Liz previously blogged about how the SEC’s proposed insider trading rules can affect your option grant policies & practices. If you’re re-examining your option grant practices now, take a look at Foley’s short and sweet article outlining best practices on stock option grants for both private & public companies. The article gives a brief overview of the tax & regulatory considerations on grant timing and setting the exercise price, required approvals and other checklist items that companies sometimes overlook. One of these checklist items is to remember checking that the proposed option grants comply with the applicable equity plan’s terms – before the plaintiffs do it for you.
Here’s the latest Semler Brossy memo on say-on-pay results as of May 19, showing that 26 Russell 3000 companies have failed thus far (with 17 failures added since Semler’s last report, including Intel & PacWest Bancorp) – which brings the failure rate to 2.7%. The Russell 3000 failure rate is still lower than the failure rate Semler Brossy saw at this time last year (at 3.1%), but it’s above the average failure rate in 2020 (2.3%). Below are some additional excerpted stats:
– The current Russell 3000 average vote result of 90.4% is similar to the index’s average vote at this time last year (90.4%); the current S&P 500 average vote result of 88.3% is below the index’s average at this time last year (89.6%), and is consistent with the year-end vote result in 2021.
– The failure rates for the Russell 3000 and S&P 500 are lower than the failure rates at this time last year: the Russell 3000 is 40 basis points lower at 2.7% and the S&P 500 is 100 basis points lower at 3.4%.
– 10.0% of Russell 3000 and 10.8% of S&P 500 companies have received an ISS “Against” recommendation thus far in 2022.
You may also want to check out the chart on pg. 3 showing the likely causes of say-on-pay votes under 50% in 2022. The largest likely causes are problematic pay practices and mega-grants/special awards.
A recent Aon memo analyzed the evolution of human capital management disclosures among 103 filings from S&P 500 companies for the 2021 fiscal year – Year 2 of required disclosure. Below are some of the highlights:
– The most prevalent categories for HCM disclosure in 2021 were employment (quantitative) at 98%, talent development (qualitative) at 89%, and compensation & benefits (qualitative) at 83%.
– There’s still a lack of quantitative information in HCM disclosures generally. However, upon comparing year-over-year disclosures for 73 S&P 500 companies, companies are increasingly disclosing gender or race/ethnicity data, as well as quantitative data on employee geography and turnover data (though quantitative turnover data was still reported by less than 1/3rd of those companies).
– Just over half of the 103 companies disclosed both gender and race/ethnicity breakdowns of their workforce, and 41% had more comprehensive disclosure covering those quantitative diversity metrics with job type, career levels and other categories.
– Aon notes that there was a decrease in pay equity study disclosures – which may indicate that companies are acting on the 2020 pay equity audit results, instead of focusing on disclosures on the audits themselves.
Aon notes that “disclosing quantitative DEI factors by job type or career, discussing pay equity studies and addressing turnover” are getting traction, and companies can prepare by measuring these metrics & understanding the reasons behind company-specific trends. The article provides several other to-do actions on pg. 6, which includes considering revisions to your 2023 HCM disclosures now & building in time to review next year’s proposed disclosures with the committee responsible for human capital oversight.
Investors will continue to expect more from Human Capital disclosures going in to next proxy season – and another SEC proposal is still expected, too. There are step-by-step actions that you must take to keep approval ratings high for your comp committee. To arm yourself – and your board – with the info you need, register for our upcoming “Proxy Disclosure & Executive Compensation Conferences” – coming up virtually October 12-14. Among other critical topics, our agenda includes “Human Capital Disclosure – Mastering SEC & Investor Expectations” – with Aon’s Pam Greene, Gibson Dunn’s Ron Mueller, CalPERS Tamara Sells, and Wilson Sonsini’s Amanda Urquiza. Other sessions will include practical guidance on handling the compensation committee’s evolving role and how to protect your board from the next maelstrom.
