This blog from Pearl Meyer’s Sharon Podstupka points out that it’s not too soon to begin drafting your CD&A – particularly if your comp committee changed executive goals or compensation structures during 2021. Sharon predicts that these items will be the most challenging to address and would benefit from a head start:
1. Goal-Setting – “If your organization had to take an alternative approach to setting performance goals for 2021 given the continued market uncertainty at that time, it will be extra important to clearly outline the factors the committee considered in making its final decisions—especially if year-end results are currently projecting to be significantly higher than the original expectations (e.g., we set conservative targets and never could have forecasted how great we’d do by the end of the year).”
2. ESG Metrics – “If your organization has formally adopted ESG metrics in your annual or long-term incentive plans for 2021 or are planning to adopt them for 2022, make sure the CD&A is putting this change front-and-center and then some… For those that do not have formal ESG metrics in their plans, you’ll still want to be clear in the CD&A about how ESG influences compensation committee decisions about NEO pay.”
3. Board Responsiveness & Shareholder Engagement – “If your CD&A doesn’t acknowledge how the compensation committee stays connected to shareholders on executive compensation matters, you are open to scrutiny. And, if your organization is in a situation where it has experienced declining support over the years and/or below 70% support (for ISS) and/or 80% support (for Glass Lewis), this should be viewed as a critical area of content to address even if no changes to the plans were implemented.”
– Liz Dunshee
Programming Note: The Advisors’ Blog will be off tomorrow and Friday, back next week. Merry Christmas, to those who are celebrating!
A recent Willis Towers Watson memo looks at how S&P 100 stock ownership & retention guidelines have changed over the past 6 years. Here’s an excerpt from the firm’s summary, with a few key stats:
– Stock Ownership Guidelines: Company stock ownership required for S&P 100 CEOs is climbing to a value of six times salary or higher. While the most common multiple for S&P 100 CEOs has remained six times salary since 2015, CEO multiples greater than that have gained traction and appear on pace to become the majority practice in the near future. Companies using a CEO multiple greater than six times salary represented 27% in 2015, 33% in 2019 and 42% in 2021. 90% of the S&P 100 use a salary multiple approach for stock ownership guidelines.
– Stock Retention Requirements: Stock retention requirements have also seen significant growth since 2015. A significant majority of companies (70% in 2021) now utilize retention requirements in conjunction with their stock ownership guidelines, signaling an increased commitment to both total ownership value and long-term consistent holdings with less strict adherence to the time needed to comply with policies. One driver of these policies occurred in September 2019 when the Council of Institutional Investors (CII) suggested that ownership guidelines and retention policies should be included as part of an executive compensation program focused on building long-term (at least five years) shareholder value. Prior to this suggestion, in 2015, Institutional Shareholder Services (ISS) began to account formally for these policies when evaluating and scoring a company’s equity compensation plan.
The SEC recently posted its Reg Flex Agenda – which reflects rulemaking priorities of the Chair. It contemplates revisiting a couple of Dodd-Frank rules that had previously been relegated to the “Long-Term Actions” list and seemed like they might fade into oblivion:
– Pay-for-performance – considering reopening the comment period, in April 2022, on rules to implement Section 953(a) of the Dodd-Frank Act, which would require companies to disclose the relationship between executive compensation actually paid and the company’s financial performance
– Bank bonuses – considering reproposed regulations under Section 956 of Dodd-Frank in October 2022, which would prohibit incentive-based payments that encourage inappropriate risks at a covered financial institution
Clawbacks are also still on the agenda – the SEC reopened the comment period for those rules back in October. The SEC isn’t obligated to accomplish what’s on the Reg Flex Agenda – within the specified timeframes or at all. But Chair Gensler has said several times that he wants to complete Dodd-Frank rulemaking, and so far, he appears to be taking steps to do that.
When it comes to the 2022 US proxy voting guidelines, the asset manager’s overall approach to executive compensation is consistent with last year’s guidelines – with a striking change. Last year’s guidelines said that where BlackRock concludes that a company has failed to align pay with performance, it would vote against say-on-pay and consider voting against the compensation committee members. In 2022, BlackRock is taking a harder stance. The voting guidelines say:
Where we conclude that a company has failed to align pay with performance, we will vote against the management compensation proposal and relevant compensation committee members.
While BlackRock typically supports say-on-pay proposals (84% globally, and even higher in the US), this policy means that directors will face immediate “against” votes from the asset manager when executive pay packages aren’t approved. This follows an approach started in the pension fund space a couple of years ago that appears to be catching on. Given BlackRock’s holdings and the signal that diminished director support can send to activists, it’s a risk that compensation committees should be made aware of. Here are other executive compensation-related updates to BlackRock’s voting guidelines:
– Reflective of its updated Global Principles on the alignment of ESG metrics with executive pay, Blackrock notes that a company’s “performance-based compensation should include metrics that are relevant to the business and stated strategy or risk mitigation efforts” – and is supportive of incentive-based plans that foster sustainable achievement of both financial AND non-financial results.
– Blackrock previously noted that the vesting timeframes under incentive plans should support long-term value creation – and now notes the holding timeframes should support the long-term focus as well.
