The Advisors' Blog

Over the past few years, we’ve seen a growing interest in gender & racial pay equity audits, from companies incorporating ESG into their executive pay to proxy advisors to investors. For companies jumping into the fray to conduct a pay equity audit, here’s a new checklist on the nuts and bolts of pay equity data collection and interpretation by Mark Borges and J.T. Ho – check it out!

– Emily Sacks-Wilner

Liz blogged a couple of months ago about how investors are starting to assess pay ratios as part of the say-on-pay analysis. According to a recent study by a group of B-School profs (Alam, Ghosh, Ryan Jr. and Wang), the best way for companies to come out favorably on these types of voting policies is probably to make real changes to CEO and/or employee pay, versus taking steps that could be viewed as “gaming the calculation” of the median employee. The study analyzes these three questions:

(i) Do discretionary choices in the methods used to estimate the pay ratio allow firms to influence the reported pay ratio without making real changes to CEO or employee pay?

(ii) Do investors react differently to pay ratio disclosures based on the choice of method employed?

(iii) Do firms strategically use these discretionary choices when facing social pressure toward income equality?

The professors conclude that companies disclose lower pay ratios when using “more complex methods to identify the median employee” – and companies “headquartered in a state with stronger aversion toward income inequality” are more likely to choose these more complex methods, presumably in response to societal pressure. At the same time, the study shows that shareholders react negatively to those complex methods. That’s consistent with another study that Liz blogged about a couple years ago.

Compensation committees will need to stay aware of these perceptions and pressures. It will be a juggling act to set competitive executive compensation while also balancing pressure to minimize inequality. While the outcome of those decisions will vary by company, human capital oversight and potential increases to workforce compensation are shaping up to be hot topics for almost everyone again this year.

– Emily Sacks-Wilner

To kick off 2022, here’s a summary of Longnecker’s blog covering upcoming compensation strategies & emerging trends – for executives and the broader workforce:

– ESG: “As public pressure and changing cultural norms continue to evolve, ESG looks to stay as a new benchmark criteria for today’s business leaders. Specifically, institutional investors are holding company operations accountable for their effects on the environment and their surrounding communities. Surveys show that already, 45% of FTSE 100 companies incorporate ESG metrics in their executive pay programs.” ESG is a global phenomenon, and it’s also here to stay in the U.S. Get ready to see ESG metrics incorporated into companies’ incentive programs.

– Compensation Clawbacks: Liz recently blogged about McDonald’s successful clawback – and though there hasn’t been much new activity after the SEC comment period for the clawback proposals closed, companies should review their clawback policies and how the proposed rules might work with existing and upcoming incentive plans.

– Proxy Disclosures: Longnecker notes that “in addition to Human Capital Management, CEO Pay Ratio and other disclosures, Perquisite disclosures continue to be an enforcement priority for the SEC.” You can also check out our handy checklists on perks disclosure and other executive compensation disclosures as you start drafting.

– Flexibility & Remote Work: Longnecker suggests that “remote work options and flexibility are emerging trends that will continue to gain momentum in 2022 as employees place high value on these benefits.”  Flexibility may also promote employees’ mental health, which is another factor in human capital management.

– Variable Compensation to Reward Top Performers: Longnecker projects “an upward trend in variable pay strategies, especially at the employee level going into 2022” and flags that variable pay programs and spot awards are “proven methods to improve retention at both the employee and executive levels.”

– Mitigating Pressure on Compensation Budgets & Rising Wages: Longnecker notes that employers can mitigate the dual issues of struggling to fill open positions and raise base salaries by “retain[ing] current employees, offer[ing] learning and development programs to fill positions from within, tak[ing] a holistic approach to total rewards and look[ing] beyond compensation.”

– Emily Sacks-Wilner

As everyone plots out the agendas for upcoming board & committee meetings – and considers governance disclosure that will go in the proxy statement – a member recently posted this question to our “Q&A Forum” (#1390):

Does the compensation committee need to/should it approve personal security and/or other perks on an annual basis?

John Jenkins responded:

Yes, I think comp committee oversight of the nature of the perks that are provided to executives is essential and that committee approval of them on an annual basis is appropriate. After all, the perks a company provides are an element of executive comp. Stock exchange rules require the comp committee to approve CEO compensation and to recommend the compensation of compensation for other executive officers. Many charters go beyond that, and delegate responsibility for executive comp to the comp committee.

Perks are an investor hot button and an area that’s gotten a lot of attention from the SEC’s Division of Enforcement, and oversight from the comp committee is expected. Here’s what the CII had to say at the time the SEC adopted the revised comp disclosure rules:

“Company perquisites blur the line between personal and business expenses. The Council believes that executives, not companies, should be responsible for paying personal expenses—particularly those that average employees routinely shoulder, such as family and personal travel, financial planning, club memberships and other dues. The compensation committee should ensure that any perquisites are warranted and have a legitimate business purpose, and it should consider capping all perquisites at a de minimus level. Total perquisites should be described, disclosed and valued.”

