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!
Earlier this week, a federal district court judge issued an unpublished opinion in a long-running clawbacks case. Even though the case doesn’t create formal precedent, it may affect decision-making as we all look to finalize Dodd-Frank clawback policies by December 1st of this year. Specifically, it emphasizes that it’s important to follow state law contract principles when you put a policy in place, if you want to be able to enforce the company’s rights under that policy down the road. Enforceability matters because under the new listing standards and SEC rule, companies aren’t required to merely adopt a clawback policy, they are also required to comply with the policy by recovering erroneously paid incentive compensation reasonably promptly – with delisting at stake.
In Monday’s case, the judge granted summary judgment in favor of Hertz’s former CEO, shutting down the company’s 2019 claim that he had breached the company’s clawback policy – as well as representations in his separation agreement – by creating a “tone at the top” that may have led to inappropriate accounting decisions. Although the former CEO settled with the SEC in 2020, he continued to fight reimbursing the company. Mike Melbinger blogged about this case at the “motion to dismiss” stage in 2021.
Hertz alleged that this was a case of misconduct that caused a restatement. It sought to claw back incentive-based compensation that was paid in prior years based on achievement of later-restated revenue, by way of the company clawback policy. It also sought to rescind golden parachute payments that it made to the former CEO under his separation agreement. Both the clawback policy and the separation agreement required a finding of gross negligence, fraud or willful misconduct.
The holding underscores that adopting a clawback policy is only one step in the process of recovering compensation – a point that Ron Mueller reiterated in yesterday’s webcast on this site and has been preaching at our “Executive Compensation Conference” for many years. If there were doubts about whether to have executives agree in writing to be bound by company policies, this decision supports the notion that you do need a contractual basis for enforcement. And according to this opinion, simply incorporating a general policy into other agreements doesn’t work. Here’s an excerpt (citations omitted):
Hertz argues that the Clawback Policies were incorporated into “various other agreements” with Frissora and as such, are enforceable through this incorporation (“Incorporation Argument”). Specifically, Hertz argues that the following documents incorporate one or both Clawback Policies: (1) Frissora’s Employment Agreement, which Hertz argues incorporates both Clawback Policies because it states that the violation of a “material company policy” constitutes a defined cause to terminate Frissora’s employment; (2) the Separation Agreement, which Hertz argues incorporates the 2014 Clawback Policy by reference; and (3) Hertz’s “bylaws,” which Hertz argues incorporate both Clawback Policies because they “impose on [Frissora] and other senior executives the solemn duty of abiding by and enforcing company policies.” …
The Court agrees with Frissora that Hertz can only argue that the Clawback Policies are stand-alone contracts. Accordingly, if the Court finds that they are not enforceable contracts, then Hertz’s breach of contract claims under Counts I and II will fail.
The court went on to explain that the company’s clawback policies – which were set forth in board resolutions, incorporated into the company’s standards of business conduct, and described in public filings – were simply mechanisms by which Hertz would enter future contracts, and were not themselves enforceable contracts. The court also determined that the company’s general standards of business conduct weren’t enforceable contracts because (according to the court) they:
– Contained “only vague and aspirational language,”
– Had no yardstick by which to measure compliance with the standards,
– Stated that they were a “guide” not a “contract,” and
– Did not expressly have employees indicate that they would agree to be legally bound by the document.
There were some procedural & litigation strategy issues at play throughout all these findings, which also affected the court’s decision to reject the company’s attempt to rescind the payments under the separation agreement. And it’s possible Hertz will appeal. Nevertheless, this case shows that you need to keep basic contract principles in mind for company policies if you want to be able to enforce them. Also see question #1467 in our “Q&A Forum” on this site, which discusses contractual interpretations of bylaws vs. policies.
We’ll be posting memos about this case in our “Clawbacks” Practice Area – and rest assured we’ll also be discussing the implications at our “20th Annual Executive Compensation Conference,” which is coming up virtually on September 22nd and, as always, follows our “Proxy Disclosure Conference” on September 20-21. Here are the agendas for that pair of conferences. If you haven’t already signed up, now is the time! You can register online (via the “virtual conferences” drop-down), call 800.737.1271, or email sales@ccrcorp.com.
ISS announced last week that their peer group submission window will be open from 9 am ET on Wednesday, July 5th until 8 pm ET on Friday, July 14th, for companies that have annual meetings slated to be held between September 15, 2023 and January 31, 2024. Here’s an excerpt:
As part of ISS’ peer group construction process, on a semi-annual basis, corporations are requested to submit changes they have made to their self-selected peer groups for their next proxy disclosure. ISS considers companies’ self-selected peer groups as an important input as part of its own peer group construction methodology…
Submissions should reflect peer companies used (or to be used) by the submitting company for pay-setting for the fiscal year ending prior to the company’s next upcoming annual meeting.
Companies who haven’t made any changes to their previously disclosed peer groups, or don’t want to provide this information in advance, aren’t required to participate. If you don’t submit new info, the proxy-disclosed peers from your last proxy filing will automatically be factored into ISS’ peer group construction process. We have more info on this topic in our “Peer Groups” Practice Area.