prompt the commencement of delisting proceedings by the applicable exchange.

First, on the annual report in 10-K, the policy itself will have to be filed as an exhibit to the 10-K, and then there will be two new boxes to check on the cover page of Forms 10-K, 20-F and 40-F to indicate if the financial statements that are covered by the filing reflect the correction of an error to previously issued financials, and whether those corrections were restatements that required recovery. The SEC justifies this by saying that the check boxes will provide greater transparency, in particular around “little r” restatements, and they’ll allow investors to more easily identify which restatements triggered a compensation recovery analysis.

The new rule also amends Item 402 of Regulation S-K and Forms 40-F and 20-F to require listed issuers to disclose how they have applied their recovery policies. First, there’s a new instruction to the Summary Compensation Table that requires that any amounts that are recovered pursuant to a clawback policy have to reduce the amount that’s reported in that applicable column in the table, as well as the total column for the fiscal year in which the amount recovered initially was reported. Any of those adjustments have to be identified in a footnote to the table, as well.

Then, there’s new Item 402(w) that kicks in if at any time during or after the last completed fiscal year, the issuer had to prepare an accounting restatement that required recovery of erroneously awarded compensation pursuant to the clawback policy, or if there was an outstanding balance as of the end of the last completed fiscal year of erroneously awarded compensation to be recovered as a result of a prior restatement, then that requires certain disclosure of information pursuant to Item 402.

– John Jenkins

A recent Willis Towers Watson study highlights the prevalence of ESG metrics in executive comp plans. The firm reviewed public disclosures from more than 800 companies, including S&P 500, FTSE 100, TSX 60 and major European indices. This excerpt summarizes its findings:

In Europe and North America, ESG metrics are used by more than three-quarters of companies when determining executive incentive compensation, ranging from 69% in the U.S. to about 90% in Europe and the U.K. While most companies incorporate ESG metrics into their short-term incentive (STI) plans, measurement of ESG in long-term incentive (LTI) plans has increased sharply over time, especially in Europe (46% of companies) and the U.K. (37% of companies). In the U.S. and Canada, the adoption of ESG metrics in LTI plans remains low (8% and 7%, respectively).

The study found that social metrics feature most prominently in comp plans. Human capital metrics, including talent management, succession planning, DEI, and employee health and safety are the most common. Human capital metrics were used by 68% of European and North American companies.

The survey also reviews how companies incorporate ESG metrics into their comp plans, and observes that they’re used as a separate, weighted metric nearly half of the time.  It also provides information on how usage of ESG metrics varies among industries.

– John Jenkins

An interesting Forbes article recently took a look at what happens at companies when CEOs take a pay cut.  As this excerpt notes, the results were striking:

After a large CEO pay cut, financial performance tends to rebound. Among US firms, the median profitability increases from -8% to 10% in the 3 years following a large cut, according to a study by researchers from Nanyang Technological University, University of Washington, and University of British Columbia.

The profitability improvements in CEO pay-cutting firms are larger than in comparable firms that did not cut the boss’ salary, according to the authors’ analyses. In other words, improvements after a CEO pay cut are not just because the industry is recovering, according to the authors. Firms seem to operate more effectively after a CEO pay cut.

Cutting pay can produce almost as much improvement as replacing the CEO, according to the authors of the study. This tends to be especially likely when the board pairs the pay cut with strong incentives for reversing declining firm performance.

The Forbes article points out that other studies have found that a CEO taking it on the chin when it comes to pay also results in shareholders being more likely to approve future CEO pay packages and increase employees’ willingness to bear an increased workload to help improve company performance.

– John Jenkins

The messy story of McDonald’s Corporation’s decision to terminate its former CEO Stephen Easterbrook added another chapter yesterday, when the SEC announced that it had initiated settled enforcement proceedings against the former CEO and the company arising out of his departure.  This excerpt from the SEC’s press release explains its allegations:

According to the SEC’s order, McDonald’s terminated Easterbrook for exercising poor judgment and engaging in an inappropriate personal relationship with a McDonald’s employee in violation of company policy. However, McDonald’s and Easterbrook entered into a separation agreement that concluded his termination was without cause, which allowed him to retain substantial equity compensation that otherwise would have been forfeited. In making this conclusion, McDonald’s exercised discretion that was not disclosed to investors.