I think that the general perquisites provided to the company’s executives need to be reviewed and approved by the compensation committee just like any other compensation plans or practices that apply to its executive officers.

– Liz Dunshee

The Canadians are sorry, but some of them have had enough of excessive CEO pay at US companies. As investors to the north and elsewhere begin to incorporate “fairness” concepts into their say-on-pay guidelines, this blog from NEI Investments – a Canadian investment manager focused on responsible investing – highlights several solutions that are on the table for those concerned about internal pay equity. Here are two excerpts, summarizing a recent roundtable discussion:

– The group acknowledged that integrating language related to pay disparity into voting guidelines is important as a way to determine how appropriate the ultimate amount awarded to executives is.

– Despite some limitations with the median worker pay ratio, participants said it makes an excellent jumping off point for corporate engagement. It can lead to questions such as: How do boards use the ratio to set CEO compensation? Does the company plan to set a target ratio, and how would they go about meeting that target? How do employees feel about pay, given the ratio?

The blog also notes that investors involved in these discussions may be taking a closer look at pay structures for both executives & other employees – including limiting CEO salary increases, reverting to an executive pay structure that is more heavily weighted towards salary, tying vesting of equity awards to worker satisfaction, and applying pressure on companies and the government to raise non-executives’ compensation. The initiatives here appear to be a long-term play, but one worth watching.

– Liz Dunshee

FW Cook has released its 49th Annual “Top 250 Report” – which examines the long-term incentive practices & trends of the 250 largest companies in the S&P 500. This excerpt lays out the key findings:

• Long-term incentive mix continues to be strongly oriented towards performance plans; on average, performance awards represent 58% of total long-term incentives.

• Total Shareholder Return continues to increase in prevalence – now used by 69% of companies vs. 56% in 2016 – and remains the most common performance metric among the Top 250 companies, with 95% of companies that use it measuring it on a relative basis (up from 86% in 2016).

• Beyond TSR, an increased number of companies evaluate financial metrics on a relative basis rather than on an absolute basis due to market volatility and to avoid the need for multi-year goal setting; more companies migrated towards use of broad or industry-relevant indices for comparisons to enhance sample size and reduce impact of volatility/M&A activity associated with a smaller sample size.

• Median threshold and maximum performance goals remain relatively constant from 2019, even with individual companies setting broader performance ranges in response to the COVID-19 pandemic. Based on available disclosure of FY21 goals, there is some early indication of companies setting wider performance ranges.

• An increasing number of companies measuring relative TSR performance set targets above median (29% in 2021 vs. 23% in 2019), which is likely in response to proxy advisory firms’ view that target earnout should require above-median performance.

– Liz Dunshee

While many folks were hard at work on year-end deadlines – or taking well-deserved breaks – there was a big development in the clawbacks space. McDonald’s announced via a Form 8-K and press release that its former CEO, Steve Easterbrook, had returned more than $105 million in equity awards & cash. As part of the settlement, Easterbrook also apologized to the company, the board and the broader McDonald’s community.

The company took the extraordinary step of suing Easterbrook in 2020 after an anonymous tip indicated that he may not have been truthful at the time of his 2019 termination about his relationships with employees. The tip prompted an internal investigation, and in some ways gave the board a “do-over” after it had determined that the original termination – which resulted from a consensual employee relationship against company policy – was not “for cause” but just a demonstration of “poor judgment.” As I blogged when the complainant was filed, the board said that it would not have approved a separation agreement characterizing Easterbrook’s termination as “without cause” if it had been aware of his dishonesty and additional conduct violations.

This isn’t the first time a former exec has had to pay back incentives – a recent example happened in 2020 when the SEC ordered Hertz’s former CEO to repay $2 million following a restatement. As this NYT article recaps, there have also been larger settlements, relating to options backdating & fraud. But this settlement is unique in that the misconduct is not directly tied to financial issues.

Last year at this time, Lynn blogged that shareholders were calling for resignations of the McDonald’s board chair and the compensation committee. All directors were re-elected, but in a move that may be aimed at appeasing some of the discontent around oversight of #MeToo issues, the company’s press release also reiterates previously announced mandatory training for both company-owned and franchised locations:

Recognizing its scale and resulting influence, McDonald’s will continue to promote safe and respectful workplaces. McDonald’s is implementing mandatory and industry-leading Global Brand Standards for safe, respectful and inclusive workplaces, which require all 39,000 McDonald’s restaurants to adhere to these new standards.

– Liz Dunshee

I previously blogged about compensation committees using discretion in incentive plans to retain executives through the pandemic. But with the spotlight on human capital management, compensation committees need to look at executive compensation in conjunction with workforce compensation. Here are recent workforce compensation poll results from Pearl Meyer – the poll was conducted from November to December 2021 with 339 companies participating (179 public, 109 private and 51 non-profit), and was inspired by the “growing concerns about rising inflation and increasing competition for talent.” Below is an excerpt of Pearl Meyer’s key findings, for boards and management teams tackling hiring and turnover issues:

– After more than two decades of very flat total base salary increases hovering in the low 3% range, we are expecting 2022 increases to surpass 4% for all employee groups combined. Moreover, nearly all survey respondents will be providing employees with base salary increases in the coming year.