Our “Early Bird” rate expires next Friday, June 10th – so register today for the best price. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Yikes! Vice Chancellor Laster issued a 115-page opinion this week that should have you running to double check your equity grant ledgers & records. The facts of the case relate to a performance share award that could exceed plan limits if the performance is achieved:
The 2019 Plan limits the number of performance shares that the Committee canaward to any single individual in the same fiscal year. In March 2020, the Committee made two grants of performance shares to the Company’s chief executive officer (“CEO”), defendant Gerry P. Smith (the “Challenged Awards”). Each of the Challenged Awards entitled Smith to receive a variable number of performance shares, with the actual amount determined by the Company’s performance over a three-year measurement period that will end in 2023. If the Company performs well, then the aggregate number of shares that Smith is entitled to retain will exceed the limit in the 2019 Plan.
The plaintiff is a stockholder, and is asserting a claim for breach of the Plan. But there’s more. The plaintiff also appears to have successfully turned that claim that the grant was defective into a Caremark-like claim against the entire board. Here’s an excerpt:
In contrast to the preceding issues, which are governed by settled law, the plaintiff also advanced a novel theory. According to the plaintiff, all of the directors—including the directors who did not approve the Challenged Awards—breached their fiduciary duties by not fixing the obvious violation after the plaintiff sent a demand letter calling the issue to their attention. There is something disquieting about a plaintiff manufacturing a claim against directors by acting as a whistleblower and then suing because the directors did not respond to the whistle.
Nevertheless, the logic of the plaintiff’s theory is sound: Delaware law treats a conscious failure to act as the equivalent of action, so if a plaintiff brings a clear violation to the directors’ attention and they do not act, then it is reasonably conceivable that the directors’ conscious inaction constitutes a breach of duty. The same logic animates a Caremark claim that rests on the theory that the board consciously ignored proverbial red flags, although the source of the notice that the board receives is different.
Vice Chancellor Laster notes that this type of claim presents “obvious policy issues” – but:
The plaintiff, however, has pled what seems like one of the strongest possible scenarios for such a claim. The limitation in the 2019 Plan is plain and unambiguous. Under established precedent, the failure to comply with a plain and unambiguous restriction in a stockholder-approved equity compensation plan supports an inference that the directors acted in bad faith. The recipient of the Challenged Awards was a fellow fiduciary who faced the same obligation to fix the flawed grants as the other members of the Board. If there was ever a time when all of the directors had a duty to take action to benefit the Company by addressing an obvious problem, it is reasonably conceivable that this was it.
With admitted trepidation about knock-on effects, this decision permits the claim to survive pleading-stage analysis. In light of the policy implications that claims of this sort present, future decisions must consider carefully any attempts by plaintiffs to follow a similar path.
The defendants’ motion to dismiss was denied, and the case moves forward. Not legal advice, but this opinion suggests that if you get a demand letter, it’s worth taking this decision into account and fixing the identified issue – even if the plaintiff leverages that clean-up reaction for a settlement. The even better approach is to try to avoid the issue in the first place, through regular equity plan audits. See our checklist with step-by-step guidance on share counting.
If you find yourself exceeding plan limits, we also have an issue-spotting thread in our “Q&A Forum” (#177). Also see this blog about a 2013 Delaware case, and this blog about the “inducement grant” alternative.
A majority of big companies now include some type of ESG metric in their executive pay program. The jury is still out on whether that’s a good thing. One view is that “what gets measured gets managed” – so incorporating ESG goals into incentive plans shows that the company is serious about progress. At the same time, some people think that the real winners here will always be highly paid executives. Investors aren’t a monolith – they fall in both of these camps.
A recent Pay Governance memo says that the concern about using ESG incentives to improperly reward executives might be overblown – at least based on current data. Ira Kay, Mike Kesner and Joadi Oglesby looked at S&P 500 data to test the theory, and here’s what they found:
1. ESG reduced the overall payout at 75% of the companies using a weighted metric, with the median reduction equal to 9%.