Subsequently, in July 2020, McDonald’s discovered through an internal investigation that Easterbrook had engaged in other undisclosed, improper relationships with additional McDonald’s employees. According to the SEC’s order, Easterbrook knew or was reckless in not knowing that his failure to disclose these additional violations of company policy prior to his termination would influence McDonald’s disclosures to investors related to his departure and compensation.

Without admitting or denying the SEC’s allegations, Easterbrook consented to a cease & desist order prohibiting future violations of the antifraud provisions of the federal securities laws, and imposing a $400,000 fine and a five-year officer and director bar.  The company consented to a cease & desist order prohibiting future violations of Section 14(a) of the 1934 Act and Rule 14a-3 thereunder.

As Liz blogged last year, the company sued the former CEO and reached a settlement under which it “clawed back” over $100 million in equity awards and cash based on the company’s claims that the board wouldn’t have approved a separation agreement characterizing his termination as “without cause” if it had been aware of his dishonesty and additional misconduct.  The company’s efforts to claw back that compensation, together with its other efforts to cooperate with the SEC’s investigation, resulted in the agency’s decision not to impose a financial penalty on the company.

Commissioners Peirce and Uyeda dissented from the SEC’s decision with respect to the company. In their dissenting statement, they expressed their view that the SEC was rewriting the disclosure requirements of Item 402 of Reg S-K through an enforcement proceeding. Here’s an excerpt:

We are unaware of prior Commission or staff actions or positions applying Item 402 in the way that the Order does.  Additionally, the Order can be read to suggest that the underlying reasons for why the company decided to terminate a named executive officer “without cause” instead of “with cause,” and vice versa, need to be disclosed under Item 402.  Such “hiring and firing discussion and analysis,” however, is beyond the rule’s scope.

The statement went on to note that industry practice for complying with Item 402 has developed over many years, and that an enforcement action is not “a reasonable regulatory approach” for announcing a novel interpretation.

It seems to me that the dissenters make a good point – executive termination disclosures tend to be terse, often for sound business and legal reasons. Imposing a requirement that companies must disclose the reasons why they opted to treat a particular termination as being “without cause” adds another layer of complexity to an already challenging process, without in most cases providing a significant benefit to investors.

– John Jenkins

On December 16th, ISS issued a new set of Equity Plan FAQs and a new set of Compensation Policies FAQs.  This Edward Hauder Blog summarizes the changes.  Here are a couple of excerpts from the blog that provide an overview of the changes:

Equity Compensation Plan FAQs.  ISS announced several changes, including how it will determine the common shares outstanding (CSO) when there are economic proposals such as mergers or acquisitions that are on the agenda, how burn rate will be considered (including the new Value Adjusted Burn Rate methodology), implications of a change in index membership or GICS classification within the last three years, and changes with respect to the Equity Plan Scorecard (EPSC) model.

Compensation Policies FAQs.  ISS indicates that there will be no changes to any of the quantitative pay-for-performance (P4P) screens for 2023 used to inform its Say-on-Pay (SOP) vote recommendations. However, ISS did change how it will use its Financial Performance Assessment (FPA) measure in 2023 by expanding the number of situations that it can be used to change the ultimate P4P concern level. Starting February 1, 2023, ISS can use FPA result to not only move a low bordering medium concern company to a medium concern or a medium concern company to a low concern, ISS will be able to move concern down to medium for certain high concern companies and up to high concern for certain medium concern companies.

The blog points out an additional point worth noting concerning how ISS will use the FPA result – since FPA is a proprietary ISS and it has not fully disclosed how it calculates these amounts, companies will have a very difficult time determining their FPA score and how it will impact ISS’s assessment of their P4P concern level.  In turn, that’s going to make it harder for these companies to assess what recommendation ISS will make on their say-on-pay proposal.

