You can still register for our popular conferences – the “Proxy Disclosure & 18th Annual Executive Compensation Conferences” – to be held virtually Wednesday, October 13th – Friday, October 15th. We’ll be covering the changing expectations from investors and other stakeholders – with practical guidance on how to use the annual reporting season to your advantage.
For more details, check out the agenda – 17 panels over 3 days. Our speakers are fantastic and this is truly a “can’t miss” event for anyone involved with proxy disclosures, corporate governance, and executive pay.
Conference attendees will not only get access to our unique & valuable course materials (coming soon) – we’ll also be making video archives and transcripts available after the conference, so that you can refer back to all of the practical nuggets when you’re grappling with your executive pay decisions, disclosures and engagements. Plus, our live, interactive format gives you a chance to earn CLE credit and ask real-time questions.
Register today! As an added benefit to members, this year we are offering a discounted conference rate to those who have a paid subscription to any one of our sites.
I’ve blogged a few times about “pay ratio” tax proposals – mostly at the state level. Although they haven’t really taken off, this CNBC article and other sources say that Democrats are currently revisiting the idea – along with a number of tax measures that could affect executive compensation.
It’s good to be aware of this in case the comp committee or an executive asks about it, but know that it’s all pretty speculative at this point as lawmakers try to gather support for the budget bill and social spending proposals. Ideas on the table include:
– Taxing stock buybacks, or treating them as taxable dividends to shareholders
– Reducing corporate deductions for executive compensation
ISS recently released its “Compensation 2021 Proxy Season Review.” The full report is available only to corporate & institutional subscribers – but here are the key takeaways:
– Say-on-pay support continued its downward trend, while the failure rate matched the record high. Since 2018, the median say-on-pay vote support has declined each year and remained below 96 percent in 2021. The percentage of companies with failed say-on-pay votes increased to 2.6 percent, up from 2.1 percent in 2020. This is tied with 2012 as the highest failure rate since mandated votes began.
– CEO pay levels again reached record levels, despite widespread salary freezes and reductions. Continuing CEOs in the S&P 500 as well as the Russell 3000 saw overall pay increases that were primarily due to larger long-term equity incentives. The median CEO pay package was at an all-time high in both indices, despite the fact that many companies froze or reduced base salaries in response to the pandemic.
– COVID-related issues dominated disclosures and pay decisions. Compensation committees grappled with the increasingly difficult task of implementing executive pay programs that account for new realities and shifting strategies. Many companies that elected to make adjustments to in-progress long-term incentives faced investor opposition, leading to a number of high-profile say-on-pay failures.
– The use of discretionary bonuses increased, in part due to the pandemic creating uncertainty around goal-setting. The prevalence of discretionary CEO bonuses increased in both the S&P 500 and non-S&P Russell 3000, as many compensation committees had difficulty setting goals amid the pandemic. Further to this, payouts of formal performance-based bonus programs decreased in both indices.
– Companies continue to emphasize performance-vesting equity incentives. Within the S&P 500, most companies continued to deliver the majority of the value of CEO equity awards in performance-vesting vehicles. The proportion of CEO equity awards as performance-vesting reached a new high of 58 percent.
– Companies are improving disclosure around non-employee director pay. Despite an increase in the number of instances of outlier director pay levels identified, with each year more companies are disclosing reasonable explanations. Approximately three-fourths of companies disclosed a sufficient rationale for high director pay, up from two-thirds of companies in the prior year.
This 16-page Sullivan & Cromwell memo gives a nice overview of voting results for say-on-pay and equity plan proposals through June 30th. The memo also gives tips for pay-related engagements as we head into 2022. Here’s an excerpt:
Companies should ensure that the appropriate personnel at institutional investors are involved in the engagement process. Larger institutional investors generally have both environmental, social, and governance (ESG) experts and investment professionals, all of whom may provide input into the voting process but may have differing views. Institutional ESG expertise is particularly important with respect to compensation programs as companies increasingly consider tying pay to ESG metrics and shareholders expect alignment between compensation and ESG outcomes.
Companies therefore should ensure that the appropriate company representatives are part of engagements and that materials are appropriately tailored. Institutional investors are likely to send representatives with a high degree of expertise and specialization, and generalized presentations may not suffice.
Board representation in discussions, especially on topics such as succession planning or executive compensation, may be appropriate but should be evaluated on a case-by-case basis, taking into account the engagement history, the purpose of the meeting, the experience of the relevant directors with direct shareholder engagement and Regulation FD (among other things), and the preferences of the investor with whom the company is engaging.
The memo also recaps ISS’s approach to say-on-pay recommendations, which is important to understand as the proxy advisor continues to influence voting outcomes:
[A]lthough pay-for-performance is just one factor in the overall compensation assessment, it remains the main determinant of ISS’s recommendation on the say-on-pay vote, as has been the case in recent years. This year, however, ISS has also increased its focus on compensation committee communication and responsiveness, ascribing high concern to twice the number of companies this year compared to 2020. This increased focus by ISS highlighted the importance of engagement by public companies with their shareholders on matters relating to compensation.
