Last week, the Delaware Court of Chancery granted in part, and denied in part, a motion to dismiss a derivative suit with two breach of fiduciary duty claims, an unjust enrichment claim, and a corporate waste claim. In Knight v. Miller et. al., the plaintiff, Robin Knight, challenged option awards granted to Universal Health Services, Inc.’s directors and officers by its compensation committee at the outset of the Covid-19 pandemic. The defendants (comprised of UHS and various UHS directors & officers) moved to dismiss, generally on the “basis of a fair process and a fair price.”
As background, the compensation committee met on March 18, 2020 (prior to market open) and granted option awards with the strike price equal to the closing price that day – which happened to be the same day that UHS stock hit $67.69 a share, the lowest closing price since September 2013. The stock rebounded to $100.13 per share on March 30, 2020, after various phases of federal Covid-19 relief legislation was announced and enacted. Notably, the compensation committee meeting in question was scheduled at least 6+ months in advance, and the defendants stated that since 2014, the option grants were normally made in March meetings (except for once in April).
Zoning in on the fiduciary duty claims, the plaintiff pled that (1) the compensation committee breached their fiduciary duty in granting these March 2020 awards to the directors and officers, and (2) all defendants breached their fiduciary duties for accepting these March 2020 awards.
Breaking down the claims further by categories of defendants, the Court allowed the breach of fiduciary duty claim against the compensation committee for granting awards to directors (excluding the controlling defendants) to move forward. Since the act of directors fixing their own compensation is intrinsically self-interested (even if allowed by the DGCL), this was subject to an entire fairness standard of review. The Court said (with footnotes removed):
The Complaint pleads the following, implying lack of entire fairness: first, that the Compensation Committee disregarded certain considerations related to the emergence of the COVID-19 pandemic; second, that the Company’s peers even in its self-selected peer group received significantly less compensation; third, that the Company, speaking through its CFO, considered the Company stock a “buy” even at a price over $20 in excess of the strike price established for the March 2020 Awards; fourth, that at least one analyst identified a year-end price target for the Company of $127, using a model that purported to incorporate the effects of COVID-19; and finally, that Alan Miller was “actively lobbying” the federal government via his activities with FAH, and therefore “knew or had reason to know of the timing and extent of federal grants,” including relief that UHS might reasonably expect to receive. These facts are sufficient to raise a reasonably conceivable inference of an unfair transaction at the plaintiff-friendly pleading stage. This finding does not preclude the Compensation Committee Defendants from establishing that the March 2020 Awards were in fact entirely fair.
The Court also allowed the breach of fiduciary duty claim against the compensation committee for granting awards to controlling defendants to move forward. Although neither of the controlling defendants were seated on the compensation committee, they were directors & controlling stockholders who received a non-ratable benefit – so entire fairness standard applied. However, for the breach of fiduciary duty claim against the compensation committee for granting awards to the executive officers, the Court applied the business judgment rule & granted the motion to dismiss.
As to the fiduciary duty claim against all of the defendants for accepting the equity awards, the Court concluded that “what is required is a defendant’s knowingly wrongful acceptance of compensation, and that the standard must be bad faith. That is, there must be a sufficient pleading of scienter to support a bad faith claim, which serves as a claim based on breach of the duty of loyalty.” The Court didn’t find enough in the record to sustain even a claim that the compensation committee acted in bad faith when making the grants, let alone that the defendants accepted the grants in bad faith – and granted the motion to dismiss.
The Court also granted the motion to dismiss the corporate waste claim, but allowed the unjust enrichment claim to move forward.
Here are some of the latest stats from Willis Towers Watson on say-on-pay votes at Russell 3000 companies & equity plan votes at S&P 1500 companies, as of April 19, 2022:
– 4 failed say-on-pay votes at Russell 3000 companies (pushing the failure rate to 3% compared to 2.1% at our last check-in)
– 9% ISS negative say-on-pay vote recommendations (down from 12% in 2021)
– 69% rate of “high” ISS concerns re: pay-for-performance among proposals that ultimately received a negative ISS vote recommendation (down from 77% in 2021)
– 91% average support (and no failures) for S&P 1500 equity plans
– 3% ISS negative equity plan recommendations (down from 13% in 2021)
While we’re seeing some surprises on the environmental & social shareholder proposals that went to a vote this season, it looks like it’s less of a rollercoaster ride on the say-on-pay front so far (or have I jinxed it now?). As we face the second half of the 2022 proxy season, we’ll keep posting updated stats in our “Say-on-Pay” Practice Area.