– Results indicate that organizations are responding to this perfect storm of record inflation, high turnover rates, and a shortage of labor by providing more generous increases as a tool to attract and retain talent.

– Private-for-profit organizations reported the highest total increase figures, followed by publicly traded companies.

– This very timely survey reports that half of respondents anticipate 2022 base pay increases to be higher than what was originally expected earlier in the year, indicating that organizations are revisiting the annual compensation planning exercise. Of those organizations with higher projected increases than was originally expected earlier in the year, 40% report increases greater than 5%.

– Emily Sacks-Wilner

Programming Note: The Advisors’ Blog will be off tomorrow and Friday. We’ll see you in 2022. Happy New Year!

Due to the Covid-19 pandemic, some compensation committees had to use their discretion with incentive plans to retain and motivate executives. While investors and proxy advisors seemed to give more leeway to discretionary changes in year one of the pandemic, there’s growing expectation that executive compensation designs should swing back towards pre-pandemic practices – we’ve seen this reflected most recently in ISS’s updated FAQ for pandemic-related pay adjustments. Semler Brossy offers some suggestions for building more resilient compensation programs that can both withstand uncertainty and motivate executives:

– Extended runways for short- and long-term incentives: Semler Brossy suggests that for annual bonuses, compensation committees can consider setting up “longer runways for earning awards by widening the range of outcomes that trigger payouts. This approach allows for greater performance volatility with the opportunity for some payout at lower levels of performance, and a higher bar for maximum payouts.” Compensation committees can also “shift down the payout curve” so executives can still meet their targets and get their bonus during difficult times, but “not receive windfalls if a crisis creates tailwinds.”  For long-term incentives, companies can consider using additional metrics that reflect the company’s long-term strategy, including ESG metrics. In addition, “boards may also include metrics with different time frames, such as four-year terms.”

– Qualitative scorecards for annual bonuses: Companies can increase the impact of non-financial metrics in their executive compensation designs, and scorecards can help objectively frame these non-financial results. These qualitative scorecard metrics “can be strategic (such as boosting market share growth in targeted channels or setting up new businesses), operational (cost management or productivity), ESG-related (especially environmental and social), or some combination of all of these.” Boards will still have to exercise some discretion, but a properly constructed scorecard may be able to clearly connect the dots between executive performance and fair pay.

– Relative metrics in long-term incentives: Semler Brossy notes that “relative metrics, such as market share, total shareholder return, EPS, or ROIC against a defined peer group, can also overcome the problem of external factors” but notes that relative metrics have some drawbacks – including not having a truly comparable peer group.  Committees can also consider “reducing the plan’s weighting of its performance component” as an alternative to using relative metrics, as long as 50%+ of the awards are tied to performance and not tenure.

For compensation committees looking to get a quick refresh on where peers have landed in 2021 with executive compensation designs and practices, here’s also Farient’s handy Covid tracker – it tracks executive and director compensation for the Russell 3000 (currently as of July 31, 2021).

– Emily Sacks-Wilner

Willis Towers Watson’s Global Executive Compensation Analysis Team (GECAT) found some equity compensation program trends for S&P 500 companies by analyzing the reported overhang, run rates and long-term incentive fair values for fiscal years 2017 through 2020, as well as those of 2021 mid-year filers. Here is an excerpt of their key findings – which may come in handy for counsel working with stock plans and considering additional incentive plan share authorization proposals for next year’s proxy:

– The use and mix of full-value awards continues to increase annually. Restricted stock usage was highest in the information technology sector (79% of LTI mix); performance-based stock usage was highest in the utilities sector (55% of LTI mix), and stock option usage was highest in the industrials sector (23% of LTI mix).

– S&P 500 median run rates have declined 10% since 2017, coinciding with a reduction in the use of stock options. The utilities sector experienced the most significant run rate decline of 22% since 2017. A preliminary review of 2021 grants shows this trend continuing.

– S&P 500 median overhang continued its downward trajectory from 7.4% in 2017 to 6.4% in 2020. The health care sector had the highest overhang rate at 8.5%, while the utilities sector continued as the sector with the lowest overhang rate at 2.4%.

– The highest median LTI fair value increase once again occurred in the communication services sector, which increased 114% over 2017 figures. The consumer staples and consumer discretionary sectors experienced a 4% and a 22% increase, respectively. A preliminary look at 2021 figures shows a higher LTI fair value on an absolute dollar basis, with a decrease in the value as a percentage of market capitalization year-over-year.

– The percentage of companies requesting shares to fund stock incentive plans increased from 14% in 2017 to 20% in 2020, while the average number of shares requested decreased from 3.8% (2018) to 3.2% (2020) of common shares outstanding (CSO).

– Emily Sacks-Wilner