Of the 12 companies that received a high concern rating on compensation committee communication and responsiveness, four received a rating of low concern with respect to pay-for-performance (and another three received a low initial quantitative concern rating with respect to pay-for-performance). For five of these 12 companies, compensation committee communication and responsiveness was the only category in which the issuer received a high concern rating.
As we’ve blogged repeatedly, diversity metrics are the most common addition to pay plans right now – but many companies that they’ll be adding those goals on a prospective basis have not yet filed proxies to explain the details. This Equilar blog looks at a couple of early examples of proxy disclosures, specifically:
The blog also notes that from March to July, there was a five percentage point increase in the number of Fortune 100 companies that were using at least one type of ESG metric, pushing the total to over 40%.
The latest Semler Brossy recap of say-on-pay results says that results this year are a mixed bag. From a trend perspective, S&P 500 companies seem to have more to worry about than the Russell 3000, with a higher failure rate and lower voting averages overall. Here’s more detail (also see this Semler Brossy memo, for further analysis of the extra scrutiny of big companies):
– Failure rates are leveling out from what we saw earlier in the season, and it appears that most failures were due to Covid-related pay actions
– The current failure rate (2.8%) remains above the failure rate at this time last year (2.2%) and is slightly lower than our June 24th report (2.9%)
– The percentage of Russell 3000 companies receiving greater than 90% support (76%) is greater than the percentage at this time last year (73%)
– The current average vote results of 90.5% for the Russell 3000 and 88.7% for the S&P 500 are below the average vote results at this time last year
– The average vote results for the S&P 500 reflect an acceleration of a 4-year decline in average approval rates
– The average Russell 3000 vote result thus far is 180 basis points higher than the average S&P 500 vote result, which is 80 basis points larger than the spread at this time last year
Should companies be worried about say-on-pay failures heading into next year, or was 2021 an anomaly? If you’re a company that received a lower than normal vote this year, what do you need to do to bounce back? We’ll be talking about these issues (and many more) at our “Proxy Disclosure & Executive Compensation Conferences” – coming up virtually October 13th – 15th. Check out the agenda – and register today to get the info you need. Members of our sites get a discounted rate!
Here’s something that my colleague John Jenkins blogged recently on TheCorporateCounsel.net: We’ve previously blogged about Covid-19 related securities litigation, but this Proskauer blog flags something a little different – derivative litigation targeting comp awards that the plaintiffs essentially claim were “spring loaded” due to the pandemic-related market volatility:
While we are growing accustomed to pandemic-based shareholder actions relating to improper health and safety disclosures or misrepresentations relating to COVID-19 treatments and tests, this month brings a novel variant of the COVID-19 lawsuit. A Universal Health Services Inc. investor has filed a derivative suit against company officers and directors, claiming they took advantage of a pandemic-related drop in the company’s stock price to grant and receive certain stock options that were unfair to the company and its stockholders.
The plaintiff investor claims that “company insiders took advantage of the temporary drop in the company’s stock price to grant and receive options to buy the company’s stock at rock bottom prices, thereby showering themselves in excessive compensation.” The complaint alleges that the drop in stock price was “not caused by any changes in the company’s fundamentals or business prospects,” but instead was entirely attributable to the effect of the pandemic on the markets writ large.
The blog points out that the timing of the awards was pretty terrific from the recipients’ standpoint. The stock popped 25% the day after they were granted and by 47% within a week. According to the complaint, in just twelve days, the defendants reaped over $30 million in gains. The complaint alleges that the officers who received the grants unjustly enriched themselves and that the comp committee committed waste in making the awards.
You might’ve thought that executive “mega grants” disappeared a decade ago, along with new episodes of Jersey Shore. But this Pearl Meyer memo says they could be making a comeback. The memo defines “mega grants” as awards that have at least some of these characteristics:
– A grant date value of more than 10x the CEO’s (or other executive’s) salary;
– Represents a significant percent of common shares outstanding (e.g., 3% to 12% or more of common stock outstanding [CSO]);
– A one-time multi-year award, with an expectation of no further equity awards being provided to the recipient for several years; and/or
– Extended vesting/performance horizons, often seven to 10 years.
While proxy advisors and investors tend to dislike outsized awards, there may be situations where the benefits outweigh the risks. This Aon memo walks through ways to align mega grants with stakeholder interests – and gives examples of terms & conditions. Here are a few suggestions:
– Expressing the award’s ultimate value as a percentage of the value created for shareholders helps to articulate the value sharing between executives and shareholders. Targeted values of the award often range between 1-5% of total company value, with the majority on the lower end of the spectrum. Going above this range comes with substantially more risk, and in turn, should be accompanied with more performance rigor and justification.
– It is not uncommon for executives to forgo other compensation during the performance period of awards like this to help justify the quantum.
– Even if shareholder approval is not required, we recommend seeking approval to help mitigate risks.