– Blackrock previously had language to “consider biennial and triennial timeframes [for say-on-frequency proposals], absent compensation concerns” – this was removed for 2022. Instead, Blackrock believes “shareholders should have the opportunity to express feedback on annual incentive programs and changes to long-term compensation before multiple cycles are issued.” Blackrock may be giving more leeway on incentive plans by underscoring long-term value creation, but it may be balancing that with the ability to chime in annually on executive compensation practices.
– Blackrock previously generally supported proposals asking for shareholder approval of golden parachute plans that “exceed[ed] 2.99x an executive’s current salary and bonus, including equity compensation” – this was removed for 2022, which suggests Blackrock may be less inclined to use specific numeric thresholds to come to a vote.
On the Global Principles, last year, Blackrock added new language on sustainability issues – and this year, it’s largely looking to make more incremental updates. Blackrock flags five notable updates in its 2022 Global Principles relating to climate risk, sustainability reporting, board diversity, ESG in executive compensation and changes to corporate form. Here’s an excerpt from the summary document regarding ESG metrics in executive compensation – and it’s similar to the approach that Glass Lewis announced last month:
Our principles have long articulated our view that performance metrics for incentive plans should be stretching and aligned with a company’s long-term strategy and business model. BIS looks to the board to set incentive pay targets that are transparent and linked to performance. In response to inquiries from companies, as well as greater interest among other stakeholders, we have added to our 2022 Global Principles that BIS does not have a binary position on the use of ESG-related criteria in compensation programs, but believes that where companies choose to include them, those metrics should be aligned with a company’s strategy and business model and should be as rigorous as other financial and operational targets.
Blackrock notes that these Global Policies are “deliberately high level,” which makes sense given the emphasis on a company-specific approach to ESG metrics. It’s also helpful to refresh onBlackrock’s memodetailing its approach on executive compensation – ESG metrics should be meaningfully tied to the company’s ESG efforts and long-term business strategy.
Tune in tomorrow for the webcast – “Compensation Committee Responsiveness: How to Regain High Say-on-Pay Support” – to hear Aileen Boniface of Clermont Partners, Steve Day of Calfee, Halter & Griswold, Brad Goldberg of Cooley and Tara Tays of Pay Governance break down key 2021 lessons on say-on-pay and problematic pay designs, and discuss how to bring your “A game” to shareholder engagement for the upcoming proxy season.
If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submityour state and license number and complete the prompts during the program.
Members of this site are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, subscribe now by emailing sales@ccrcorp.com – or call us at 800.737.1271.
Liz recently blogged about ISS’s updated FAQs on pandemic-related pay adjustment. It looks like investors are steadily expecting companies to go back to pre-pandemic compensation designs, although there’s still some confusion swirling around with new Covid-19 variants. That uncertainty makes it challenging for compensation committees working to incentivize and retain executives during this time, especially when it comes to setting appropriate performance targets. Meridian shared some practical pointers on clawbacks, compensation disclosure and performance-based equity, based on a recent Conference Board webcast. Here is an excerpt of the practical PSU pointers for compensation committees to consider:
– Use a wider range. Set the performance threshold for a minimum payout at a level that still gives executives a chance of an earnout even when the company has a bad year, but set a high bar for a maximum payout to keep your shareholders happy and to drive superior performance.
– If you’ve moved away from relative total shareholder return (TSR), consider reintroducing it or making it a more prominent feature of your program. Relative TSR has disadvantages as a performance metric because so many factors affect stock performance that are out of executives’ control. But it allows for payouts if your industry or the entire economy are affected by a major negative event, and it clearly aligns payouts with your shareholders. So consider having, for example, 50% of your PSUs linked to a company-specific financial metric, while 50% is linked to relative TSR.
– Simplify and verify the “adjustment” process. If you’ve chosen a metric such as adjusted earnings per share (Adjusted EPS) as your performance target, avoid asking your compensation committee to approve a lot of de minimis[.] Consider having the audit committee approve adjustments to financial performance before they go to the compensation committee. Ensure adjustments can go both ways: don’t just back out the bad news; back out the unexpected windfalls too.
– Keep your performance share plan simple. One way of avoiding having a single bad year putting all of your outstanding PSU plans underwater is by “banking” PSUs on an annual basis as you go along. But keep in mind that you still want these to be long-term plans and don’t want to make your program so complicated that it cannot be understood by investors or by the executives it is intended to motivate.
With the amount of annual compensation that executives earn, some people think that retirement benefits aren’t much of a competitive factor. However, this Meridian memo flags a real-life example “concerning the adequacy of retirement benefits involv[ing] a former CEO and current board chair of a Fortune 500 company.” The memo explains that a company can provide executives with a path towards retirement with well-constructed retirement vesting provision in equity awards, while still avoiding problems that can arise with accelerated awards or not treating similarly situated employees in the same manner. Here’s a short excerpt of Meridian’s step-by-step process in designing retirement provisions for equity awards:
– “Step 1: Defining Retirement Eligibility: Drawing a line in the sand somewhere is important, but the approach taken should consider your employee base, as well as your ability to attract and retain talent. Many organizations historically defined retirement simply as an “age-only” requirement (e.g., age 65). However, there has been a shift toward a “points system,” where each year of age and each year of service count as one point (e.g., age + service = 72, often with a minimum age requirement), or even a combination of the two approaches (e.g., 72 points or age 65). Combination approaches have the benefit of balancing rewarding those with long tenure, while still encouraging potential “late career” hires to join your organization.”
