Emily blogged last week about the resurgence this proxy season of shareholder proposals relating to severance arrangements. I’m pleased to follow up with more detail via this guest post from Orrick’s J.T. Ho and Bobby Bee (and join us at our “19th Annual Executive Compensation Conference” for more on this topic…):
The 2022 proxy season has seen a spike in a recurring 14a-8 proposal that requests issuers implement policies limiting executive severance amounts. As of publication, at least fifteen issuers have been required to include this proposal in their 2022 proxy statements.
The proposal at issue dates back, essentially unchanged, to as early as 2003, and has been submitted by well-known shareholder activists (such as John Chevedden, Kenneth Steiner, James McRitchie, and Myra K. Young). In each case, the proposal requests that boards seek shareholder approval of any executive pay packages providing for severance or termination payments exceeding 2.99 times the sum of base salary plus bonus. The activists include as severance or termination payments not only cash payments but also, notably, the cash value of most other severance or termination compensation, including outstanding equity awards that accelerate upon a separation event. Acceleration of equity is common upon termination of top executives, however, and the value sometimes dwarfs cash payments. How should issuers prepare for the possibility of such a proposal, or respond if they receive one?
Despite proxy advisors’ general support of such proposals, most issuers faced with these proposals have been able to secure a shareholder vote rejecting it. In justifying their “no” vote recommendations, issuers have pointed to existing practices or policies limiting cash severance benefits. Some have also succeeded by pointing to limits newly adopted in response to the proposal. Of note, however, many issuers have obtained a “no” vote even while specifically excluding from their limitations the cash value of accelerated vesting of outstanding equity awards, justifying that exclusion by the need to offer competitive compensation packages to top executives. Consider Verizon’s experience – and the success of other companies that have been able to point to existing policies that cap cash severance:
In 2003, Verizon’s shareholders approved a proposal brought by Jack Cohen through the Association of BellTel Retirees. In response, in 2004, Version adopted a cash severance policy that requires Verizon’s board to seek shareholder ratification of any senior executive severance agreement providing for total cash value severance exceeding 2.99 times the sum of base salary plus bonus. The 2004 limitation did not apply to equity vesting policies. Verizon has been subject to the same proposal no less than nine times since, and each time the proposal has failed to obtain majority vote.
Many other companies have found similar success without limiting outstanding equity awards. Eight of the fifteen issuers identified as of the date of this publication for the 2022 proxy season received “no” votes on this proposal by pointing to existing policies or practices capping only cash severance payments and not equity, including: Allegiant Travel Company, UnitedHealth Group Incorporated, XPO Logistics, Inc., Lincoln National Corporation, Southwest Airlines Co., Verizon Communications Inc., General Electric Company, and The AES Corporation.
Even policies enacted between receipt of the proposal and the issuer’s annual meeting have been effective. For example, the Colgate Palmolive Company adopted an “Executive Officer Cash Severance Policy” on April 11, 2022, just one month prior to its 2022 annual meeting. As a result, and despite the adopted policy excluding accelerated equity vesting from its limitations, 56% of shareholders voted against the proposal. Similarly, NCR Corporation adjourned its 2022 annual meeting solely with respect to this proposal to allow additional time to engage with stockholders regarding a proposed Cash Severance Policy (which also excluded accelerated equity vesting) prior to voting. 61% of NCR Corporation shareholders ultimately voted against the proposal.
Our research shows activist proposals for this issue are on the rise and there is limited opportunity for excluding it under Rule 14a-8(i)(7) “ordinary business” grounds, as the SEC has historically rejected attempts to do so. Accordingly, issuers without existing severance limitation policies should consider, and may benefit from adopting and publicizing, a formal severance policy that limits cash severance payments to 2.99 times the sum of base salary plus bonus (with latitude granted to the issuers in determining whether such policy limitations will include or exclude the cash value of accelerated vesting of outstanding equity awards). Such action may put issuers in a better position to avoid receiving such a proposal, or to address it without needing to hastily adopt a policy in advance of the annual meeting.
Way back in 2017, before many folks had even heard the term “human capital,” the investor-led “Human Capital Management Coalition” submitted a rulemaking petition to the SEC – calling for additional disclosure about policies, practices & performance. I taped a podcast around that time with Cambria Allen of the UAW Retiree Medical Benefits Trust (the HCM Coalition’s leader), to discuss that petition. By 2019, the SEC proposed amendments to Regulation S-K that added “principles-based” human capital disclosure requirements in response to investor appetite for that info. The SEC adopted those rules in 2020.