2. Most ESG-weighted metric companies (56%) used a 20% weighting or less.
a. In some cases, the company used a scorecard approach and did not provide sufficient detail to determine the portion of the weighted metric attributable to ESG; in those cases, we included the entire weighting.
b. Many of the companies with a >20% weighting included ESG and other strategic metrics.
3. Of the companies that incorporated ESG metrics as part of a modifier, 33% increased payouts and the remaining 67% had no effect or reduced payouts.
4, The average impact on payouts for companies using a modifier on the financial performance metrics ranged from +35% to -14% and averaged +2%.
5. These findings indicate that the compensation committee members are acting conservatively in setting and scoring ESG goals — thus the narrow band around target for most companies.
The Pay Governance team notes that it’s still early days here – but ESG incentive criticism isn’t supported by current data. Visit our “Sustainability Metrics” Practice Area for analysis of ESG executive pay trends – including our checklist.
Last week was peak “annual meeting” – with 119 meetings on Thursday alone, according to data from ISS Corporate Solutions. Although the overall say-on-pay failure rate has held steady this year, median CEO pay set a record for the 6th year in a row ($14.7 million!), and that has resulted in a few failed advisory votes. This WSJ article recounts abysmal results at two high-profile companies, and mediocre support at others.
At one company that barely eked by, special awards were in the spotlight. SOC Investment Group filed this notice of exempt solicitation to discourage other shareholders from supporting management’s say-on-pay proposal, in which it advocates “near-zero” tolerance for special awards. Here’s an excerpt:
The company granted Named Executive Officers (NEOs), including the CEO, special “one-time” performance equity awards in addition to their ordinary-course equity awards in fiscal 2021, which we view as unnecessary for the following reasons:
1. Executives already have large amounts of vested and outstanding equity that reward them when the company’s shares appreciate.
2. The special award is not necessary because it rewards executives for what should constitute their normal job duties.
3. Special awards may not solve retention challenges and are a chief cause of executive overpay.
As a general principle, we believe that special awards are inappropriate in almost all cases and has become an overused practice in executive compensation, one that we advocate moving toward near-zero tolerance for. Notwithstanding our belief, in this specific case the company does not offer a particularly compelling rationale for the special award—the grant appears to reward for what we feel should be viewed as ordinary-course business decisions and efforts of executives in any large corporation.
The letter goes on to provide more rationale for each of these 3 points. If you are considering a special award, it’s worth reading this before you move forward, so that you’re prepared to justify the decision. As we’ve noted, granting a “special award” is akin to a mortal sin in the eyes of some proxy advisors & investors.
As a result of recent stock market volatility combined with a tight labor market, some companies are dusting off option repricing playbooks. For good reason, a lot of us are rusty on how this works (while others of us might have some PTSD from the last time that repricings were widely used). White & Case compiled this 18-page guide on the topic, which covers:
1. Structuring Repricings
2. Shareholder Approval Requirements
3. Tender Offer Rules
4. Other Considerations (Tax, Accounting, Section 16, etc.)
5. Foreign Private Issuers
6. Alternative Strategies
There are a lot of traps for the unwary here – so make sure to check out the memo and the other resources in the “Underwater Options” section of our “Stock Options” Practice Area. Also, be on the lookout for our next issue of The Corporate Executive – Dave is planning to analyze the impact of market volatility on executive pay from a bunch of different angles. If you aren’t already receiving that newsletter, call (800) 737-1271 or email sales@ccrcorp.com.
A member recently asked this question in our Q&A Forum (#1411):
We are looking for any type of guidance/handbook/alert that gives any insight into Change in Control Plan participants BELOW the executive leadership team (e.g., how common this is, how to determine participants). Are you aware of anything? Thanks!
John responded:
I think it’s not unusual to provide change in control compensation to people beyond the NEO group, but I don’t think it’s common to provide change in control agreements along the same lines as those provided to NEOs. We have a lot of materials on change in control arrangements in our “Severance” Practice Area, and you may want to take a look there.