– “Step 2: Defining Retirement Qualification (“Good Leaver Policy”): …Companies should consider developing a “good leaver” policy as part of any retirement vesting provision. Under this policy, a retirement-eligible employee should provide ample notice (e.g., six months) to qualify for retirement treatment. This notice period should be established to allow for necessary succession planning. Retirement opens up opportunities for the next level of talent to advance in their career. If the next level of talent is not ready for the challenge, the notice period may provide enough time to hire an outside candidate. Additionally, some organizations require another qualifier in order to receive favorable equity vesting treatment upon retirement: a retirement-eligible employee must be employed for a certain period post-grant (e.g., six to 12 months).”
– “Step 3:Choosing Vesting Treatment: Calling for forfeiture of all outstanding equity upon retirement is probably too punitive, while full accelerated or continued vesting is often viewed as too generous. The answer likely lies somewhere in between. It is also important to consider standard vesting provisions for annual grants, in addition to vesting provisions for other forms of termination (i.e., retirement treatment should be equally or more favorable than not-for-cause treatment).”
Skadden is out with its annual checklist of matters to consider for the upcoming annual meeting & reporting season. It provides updates on proxy advisor policies, recent voting trends that could affect 2022 planning, and recommended steps. This year’s version is 48 pages long! As always, it has headings and navigation links to skip to what you need, and it’ll also be posted soon to our “Proxy Season” Practice Area.
Here are key items that the Skadden team recommends thinking about for executive compensation (also see my earlier blog):
1. Incorporate “lessons learned” from the 2021 say-on-pay votes and compensation disclosures and prepare for 2022 pay ratio disclosures
2. Consider trends & developments on employee, environmental, social & governance metrics in executive compensation
3. Evaluate Hart-Scott-Rodino Act implications in executive compensation
4. Note status of pending SEC rulemaking relating to clawback policies under Dodd-Frank
Yesterday, proxy advisor ISS published updated “FAQs” for pandemic-related pay adjustments. This 6-page document refines the FAQs originally published in October 2020, and explains how ISS will approach these issues beginning in the 2022 proxy season.
The new document notes that the upcoming proxy season will be the third year in which the pandemic has been in play (and the second year of executive pay proxy disclosure occurring under pandemic conditions). Many of the temporary base salary reductions have been lifted, and the “surprise element” of the pandemic is no longer applicable. So:
As in pre-pandemic years, any mid-year changes to metrics, performance targets and/or measurement periods, or programs that heavily emphasize discretionary or subjective criteria will generally be viewed negatively. This will be of particular focus for companies that exhibit a quantitative pay-for-performance misalignment.
However, in certain circumstances lower pre-set performance targets (as compared to 2020) and/or modest year-over-year increases in the weighting of subjective or discretionary factors may be viewed as reasonable for companies that continued to incur severe economic impacts and uncertainties as a result of the pandemic in 2021 (see question #5 below). As before, Companies should clearly explain target setting and any changes to the program, to allow investors to evaluate the compensation committee’s actions and rationale.
The FAQs discuss what disclosure would be useful if mid-year adjustments are made, and/or if incentive targets are lowered below prior-year levels due to pandemic issues. Regarding long-term incentives, the FAQs now say:
As before, changes to in-progress long-term incentive cycles will generally be viewed negatively, particularly for companies that exhibit a quantitative pay-for-performance misalignment. Modest alterations to go-forward cycles (i.e., awards granted for the cycle beginning in 2021) may be viewed as reasonable, particularly for companies that continue to incur severe negative impacts over a long-term period.
For example, some movement from quantitative to qualitative metrics or modest increases in the proportion of time-vesting awards. More drastic changes, such as shifts to predominantly time-vesting incentives or short-term measurement periods, would continue to be viewed negatively. Companies should clearly explain any changes to the program, to allow investors to evaluate the compensation committee’s actions and rationale.
The theme of these FAQs is that investors are expecting a return to traditional incentive structures. They want a strong link to performance and disfavor one-time awards. Deviations from that will be viewed negatively and should be accompanied by robust explanations. The FAQs also clarify that in 2022, ISS will return to its regular scoring thresholds for the Equity Plan Scorecard (it had raised the passing score for some companies in 2021).
Bruce Brumberg – who among other roles has blogged on this site and is the co-founder of myStockOptions.com – recently alerted me to his updated page on year-end planning for anyone who receives or is involved with equity compensation.
Bruce notes that multi-year tax planning is more important than ever (and while some individuals cannot be reined in, perhaps by helping your execs look ahead, you can avoid a situation in which they are liquidating a lot of holdings via a Twitter poll). Here are 4 tips that he highlights: