Total shareholder return is one of the most prevalent metrics in long-term incentive plans. Now, a newer way of incorporating TSR is starting to gain traction. This blog from MyLogIQ gives details on an emerging practice that Lynn identified back in 2020. Here’s an excerpt:
Rather than weighting TSR to determine a payout on a portion of an award, e.g. linking 33.3% of total potential shares to TSR performance, TSR performance instead determines a final adjustment to the value of the award, e.g. -25% for poorer results and +25% for superior ones. Utilizing the CompanyIQ® platform, MyLogIQ found that the proportion of R3000 companies that used a TSR modifier grew by two percentage points per year from 2018, when 8% leveraged a TSR modifier, to 2020 when that figure was 12%.
TSR performance is typically measured relative to a performance peer group, which can be a designated custom group of performance peers selected by the board or a stock index such as the S&P 500. For example, a board can target 50th percentile (pctl) TSR performance within a group rather than an absolute TSR goal. In 2018, 72% of R3000 TSR modifier metrics were relative. In 2020, 80% of metrics were rTSR.
The blog says that the modifier is typically a 25% or 20% adjustment – which can be positive or negative based on achievement of threshold, target (typically no adjustment) or maximum performance hurdles. However, one downside of this approach still being somewhat new & unique is that some equity award software may not fully accommodate it. That means that tracking awards and expense calculations could get complicated.
We’ve notedonseveraloccasions that there’s been an uptick in the number of companies that consider progress on DEI, health & safety, emissions, or other non-financial metrics when calculating executive incentives. As companies continue to sort out whether & how to add ESG metrics to executive pay plans, one important consideration is determining who these metrics apply to. A recent Deloitte report suggests that CFOs might be slipping under the radar – despite their involvement in ESG strategies. Here are a few takeaways:
– The CFO’s role in ESG typically includes tracking & reporting progress in line with regulatory & investor expectations, demonstrating ROI of purpose, and embedding purpose in investment criteria (this 16-page report takes an even deeper dive into the CFO’s role in driving sustainability)
– While 45% of CEOs surveyed have compensation tied to “purpose-related” goals, only 6% of CFOs said the same – the lowest of any roles among the C-suite, despite reporting above-average “purpose impact” on their role
– Smaller companies (less than $1 billion annual revenue) are more likely to have purpose impact C-suite roles, but compensation is less likely to tie to purpose priorities
This Forbes article from Bruce Brumberg – Editor-in-Chief & Co-Founder of MyStockOptions.com – notes that some big tech companies are changing their stock grant practices to stay attractive in the midst of the Great Resignation. Here are some of the examples he cites:
– Amazon – raising the cap on employee base pay, making stock grants when employees are promoted instead of waiting until the next annual grant cycle, considering a shift to monthly vesting (from backend-loaded), and allowing longer leaves of absence before pausing RSU vesting (and vesting will now continue during parental and medical leave).
– Apple – high-performers receiving out-of-cycle RSU grants as a retention incentive (which didn’t go over well with everyone), CEO received a new performance-based RSU grant on his 10-year anniversary based on TSR.
– Alphabet – four senior execs received new stock awards that were split between time-based and performance-based RSUs, shift to front-loaded vesting for employee RSU grants.
Bruce predicts that more companies will be examining vesting schedules and possibly making them more favorable to employees and executives. He also points out that concerns are resurfacing about underwater stock options and reduced value of previously granted RSUs. Companies may be beefing up new grants to make up for that.
I previously blogged about how companies are looking to increase workforce compensation due to inflation & talent wars. But of course, compensation committees also need to look at inflation in the context of setting executive pay. An NACD blog flags that merit budgets/salary increases and incentive plan goal-setting may be two specific areas that compensation committees need to consider in this inflationary economy. Here’s a short excerpt of the issues:
-Because the current environment is challenged by inflation, as well as ongoing pandemic and labor difficulties, some management teams might see an increase to the merit budget for the broad workforce as perhaps one of the easier decisions to make this year. It’s a different story, however, for executives. Boards have generally been more willing to increase incentive opportunities than to provide executives with significant salary increases. This is due to the bias toward performance-based compensation and can be seen in the evolution of executives’ pay mix over the past 40 years. However, incentive plans can be perceived as riskier during inflationary times—to say nothing of the other risks looming—and so higher incentive opportunities may be less valued right now than smaller salary increases.