In late March, S&P Dow Jones Indices and MSCI Inc. announced changes to the Global Industry Classification Standard (“GICS”) structure, which will go into effect next year and shake up the codes for various companies, including those in retail, data processing, bank, REIT and transport industries. A new FW Cook blog covers the main changes to the GICS classifications. This excerpt explains the potential impacts to certain ISS assessments:
– Say on Pay: peer group construction used to measure relative CEO pay and performance under ISS’ CEO pay-for-performance test, which is a key factor in ISS’ vote recommendation for Say on Pay.
– Non-Employee Director Compensation: industry sector used to identify “excessive” non-employee director pay levels, which may affect ISS’ vote recommendations for director elections.
– Equity Plan Scorecard (EPSC): industry grouping used for shareholder value transfer and burn rate comparisons in ISS’ review of equity stock plan proposals.
– QualityScore: industry grouping used in ISS’ QualityScore model, which monitors governance-related risk across four pillars: Audit & Risk Oversight, Board Structure, Compensation and Shareholder Rights.
These GICS changes will go into effect after close of business on March 17, 2023 – but given that the months are just flying by, 2023 will be upon us soon. We’ll stay tuned to see whether any ISS FAQs come out to address these upcoming changes. Visit our “Peer Groups” Practice Area for more info.
A new Pay Governance memo (posted with other resources in our “Covid-19” Practice Area) indicates that several compensation practices that were adopted two years ago in response to COVID-19 uncertainty were carried into the 2021 compensation year – and may linger even longer. Here’s an excerpt:
Wider performance curves. Many companies widened their performance curves to minimize the chance of a zero or maximum payout given the uncertainty in setting performance targets. This uncertainty persisted at the beginning of 2021, and a widening of the performance curve allowed companies to retain the basic structure of existing plans but with far less pay/performance leverage.
Semi-annual short-term incentive performance periods. Companies in industries facing the greatest level of uncertainty continued or adopted a “1 st half/2 nd half” short-term incentive plan whereby 6-month goals are set at the beginning and the middle of the performance year to allow for a “resetting” of targets at mid-year based on a more current financial outlook.
Inclusion of qualitative metrics. After unprecedented levels of discretionary adjustments were applied in 2020, some companies added or increased the weighting of qualitative metrics to allow the Compensation Committee to exercise discretion within predefined guardrails (e.g., +/- 20%).
Above target annual incentive plan payouts. Given the limited visibility at the beginning of 2021 amid the continued impact of COVID-19 (e.g., supply chain pressures, “The Great Resignation,” etc.) and 2020 annual incentive plan payouts, the majority of which were below target or zero, many companies may have established relatively conservative financial targets for their 2021 annual incentive plans. Early indications are that above target (or maximum) annual incentive payouts are being reported by companies that were more resilient than forecasted and capitalized on better-than-expected market opportunities in 2021.
So far this season, 80% of Russell 3000 companies are paying annual incentives above target (average of 160% of target), while the remaining 20% of companies have average payouts of 67% of target. Based on year-over-year comparisons for a subset of companies paying 2021 annual incentives above target, 2020 annual incentives were paid out at an average of about 90% of target.
Inclusion of relative total shareholder return (TSR) as a metric in performance share (PSU) plans. Many companies struggled to set annual financial targets, let alone multi-year goals for PSUs. To address this uncertainty, more companies may have added relative TSR to their PSU scorecards, thereby eliminating the need to establish absolute goals at the beginning of the performance cycle.
Replace multi-year goals with multiple annual goals in PSU plans. Another approach companies carried over or adopted is the use of annual goals within PSU programs, with performance measured each year and earned shares distributed on, for a 3-year plan, the third anniversary of the grant. This approach allows companies to maintain a performance-oriented plan while minimizing the risk with 20-20 hindsight of setting overly aggressive or conservative performance targets.
The Pay Governance team goes on to note several pandemic-era practices that don’t appear to be continuing: Base salary reductions, exercise of upward discretion, and modifications of in-flight LTI awards.