But, those rules didn’t go as far as many investors wanted, and there are continued calls for more prescriptive line-item disclosure requirements. I blogged earlier this summer that HCM continues to be part of SEC Chair Gary Gensler’s Reg Flex Agenda – with a proposal expected this fall.
A recent rulemaking petition submitted by the “Working Group on Human Capital Accounting Disclosures” gives an idea of how far that proposal might go. The Working Group is co-chaired by Stanford Law & Columbia Business School profs Colleen Honigsberg & Shivaram Rajgopal – and members include former GC and Acting Director of the SEC’s Division of Corporation Finance John Coates, former SEC Commissioner and current Stanford Law prof Joe Grundfest, former SEC Commissioner and current NYU Law prof Rob Jackson, Wharton’s Daniel Taylor, and other academics.
The petition calls for enhanced MD&A disclosure that explains what portion of labor costs are investment in growth vs. maintenance, very detailed tabular disclosure of labor-related info, and income statement disaggregation of labor costs. Here’s the tabular info that the petitioners are calling for, which they suggest breaking out to show by the categories of full-time employees, part-time employees & contingent workers (also see this Forbes op-ed):
– Mean Tenure, Employee Turnover & Number of Employees
– Total Compensation by Category:
– Salary
– Bonus
– Pension
– Stock Awards
– Option Awards
– Non-Equity Incentive Compensation
– Pension & Deferred Compensation
– Health Care
– Training
– “Other”
For most companies, it’s already a heavy lift to provide compensation info for NEOs. We have an entire Disclosure Treatise that walks through how to do it! That effort would pale in comparison to this workforce-wide exercise, but the petitioners argue that it would be money & effort well-spent. Time will tell whether the SEC includes anything like this in its proposal.
Rest assured that we’ll be sharing practical guidance on this topic at our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – specifically, during our session on “Human Capital Disclosure: Mastering SEC & Investor Expectations.” That’s only one of the many rulemaking topics that we’ll be covering. Check out the agendas – 18 fast-moving, practical sessions held virtually over 3 days – October 12th – 14th. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271. With human capital also being a very relevant topic to anyone navigating ESG issues, you can also add on our “1st Annual Practical ESG Conference” for a bundled discount! Tell your colleagues, and save even more for multi-seat registrations…
Life sciences companies may want to leverage equity compensation for their physician advisors – but there are complicated healthcare fraud & abuse regulations abound. A recent Fenwick memo lays out several recommendations for life science companies who want to better structure such equity compensation programs, with a short excerpt below:
– Develop and establish, in advance, objective qualifications for physician advisors who may be compensated with equity, avoiding factors that take into consideration the expected volume or value of referrals or business generation (whether currently or in the future) that a specific physician or specialty of a physician can make on behalf of the company.
– Aggregate compensation, including awarded equity, to physician advisors should be at fair market value (FMV) and commercially reasonable for the services to be provided by the physician advisor. The company should develop and maintain reasonable internal documentation to support the FMV of the full arrangement that is refreshed periodically as the advisory arrangement gets renewed.
The memo also recommends that companies develop a healthcare compliance program that encompasses compliance with various laws, including the Federal Anti-Kickback Statute – especially as companies near the coverage & reimbursement stage for their products.
This FW Cook article says that an executive’s retirement may become rocky & unpleasant without proper planning. Crafting thoughtful provisions around equity treatment upon retirement can help pave the road for smoother transitions upon separation. Here’s an excerpt from the memo about the advantages that retirement equity award provisions can provide to companies and shareholders:
– Motivating long-term business decision-making through the retirement date
– Ensuring advance notice of retirements for smoother succession planning
– Avoiding requests for individual incentive program modifications by employees approaching retirement age
– Enabling consistency in treatment across all LTI recipients
– Allowing for restrictive covenants that include important shareholder protections
– Enhancing the competitiveness of the equity program in tight labor markets
– Guarding against the need for award modifications that may create say-on-pay pressure
FW Cook also suggests that it’s a win-win for both the company & senior executives if companies set up a formal policy for the treatment of executives’ long-term incentive awards upon retirement, since it allows boards to avoid one-off treatments towards some executives and not others. It also guards against compensation committees using their discretion to modify awards, which won’t be looked upon favorably by shareholders – and may also negatively impact internal pay equity issues.