– Some companies have chosen to roll out special broad-based programs at the same time to allow others to share in the success of the company, such as an employee stock purchase plan.
– There are also the optics to manage if the award does not ultimately payout, potentially impacting retention of key executives. Even entertaining a modification if the award becomes unlikely to pay out can make the problem worse. This may also tie up compensation plans for the executives over that timeframe, limiting flexibility to a changing environment. These risks should be weighed carefully during the design phase, so the company is comfortable with this potential outcome.
– Consider including design features that help to create even stronger alignment with shareholders, such as a post-vest holding period.
– Explaining directly to shareholders why this program is necessary and why you believe in it can be very impactful to getting shareholder support.
– Articulating explicitly why this program aligns with the company’s goals and is valuable to all stakeholders helps with the qualitative review of these programs and gaining shareholder support. Companies should make sure the rationale behind the award is one the company believes and can support publicly.
There’s no “one size fits all” with ESG metrics. They have to be carefully tailored to support the specific ESG strategies & priorities that the board has directed. For that reason, metrics vary across industries. This 16-page Semler Brossy memo dives into emerging trends in different sectors. Here are some takeaways:
– Heavy industries – such as Energy & Materials – place significant emphasis on employee safety metrics, along with measures tied to environmental impact and stewardship. The Energy, Utilities & Materials industries have the highest prevalence of ESG metrics, with safety being the most common metric.
– Industries with a heavy strategic focus on recruiting & developing high-caliber talent – such as Financials, Technology & Healthcare – tend to emphasize human capital metrics such as retention and talent development
– Customer satisfaction is common among Health Care, Financials, Information Technology, Industrials, and Utilities companies. Somewhat unexpected is the low prevalence of customer satisfaction metrics in incentive plans among direct consumer businesses in the Consumer Discretionary and Consumer Staples industries, although these industries also have the lowest prevalence of ESG metrics overall.
– All industries are continuing to face pressure to demonstrate a commitment to social responsibility, which is fueling the adoption of newer “social” sustainability metrics such as Diversity & Inclusion. Blue chip companies are announcing the addition of E&S metrics to go-forward plans.
– D&I is a prevalent metric in Financials, Health Care, Information Technology, and Communication Services, which are all industries that would be predicted by SASB. However, we also find high prevalence of D&I in incentives in Energy, Utilities, and Materials businesses, which is not as intuitive and perhaps a reflection of the higher level of social scrutiny of these companies given their overall environmental footprint. Perhaps most surprising is the relatively low prevalence of D&I incentives in consumer-oriented businesses – Consumer Staples and Consumer Discretionary.
– Environmental metrics are still relatively rare. They’re most prominent by far in the Energy, Utilities and Materials sectors, where emissions is the most prevalent, followed by carbon footprint. We would not be surprised if the combination of stakeholder pressure and financial materiality (e.g., under the SASB framework) will cause environmental metrics to grow in prevalence across industries over time.
The capuchin monkey experiment is often trotted out as an example of how pay inequity demotivates employees. If we’re anything like the monkey in the experiment, we’re happy to be paid in cucumbers until we see that our colleague is getting delicious grapes. Well, directors are pretty convinced that CEOs have the same tendencies, according to a recent study from Alex Edmans and other business school profs.
In the UK-based survey of over 200 non-executive directors and 159 investors, people seemed to agree that an astronomical level of CEO pay isn’t important to execs because it “finances consumption,” but because it makes them feel like they’re being treated fairly in comparison to their counterparts. In other words, they want to feel special – which means making at least as much as their peers and getting recognized for accomplishments. In the absence of an across-the-board change (and/or a breakthrough in non-monetary ways to motivate execs), that makes it difficult to depart from the “tyranny of the 75th percentile” and ever-increasing peer-based pay – even though investors keep saying they won’t stand for it.
Here’s what else the study showed about pay decisions:
1. Directors and investors consider intrinsic motivation and personal reputation to be the most important sources of incentives for CEOs.
2. While the primary reason for variable pay is to motivate the CEO to improve long-term shareholder value, this is not because the CEO obtains utility from consuming the additional pay from good performance. Instead, variable pay provides ex post recognition of good performance, addressing the CEO’s fairness concerns and boosting her reputation.
3. How much the CEO can affect firm performance is the main determinant of pay variability. Directors view peer firm practice and investor or proxy advisor expectations as important constraints, hindering them from tailoring pay – even though investors themselves do not consider following peer practice as important. Firm risk and CEO risk aversion are not important determinants.
4. Investors strongly believe that lengthening the horizon of CEO incentives would improve decision making, with few adverse consequences. Directors disagree. Some directors are concerned about the attraction/retention effects of such a change; others believe that incentives would become less effective.
5. The majority of directors and, in particular, investors, believe that benchmarking of CEO performance measures should not be universal. One reason is that it is fair for CEO pay to mirror the shareholder experience. A second is that, for many companies, it is difficult to define an appropriate peer group or obtain information on peer performance.