– [A]t the board level, we need to at least understand the subtleties [of inflationary effects and price changes through the company’s supply chain] to develop a feel for whether any changes might be warranted to, for example, thresholds, maximums, or gatekeeper measures in any existing or future incentive plan. This is important when determining and explaining any non-GAAP (generally accepted accounting principles) or judgmental adjustments to payouts… A complicating factor for directors approving annual goals is that inflation generally results in higher earnings growth than we normally see….If demand stays strong as inflation increases, you may see companies overachieve during the early days of a cycle. Then, the opposite occurs as inflation cools, and taking earnings expectations back down to pre-inflation ranges becomes similarly difficult, especially for investors.
The blog then recommends that compensation committees consider providing potential year-end adjustments for actual vs. projected budget assumptions, or increasing the range from threshold to maximum.
I’ve previously blogged about benchmarking pay practices being detrimental to female executives. But we’re also still tackling gender pay gaps in the workplace, including with respect to equity compensation – and the inequity may potentially be coming from pay negotiation skills and managerial discretion. Barbara Baksa refers to a WSJ analysis in her NASPP blog, which found that in 2018, the average value of company stock held by men was almost 4x that of women, at $104,902 and $26,361, respectively. In addition, the inequity seems to start up front, as women receive 15-30% fewer equity grants (based on a study examining a tech startup and a large pubco).
As companies get more and more calls for pay equity audits in proxy seasons, it’s a good time for compensation committees to get familiar with how exactly companies are managing the equity grant process to root out unfair biases. And as Barbara notes, “employees who are paid less [in cash] can’t contribute as much to the company ESPP or retirement plans as their higher paid colleagues” – and they may also not be able to exercise as many stock options either – so that may affect both your workforce makeup during the hiring stage and pay inequity during the employee lifecycle.
Here’s the latest 137-page guide for compensation committees from Wachtell Lipton, and it even includes a sample compensation committee charter at the back. In the sample charter, they note that it’s not unusual for human capital management to be slotted under either the compensation committee or the Nom/Gov committee – and offer up some sample charter language on HCM oversight. As noted in the guide’s introduction, compensation committees will need to proactively manage compensation & human capital needs this year, and be prepared to act quickly to retain key contributors.
Meridian Compensation Partners released its 2021 Study of Executive Severance Arrangements Not Related to a Change in Control, with data from 100 large U.S. public companies. The study examines the following NEO severance arrangements: (i) payment triggers, (ii) cash severance benefits, (iii) stub year annual bonus, (iv) continuation of health care benefits and (v) treatment of long-term incentive awards – but doesn’t incorporate benefits payable to an NEO upon death/disability/retirement or renegotiated benefits upon actual termination. Here is an excerpt of the key findings:
– 69% of Study Group Companies provided Cash Severance to at least one named executive officer.
– The payment of cash severance is always triggered upon an involuntary termination without “cause” and to a significantly lesser extent upon a voluntary termination for “good reason.”
– 85% of companies determined the amount of cash severance based on a fixed multiple of “pay”.
Definition of Pay – The majority practice is to define pay as the sum of base salary and bonus (with
bonus typically defined as current year target bonus).
Cash Severance Based on a Fixed Multiple of Pay – The dominant severance multiple for CEOs and
other NEOs was 2.0x (62% and 40% of companies, respectively).
– 61% of companies that maintained executive severance arrangements paid stub-year bonuses on a pro rata basis (typically based on target).
– The most prevalent continuation periods were 24 months (38%) and 12 months (23%) for CEOs, and 18 months (27%) and 12 months (34%) for other NEOs.
Meridian’s survey also shows that the treatment of LTI awards varies by types of awards – and whether the NEO is the CEO. A majority forfeit stock options but fully/partially vests restricted stocks/RSUs upon a qualifying termination.