For the first time in recent years, the largest subcategory of “executive compensation” shareholder proposals related to requests to submit severance agreements to a vote. That’s according to this Gibson Dunn memo – which recaps key “shareholder proposal” developments from the 2022 proxy season and said that the “severance” category weighed in at 44% of the larger executive compensation group of proposals. Overall, there were 36 shareholder proposals on executive compensation this season, down 27% from last year. Here’s more detail:
The majority of the severance-related proposals asked “that boards seek shareholder approval of any senior manager’s new or renewed pay package that provides for severance or termination payments with an estimated value exceeding a certain percentage of the executive’s base salary and bonus.” Many of these were submitted by the same proponent – John Chevedden & his associates.
This is a topic worth watching. The memo notes that as of June 1, 2022, these severance-related proposals had an average shareholder support of 46.9%, and four received majority support.
I blogged earlier this year about Mastercard expanding its ESG incentive structure to all employees. I wondered whether other companies would start to do this – especially in light of the evolving comp committee focus on “human capital” issues.
This recent 48-page report from PwC supports the notion that it’s early days on using ESG incentives below the senior management level, but says that Mastercard isn’t the only company that’s made the jump. The practice may become more widespread as companies continue to advance their ESG strategies – and it’s worth watching. Here’s an excerpt:
Most companies interviewed said that ESG metrics in pay only apply to the executive directors, executive committee, and their direct reports. This is either because the metrics only apply to the LTIP which already has a small eligible population, and/or because companies say there is insufficient line of sight and ability to influence results deeper in the organisation. The typical weighting is 10% to 20% in the annual and/or long-term incentive.
For the minority of companies interviewed that incorporate ESG metrics in pay across the wider workforce, it is typically in the annual incentive. Several companies commented that ESG-related objectives may still feature in an individual’s personal objectives across the wider workforce, and this may influence decisions on their own annual pay awards and/or bonus.
The report also notes that practices can vary by country and industry. Inclusion of ESG metrics is very low in the Netherlands, despite the strong focus on stakeholders there, due to general skepticism of “pay for performance.” I’ve blogged about that philosophy on a few occasions.
Pay decisions are complicated and rest on many factors. Sometimes boards need to depart from “best practices” to compete for talent or reward work on key initiatives, even if it could trigger “against” recommendations and votes under the standard policies of proxy advisors & investors. That might be fine to do for a year or two, but a longer-term pattern eats into director support – and advisors should make sure that boards are aware of that.
According to a recent Semler Brossy memo, a drop in support can come as soon as the next year. An Agenda report based on data from Farient Advisors shows that controversial decisions over a 3-year period can be even more problematic. Here are more details:
– Over the past five years, average Director election vote support at companies that received a Say on Pay vote below 50% in the prior year is six percentage points lower than at companies that received above 70% support.
– Average director support in the year after a 50-70% say-on-pay outcome was about 2% lower than at companies that received above 70% support.
– Where the say-on-pay resolution received less than 85% support for at least 3 years in a row, the companies were 7x more likely to have 3 or more directors receive below 90% support.
This comes at a time when say-on-pay support is declining for large companies – and this latest Semler Brossy SOP update flags a notable spike in S&P 500 failures this year, up to 4.5%. It’s not clear yet whether support will rise as companies catch up to the enhanced investor expectations that are driving this trend – or whether this trend will continue and possibly even shift to companies outside of the S&P 500. None of this changes the fact that directors need to do what they believe is best for the company – but it does up the ante for balancing interests and engaging with different stakeholders. Especially since low say-on-pay results can draw activist attention.
In a separate memo, Farient suggests these action steps:
– Recognizing that the demands of hot talent markets and the quest for good governance are on a collision course, compensation committees still need to consider balanced approaches, particularly to special awards. Rules of thumb include:
– Exclude CEOs from special award programs
– Require performance conditions for earning awards
– Keep awards at reasonable levels
– Be crystal clear as to the rationale for the awards
– State that such awards are intended to be a one-time or infrequent occurrence
– If the company receives a poor SOP vote, the compensation committee should consider how to cure the root causes of the vote and proactively engage with investors on planned changes
– The credo for boards and compensation committees should be “absolutely no surprises.” Investors hate surprises, including one-time mega grants, retention grants, excessive pay, and poor pay-for-performance outcomes. While not all actions can be telegraphed in advance, companies should proactively engage with investors and disclose key changes whenever possible (e.g., discuss anticipated changes with investors before final decisions are made, disclose forward-looking strategies and changes, rather than simply historical ones)
As reported by ESG Today, Hewlett Packard Enterprises is joining a growing group of companies in linking executive pay to climate initiatives. HPE’s sustainability report notes:
Achieving our net-zero commitment will require a complete business transformation for which every leader at HPE will be responsible. In 2022, we will launch a mandatory climate learning program to empower and enable all our executives to contribute toward our climate goals. In addition, as of 2022, climate metrics are linked directly to the compensation of our executive committee.