– John Jenkins

Liz’s change in status has prompted us to rethink how we email our blogs to you each morning. At the end of the month, we’re going to change over from our current practice of having our blogs come from the email address of one of our editors. Going forward, all of our blogs will be sent from Editorial@TheCorporateCounsel.net. Our objective is to establish a sender address that won’t need to be changed every time there’s a change on the editorial masthead, which hopefully means that this will be the last time we have to ask you to take the time to whitelist our email addresses.

We know that whitelisting is kind of a pain in the neck, so we’ve put together this whitelisting instruction page to help you and your IT department understand what actions you may need to take in order to ensure there’s no disruption in delivery. We’re going to begin to send blogs from the Editorial@TheCorporateCounsel.net address over the course of the next several weeks, so please be sure to whitelist the new address at your earliest convenience.  We’re going to do this incrementally across our sites, and we’ll keep you apprised of when we plan to make the change for a specific site.

There are a couple of things that I also want to mention about this change. First, the name of the author of a blog will always appear in the email, so if you want to respond to the author, you can just click on the author’s name and their email address will pop up. Second, Editorial@TheCorporateCounsel.net isn’t a black hole. If you hit reply, your message will go to a folder that I’ll have access to. I’ll check that every few days and forward your email to the appropriate editor. Finally, thanks for your patience and cooperation.

– John Jenkins

Here’s a guest blog from J.T. Ho and Bobby Bee of Orrick, which passes along some helpful informal Staff guidance on the level of detail required in PvP footnote disclosure of “compensation actually paid”:

“A common question we have received from issuers as they prepare their new pay versus performance disclosures relates to just how much footnote detail is required to explain the calculation of “compensation actually paid.” Item 402(v)(3) of Regulation S-K requires (emphasis added):

“(3) For each amount disclosed in columns (c) [Compensation actually paid to PEO] and (e) [Average compensation actually paid to non-PEO named executive officers] of the table required by paragraph (v)(1) of this section, disclose in footnotes to the table each of the amounts deducted and added pursuant to paragraph (v)(2)(iii) of this section, the name of each named executive officer included as a PEO or in the calculation of the average remaining named executive officer compensation, and the fiscal years in which such persons are included. For disclosure of the executive compensation actually paid to named executive officers other than the PEO, provide the amounts required under this paragraph as averages.”

The question is whether the footnotes, as they relate to the pension value adjustments and equity award adjustments required by Item 402(v)(2)(iii)(B)(1) and Item 402(v)(2)(iii)(C)(1), could be limited to disclosing solely the aggregate amount calculated for pension value adjustments and equity award adjustments, respectively. This would be in lieu of having the footnotes disclose each of the amounts deducted and added, pursuant to sub-Items 402(v)(2)(iii)(B)(1)(i) – (ii) and sub-Items 402(v)(2)(iii)(C)(1)(i)-(vi), to arrive at such aggregate amounts, as presented in the “Model Pay Versus Performance Disclosure” from the Compensation Standards.com Special Session: “Tackling Your Pay Vs. Performance Disclosures.”

See an excerpt of the sample footnotes below, with the crux of the question whether issuers could disclose just the final adjustment columns, for each year, in their footnote disclosures:

Pension Value Adjustment Sample Footnote:

(x)….The amounts deducted or added in calculating the pension benefit adjustments are as follows:

Equity Award Adjustment Sample Footnote:

(y)…The amounts deducted or added in calculating the equity award adjustments are as follows:

We spoke with a representative from the SEC’s Office of Small Business Policy in the Division of Corporation Finance, who confirmed the SEC expects each of the amounts identified in the tables above to be included as part of the footnotes.

Issuers and service providers alike should take note of this expectation in connection with preparing and reviewing the pay versus performance disclosures.”

I apologize for the funky formatting of the tables. I wasn’t trying to pay tribute to Wonder Woman’s invisible jet – there are supposed to be row and column lines in the tables. In fact, they’re on my draft. Your guess is as good as mine as to why those lines don’t show up in published version of the tables, although I can’t rule out my own lamentable lack of skill as a cause.  For the record, the Word document that J.T. and Bobby sent was perfectly formatted.  Also, this kind of thing never happened when Liz was in charge. . .

– John Jenkins