Last week, NYC Comptroller Brad Lander and New York State Comptroller Thomas DiNapoli announced that they were launching a “vote no” campaign against the re-election of Amazon’s directors responsible for human capital management. Here is their letter to shareholders (filed with the SEC as a notice of exempt solicitation) – they’ve also set up a website devoted to the campaign. Their director complaints include:
– Despite repeated requests, the Committee has not met with institutional investors to discuss possible improvements to its human capital management oversight and disclosure
– The Committee has not adequately overseen health and safety, with adverse consequences for Amazon and its employees
– Amazon’s labor practices, repeatedly investigated by regulators, have been found to violate state and federal law and also conflict with Amazon’s own human rights policy
– Unusually high employee turnover relative to peer companies has some Amazon executives worried about running out of hirable employees in the U.S.
This vote no campaign comes at the same time that Carl Icahn has launched actual proxy contests at Kroger and McDonald’s that he says are related in part to the mismatch in executive versus employee pay. From his “open letter” to McDonald’s shareholders:
Perhaps if the Company’s executives applied the same effort to getting their suppliers to become completely gestation crate-free as they do to obtaining rich compensation packages, we would not be having this election contest. I find the Company’s executive compensation, especially relative to the average employee, to be unconscionable. For 2021, total Chief Executive Officer compensation was $20,028,132, an astounding 2,251x the average employee’s total compensation of $8,897. The Board is clearly condoning multiple forms of injustice and I believe the majority of the public would agree.
Other companies should pay attention to these threatening shots across the bow. Compensation committees are being pushed into the spotlight in regards to human capital concerns and income inequality – and the time to act is now, versus waiting for complaints.
To arm yourself – and your board – with the info you’ll need, make sure to register for our upcoming “Proxy Disclosure & Executive Compensation Conferences” – coming up virtually October 12-14. Among other critical topics, our agenda includes sessions on the compensation committee’s evolving role, human capital, and how to protect your board from the next maelstrom.
In addition, join us for the “1st Annual Practical ESG Conference.” As I blogged yesterday, it’s becoming more and more important for compensation committees to get their arms around ESG – in order to consider whether and how to add ESG dimensions to executive and even employee pay programs.
For both of these events (which can be bundled together for a discount), our seasoned and diverse speakers will be sharing practical guidance in a fast-moving format. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
Mastercard is going “all in” with motivating corporate ESG performance. In its recently filed proxy statement, the company says that investors approved of the ESG modifier that it applied in 2021 to annual incentives for senior execs (including NEOs). Due to that warm reception, it’s expanding the ESG incentive structure to all employees.
This is one of the first companies to make this move, but it may be something that becomes more common. The other piece of this that may signal a broader shift and give a roadmap to other companies is that the metric is based on emission reduction goals and disclosure. I’ve blogged that human capital, culture & DEI metrics tend to be more common for US companies right now – but there are some examples of environmental-related goals, and now we can add a high-profile company to the list. Page 88 of the proxy explains:
In addition to the annual incentive changes described on pg 77, the operational carbon neutrality metric was replaced for 2022 by two environment-based metrics measuring performance against our 2025 SBTi goals of reducing Scope 1 and 2 carbon emissions (based on a 2016 base year) and supplier engagement responsiveness to reporting to the CDP and disclosing greenhouse gas emissions information. The ESG modifier was also expanded to apply to all employees across the company (for 2021, the ESG modifier applied only to our senior executives, which includes our NEOs).
This is a development worth noting because it comes at the same time that two bigger trends are advancing. First, compensation committees are expanding to oversee broader “human capital” issues – including employee pay programs, employee morale, and employee impact performance. Simultaneously, there are broader calls for directors to oversee ESG strategy & performance. Encouraging rank & file employees to achieve ESG goals may be a way for some companies to kill two birds with one stone.
As always, your mileagemay vary. In order to be able to pay for ESG performance and avoid unintended consequences, you need to be able to set a workable strategy, measure performance, and disclose results. Are you and your comp committee ready? In addition to the executive pay disclosure issues that we can help you tackle on this site, we have a bunch of resources to help with the ESG journey over on PracticalESG.com – sign up today and join a growing group of impressive members.
Nearly all big companies use long-term incentive plans to encourage performance over periods greater than one year – and these plans often represent the most significant portion of executive pay. With pay-for-performance in the spotlight, Compensation Advisory Partners recently analyzed LTIP structures and payouts across 120 companies with median revenue of $36B and performance cycles ending in 2015 through 2020. Here are some takeaways from their new memo:
– Based on CAP’s analysis of LTI payouts from 2015-2020, the degree of difficulty (or “stretch”) embedded in long-term performance goals translates to:
• A 95% chance of achieving at least Threshold performance
• A 70% chance of achieving at least Target performance
• A 20% chance of achieving Maximum performance
– 97% of companies in the study use LTIPs – with 97% denominated in stock (vs. cash)
– 97% use a 3-year performance period – 3% use a 4-year or 5-year cycle
– The most common long-term performance plan metrics are relative Total Shareholder Return (TSR), Return measures, and Earnings per Share (EPS). Many companies use a combination of financial and stock price metrics to balance line-of-sight for executives and direct alignment with shareholder outcomes.