Comments on the SEC’s reopened “clawbacks” proposal were due at the end of November. As usual, though, the SEC has continued to welcome submissions even after that deadline, and letters have continued to roll in as recently as last week. You can view all of the comments submitted – from 2015 to present – on the SEC’s website. Here are a few notable ones:
– NYSE Group (commenting on the delisting standards that exchanges would apply in determining whether an issuer has complied with its recovery policy and advocating for Exchange staff discretion)
Many of the comments reiterate concerns that were previously raised in response to the 2015 proposal. Not surprisingly, investors are general supportive of broader corporate clawback policies, and issuers are advocating for more bright-line tests that are tied to financial statement materiality. The Davis Polk letter also discusses issuer compliance costs and the potential impact on executive compensation arrangements. There are differences of opinion on some points – e.g. whether to include a Form 10-K cover page checkbox – even amongst the issuer community. The Staff certainly has a lot to consider as it moves towards finalizing this rule.
The blog recommends that you take the SAB and these proposed rule amendments into account when considering the timing of 2022 option grants. Here’s an excerpt about what will be required if the proposal is adopted as-is:
The proposal expands the information all companies would need to disclose, not just those companies required to add a footnote to their ASC 718 expense disclosures referenced in the above example. The proposal would require all public companies, under new section 402(x), to include a description in their 10-K annual reports of their option/SAR grant policies and practices, how they determine the timing of grants (predetermined dates during the year or not), and the influence of material nonpublic information in their compensation committees’ grant timing and grant valuations.
This discussion would also be included in the company’s compensation discussion and analysis, so that shareholders can understand company option grant timing practices when considering say-on-pay votes, when approving executive compensation plans and when electing directors. We expect that these will become garden-variety discussions that all companies will be required to include, unless special circumstances exist.
For companies that make grants to named executive officers within 14 days before or after the release of material nonpublic information on quarterly reports or 8-Ks, the SEC would require additional disclosures so that shareholders understand with complete transparency how the process works. The SEC believes that many companies, after the end of a completed fiscal quarter or annual period, hold meetings with their boards of directors a week or two before issuing the earnings release when they are likely aware of material nonpublic information that could affect the stock price of the company. Rather than propose a facts and circumstances test, the SEC proposed a black letter rule that would mandate disclosure within this time frame.
This tabular disclosure would be required for companies that make awards within 14 calendar days before or after the filing of a periodic report on Form 10-Q or Form 10-K, an issuer share repurchase, or the filing or furnishing of a current report on Form 8-K that discloses material nonpublic information (including earnings information).
Instructions are provided as to how these columns must be populated, with rules substantially similar to those in the current proxy disclosure rules. All public companies must abide by the option disclosure rules, including smaller reporting companies.
The WTW team notes that if the proposal is adopted, companies could be required to provide this additional disclosure in 2023 proxies, about 2022 grants. For that reason, even though we don’t yet have the final rules, companies may want to take a second look at their 2022 grant cycle. It may be prudent to reconsider grants that are expected to fall within 14 days before or after earnings or other announcements that could affect share price – or at least consult with legal counsel on whether to be so proactive. Remember that the SEC is also looking for comments on aspects of the rule that may not work well in practice (and since the proposal still hasn’t been published in the Federal Register, which will start the clock on the comment period, you have extra time to get those in).
Here’s an excerpt from WTW’s blog, with parting thoughts:
If the regulations are finalized during 2022, it is likely that the SEC will allow companies and insiders some ramp-up time before they must comply with the new restrictions. It would certainly be worthwhile for companies to consult with their stock plan administrators to determine what actions need be taken to meet the new rules. The question of whether it makes sense to adopt the new requirements before they are finalized becomes a legal question that SEC counsel can help determine.
There’s been a lot of back & forth on whether shareholders actually provided lower support for say-on-pay resolutions last year. That’s probably because the data was mixed. Semler Brossy’s year-end summary explains:
– The Russell 3000 average Say on Pay vote (90.4%) was consistent with the prior two years.
– The Russell 3000 did see an uptick in failures (63).
– At least 32% of failures happened because of Covid-19 pay actions.
– In the S&P 500, average vote results decreased to 88.3%. This was 130 basis points below the prior year result and 210 basis points below the Russell 3000 average vote.
It’s easy to go around & around with stats, but the bottom line is that companies should not get complacent about say-on-pay. I’ve previously blogged that low support is “blood in the water” for activists. Semler Brossy’s report says that over the past 5 years, average direct support at companies that received a say-on-pay vote below 50% in the prior year is 5% lower than at companies that received above 70% support.