The accompanying press release says that the climate metrics are part of variable pay and will releate to management of carbon emissions across the value chain.
HPE had already incorporated DEI metrics into executive pay. We’ve blogged that DEI metrics are more common (but still tricky) – and highlighted considerations in implementing climate-related metrics. The new HPE climate metrics appear to tie in to the company’s commitment to reduce its global emissions footprint – including Scope 3 emissions.
The “climate incentive” train appears to be heading our way – and anyone who plans to jump aboard first needs to take foundational steps on socializing climate priorities, tracking data, and preparing for disclosure – especially where the full value chain is involved. We’ve just posted sample annotated climate disclosures for members of PracticalESG.com – based on the proposed rules that the SEC wants to adopt this fall – which will be key to this effort. We’ll be sharing practical step-by-step guidance this October at our “1st Annual Practical ESG Conference” – as well as our “Proxy Disclosure & Executive Compensation Conferences.” You can register online, email sales@ccrcorp.com, or call 1-800-737-1271. Members can also access lots of guidance in our “Sustainability Metrics” Practice Area.
For those who are newer to executive compensation, this blog from Global Shares gives a good overview of the terminology – and the drivers behind components of executive pay. Here’s an excerpt describing types of equity awards:
– Stock Options: Stock options provide an employee with the right to purchase a certain number of shares at an initially agreed price after vesting. (i.e. meeting some requirements – service-based or performance-based or both). Suitable for many companies – early stage, high growth startups and publicly traded companies – who want to issue equity broadly or with a group of selected employees.
– Restricted Stock Units: It is a grant of shares to an employee. He/she usually receives them for free but doesn’t fully own them until a vesting period has passed. Suitable for many established companies who want to offer equity broadly or with a group of selected employees without requiring payment upfront.
– Stock Appreciation Rights: It is an award based on the company stock value (They are not stock but are tied to stock performance). Holders receive a bonus in cash or an equivalent number of shares based on how much the stock value increases over a set period of time. Suitable for many companies who want to offer employees compensation without requiring employees’ upfront payment and issuing a large number of extra shares.
The blog goes on to discuss pros & cons of equity vs. cash compensation, differences in attitudes by country/gender/age, and how publicly held vs. privately held companies differ. Check out our “LTIPs & Annual Incentives” Practice Area for more guidance on structuring equity awards.
Liz previously blogged about how the concern about using ESG incentives to improperly reward executives may not be supported by current data. Another concern investors have had is whether using ESG metrics in executive compensation programs might incentivize companies to greenwash & not actually walk the walk. Here’s a study by Pawliczek, Carter and Zhong with some good news – the paper suggests that say-on-pay voting laws enable investors to demand better ESG performance, and positively impacts companies’ environmental policies. Below is an excerpt of the paper’s abstract:
Investors are increasingly demonstrating a preference for superior ESG performance among their portfolio firms. Concurrently, the use of ESG-related contracting metrics in executive compensation contracts has increased. We investigate these two related issues in the context of the adoption of Say-on-Pay (SOP) voting laws, which provide investors a direct voice about compensation and an additional avenue to express their preferences. Exploiting the staggered adoption of SOP laws around the world, we find that the use of ESG metrics in compensation contracts and ESG performance increase after SOP adoption. Notably, the improvements in ESG performance are concentrated in countries with greater increases in ESG contracting, suggesting that ESG contracting serves as a pathway to facilitate improvement in ESG performance. Additionally, improvements are concentrated among firms with sophisticated owners, in stakeholder countries, and those with CSR committees. Lastly, we show that the improvement in ESG performance contributes to the positive effect of SOP laws on shareholder value.
Investors want more transparency and accountability with ESG metrics & disclosures – and compensation committees increasingly need to consider whether and which ESG incentives are appropriate for their executive incentive programs. The spotlight on ESG metrics isn’t going away, and we’ll be covering this hot topic at our virtual “Proxy Disclosure & Executive Compensation Conferences.” Check out the agendas – 18 sessions over 3 days. Join us for expert insights October 12-14th! And tack on our “1st Annual Practical ESG Conference” for even more valuable information about ESG programs, risks & opportunities that could affect ESG metrics. The Conferences can be bundled together for a discounted rate. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.