– Target performance goals are most often set in line with the company’s business plan for absolute metrics or at median of the comparator group for relative metrics. Proxy advisory firm, Institutional Shareholder Services (ISS), has pushed for companies to set target goals for relative TSR above median of the comparator group. We have seen some companies follow this guidance in paying at target for performance at the 55th or 60th percentile; however, most companies continue to pay at target if TSR results are at median vs. the comparator group.
With the “Great Resignation” comes lots of creative ideas on retention & compensation. Some companies are trying to stay ahead of the curve by offering crypto as compensation, but we’re still watching the legal framework develop around this area. Here’s a Hunton Andrews Kurth blog outlining some of the regulatory risks that companies should watch as they consider offering cryptocurrency as compensation:
– Form of Payment – Cash or Negotiable Instrument. The federal Fair Labor Standards Act requires employers to pay minimum and overtime wages in “cash or negotiable instrument payable at par.” This has long been interpreted to include only fiat currencies—monies backed by a governmental authority. As non-fiat currencies, cryptocurrencies therefore fall outside the FLSA’s definition of “cash or negotiable instrument.” As a result, an employer who chooses to pay minimum and/or overtime wages in cryptocurrency may violate the FLSA by failing to pay workers with an accepted form of compensation. In addition, various state laws make the form of wage payment question even more difficult.
– Volatility Concerns. When compared to the rather stable value of the U.S. dollar, the value of cryptocurrencies is subject to large fluctuations…Such volatility can give payroll vendors a nightmare and can, in some instances, lead to the under-payment of wages or violation of minimum wage or overtime requirements under the FLSA.
– Tax and Benefits Considerations. Aside from wage and hour issues, the payment of cryptocurrency implicates a host of tax and benefits-related issues. The IRS considers virtual currencies to be “property,” subject to capital gains tax rates. It has also confirmed in guidance materials that any payment to employees in a virtual currency must be reported on a W-2 based upon the value of the currency in U.S. dollars at the time it was delivered to the employee. This means that cryptocurrency wage payments are subject to Federal income tax withholding, Federal Insurance Contributions Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax. For 401k plan fiduciaries, the Department of Labor recently issued guidance that should serve as a stern warning to any fiduciary looking to invest 401k funds into cryptocurrencies.
We’ve posted the transcript for the recent webcast: “The Top Compensation Consultants Speak.” Blair Jones of Semler Brossy, Ira Kay of Pay Governance and Jan Koors of Pearl Meyer shared their thoughts on:
– Key Issues and Considerations for Compensation Committees
– ESG & Human Capital Management Focus for Compensation Committees
– Gender and Ethnicity Pay Gaps and Pay Equity Issues
– Integrating ESG into Incentive Plans
– Latest SEC Rulemakings on Clawbacks and Pay-for-Performance
I blogged earlier this month about how say-on-pay is going in the 2022 proxy season. As a recap, we saw 3 companies failing from the Russell 3000 (so a 2.2% failure rate) and 8.9% of Russell 3000 companies received an “Against” recommendation from ISS as of March 31.
– Three Russell 3000 companies (2.1%) failed Say on Pay thus far in 2022. No companies failed since our last report.
– The percentage of Russell 3000 companies receiving greater than 90% support (71%) is similar to the percentage at this time last year (73%).
– The current Russell 3000 average vote result of 90.1% is similar to the index’s average vote last year, while the current S&P 500 average vote result of 85.6% remains well below last year’s average.
– The average Russell 3000 vote result thus far is 450 basis points higher than the average S&P 500 vote result; however, only 35 S&P 500 companies have held a Say on Pay vote thus far in 2022.
– 6% of Russell 3000 companies and 11.4% of S&P 500 companies have received an ISS “Against” recommendation thus far in 2022.
There’s been a lot of publicity around the pay inequality & high CEO pay ratios this season – that hasn’t translated into say-on-pay failures as of mid-April. With only 35 S&P 500 companies having held a say-on-pay vote so far, we’ve still got a long ways to go. As always, we’ll keep posting these stats in our “Say-on-Pay” Practice Area.