Here are some specific resources from that Practice Area that you may find helpful:
John highlighted some great resources in our Practice Areas, and we also have Lynn & Borges’s “Executive Compensation Disclosure Treatise” posted online for members of CompensationStandards.com. On top of that, we’ve got lots of checklists on topics like clawbacks & director expense policies. If you’re not finding what you’re looking for, give us a shout at our Q&A Forum or email us anytime at info@ccrcorp.com.
During the early months of 2020, there was a ton of coverage about CEO & employee pay cuts – with some CEOs giving up their 2020 salaries to help dampen the pandemic’s effects on worker salaries & layoffs. But a recent academic paper found that while many CEO base salaries did go down in 2020, powerful CEOs weren’t really worse off because of the increase in their total compensation that year. The average annual decrease in base salary for 330 CEOs that accepted salary cuts in 2020 was 18.6% – but the total compensation wasn’t significantly lower on average, nor was the total compensation different from those of CEOs who didn’t take salary cuts.
The paper draws on the managerial power theory of executive compensation, where “powerful CEOs exert influence over boards to extract rent through higher but unwarranted pay. Stakeholder outrage acts as a constraint on CEO pay because a CEO can suffer reputational damage if their compensation package is perceived to be egregiously out of line with stakeholder or wider societal expectations.” The managerial power theory predicts that powerful CEOs would respond to higher stakeholder outrage by restructuring their compensation to be more opaque.
During 2020, there was lots of stakeholder outrage to go around, with widespread furloughs & worker safety concerns consuming a lot of media attention. The paper argues that, “increased outrage costs [from the pay disparity during the pandemic] bit harder on powerful CEOs and triggered an adjustment to the structure, but not the size, of their compensation.” They found that the “Other compensation” category increased by 131% from 2019 to 2020 for CEOs who took a salary cut, with all else equal. The paper also noted that CEOs of companies with weaker corporate governance, low board independence and busy boards also seemed to restructure their pay structure & avoided a significant loss in income.
At the end of the day, governance is at the crux of these issues, and there’s a lot more scrutiny by a wider group of stakeholders, ranging from institutional investors to a company’s employee and customer base. With your board and compensation committee increasingly in the hot seat, you’ll want to register for our upcoming “Proxy Disclosure & Executive Compensation Conferences” – coming up virtually October 12-14. Among other critical topics, our agenda includes a session on “The Evolving Compensation Committee” – with Semler Brossy’s Blair Jones, Davis Polk’s Kyoko Takahashi Lin, Pay Governance’s Tara Tays and American Water Works’ Jeffrey Taylor.
With median pay packages for CEOs breaking records this year, here’s an updated Semler Brossy report (with data as of May 5) showing that the current S&P 500 average say-on-pay vote result (at 87.3%) is below the index’s average at this point last year (at 89.6%). There’s also a widening spread between the average say-on-pay vote results in the Russell 3000 and S&P 500 indices – at 320 basis points this year vs. 210 basis points at year-end in 2021.
However, from a 30,000 ft. level, companies seem to be cruising, as the say-on-pay failure rates for both the Russell 3000 and S&P 500 are significantly lower than the failure rates this time last year. Semler Brossy found that the “Russell 3000 is 210 basis points lower at 1.9% and the S&P 500 is 260 basis points lower at 3.6%.” Here are a few other stats from the latest Semler Brossy memo:
– 8.6% of Russell 3000 and 12.7% of S&P 500 companies have received an ISS “Against” recommendation thus far in 2022. The Russell 3000 “Against” rate is 270 basis points lower than the rate observed last year, and the S&P 500 “Against” rate is 160 basis points higher.
– 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 seven percentage points lower than at companies that received above 70% support.
– Average vote support for equity proposals thus far in the proxy season (91.0%) is 130 basis points higher than the average vote support observed at this time last year (89.7%).
– Companies receiving less than 90% Say on Pay vote support have had higher average equity plan proposal support in 2022 than in previous years.