You hear quite a lot in this space about CEO pay levels ratcheting up due to peer benchmarking and every company wanting to pay “above median.” A recent academic paper confirms that variations in CEO pay really have diminished over the last decade, since companies started disclosing peer groups and submitting “say-on-pay” resolutions. The more interesting thing that the paper found was that CEOs appear to be less inclined to take risks that could spur jumps in company performance, supposedly because they don’t see a lot of room for upward pay mobility if they get recruited away to a peer company.
I’m not completely sold, because CEO mobility has also been blamed for skyrocketing pay packages. But the data (from 5000 US companies from 2002 – 2018) did seem to support the findings. Here’s an excerpt:
That is, if the manager is successful, she could receive an offer by the industry peer paying the highest amount and/or has an external benchmark for a wage renegotiation with her board. To retain the executive the incumbent firm may then have to match this alternative pay offer. Figure 9 confirms that external tournament incentives decrease significantly over the sample period.
Overall, our evidence suggests that recent institutional developments have induced a decrease in pay variation, with meaningful consequences for firms’ outcomes.
CalPERS’ recently presented this “Proxy Voting & Corporate Engagements Update” to its Investment Committee. Page 5 contains an eye-popping trend line for the pension fund’s opposition to say-on-pay votes. Back in 2013, CalPERS voted down 9% of executive pay plans. The last two years, that number has been over 50%.
Comp Committee members are now also facing real-time consequences from that opposition. Last year, CalPERS voted “against” 3402 directors last year at 1267 companies – a significant increase from the tally of 2716 that I blogged about last summer. Last year was the first year the pension fund applied its policy to vote against comp committee members in the same year as voting against say-on-pay. CalPERS also says that it wrote to all of those companies to discuss the negative vote. Only 35% responded.
I blogged a couple of weeks ago about pre-IPO equity incentive plan practices. Recent research from ISS Governance Solutions (available for download) reinforces the finding that evergreen features are on the upswing. Here are a couple of the findings:
– With the repeal of Section 162(m) of the Internal Revenue Code, mandatory approval votes on equity plans reverted from once every five years to the exchange listing’s rules, which is generally once every ten years.
– The two-year trend from 2019 to 2020 of equity plans authorized at newly listed IPOs reveals the practice of including evergreen provisions does not appear to be declining, which points to the need for increased monitoring by investors.
It’s hard to tell from this summary whether ISS is suggesting the possible return of once-in-a-decade equity plan votes. That would be pretty shocking to me, absent a “controlled company” situation, and I’d think that – at most – a company could get away with that exactly one time post-IPO. But, I also never expected to be so excited to have a needle jabbed into my arm, which goes to show that you never know what this wild world will bring.
Activist CtW Investment Group is taking a close look at comp committees this spring. Three recent letters on their engagement page show which issues are drawing scrutiny:
1. Artisan Partners – calling for an overhaul of the comp committee because executives’ cash bonuses weren’t dependent on achievement of pre-set performance goals, and because the company has received low(ish) say-on-pay and comp committee votes in recent years (65% approval for say-on-pay in 2019, below 80% approval of comp committee members last year, repeated adverse say-on-pay recommendations from ISS)
2. General Electric – calling for an overhaul of the comp committee because of a decision to grant a replacement award to the CEO with lower performance vesting targets
3. Uber – calling for amendments to the comp committee charter and disclosure focused on human capital issues – in particular, diversity, pay equity and safety precautions for the company’s workforce – and specifically, the driver community
Here are some of the key findings from this Willis Towers Watson study of share utilization by S&P 500 companies:
– Companies have continually increased the use of full-value awards, while use of options has steadily decreased – sectors with highest use of certain forms of equity were: RSUs (IT, 79% of long-term incentive mix), performance-based stock (utilities, 54% of LTI mix), options (consumer staples and industrials 23% of LTI mix)
– Median run rates have declined by 19% since 2016, with this trend continuing based on an early look at 2020 grants
– Overhang changed slightly from 7.4% in 2017 to 6.9% in 2019, and again the trend continues based on early review of 2020 filings
– LTI fair value, in terms of dollars, has continued an upward trend – at median levels, LTI fair values increased by 27% while LTI fair value as a percentage of market cap had a 5% decrease from 2015
On the heels of State Street issuing its 2021 proxy voting & engagement guidelines that Liz blogged about last week, the asset manager also issued its 2020 stewardship report. The report provides a summary of State Street’s 2020 engagement activity and provides insight about factors influencing the asset manager’s votes on compensation proposals. Here are a few highlights:
In 2020, State Street’s vote “against” compensation proposals were mainly due to growing concerns about pay-for-performance misalignment, poor disclosure of pay structures and increasing pay quantum in the prior year.
The rationale leading the asset manager to “abstain” on pay-related proposals was the result of situations where it couldn’t provide unqualified support or where companies had responded to some, but not all, of State Street’s concerns on pay.
Poor structure (43%) was a key factor driving State Street’s voting rationale on pay proposals – the asset manager says in those cases, incentive design is still in need of improvement and there isn’t always a strong link between pay and business strategy.
For annual incentive plans, State Street expressed concerns about the plans becoming overly complex and it encourages companies to simplify bonus plans and to ensure they have clear linkage to strategy.
State Street also encouraged companies to shy away from using TSR as the sole performance metric for performance-based equity awards and instead take an approach that blends relative TSR and long-term operational metrics that align with the company’s strategy.
We’ve blogged a few times about use of D&I metrics in incentive plans – here’s an entry about use among Fortune 200 companies. As stakeholders continue with increased calls for companies to do more on the D&I front, many are looking at how and what they might do – whether it’s by incorporating D&I metrics into comp programs or pursing initiatives outside of pay programs. A recent Semler Brossy memo provides a framework and considerations to help companies through the process.
For companies to make optimal use of D&I metrics incorporated in incentive programs, the memo suggests companies check whether the majority of the following conditions would be achieved and if not, it might be preferable to delay implementation and address D&I outside of pay programs.
– There is a well-articulated strategy for execution and clarity on how success will be defined
– There is an understanding that elevating DEI may send unintended signals (e.g., tying pay to DEI but not sustainability may send a message about company priorities)
– The DEI metric(s) are part of a balanced, comprehensive assessment. Narrowly defined metrics can miss the spirit of the overall commitment (e.g., meet recruiting targets, but miss on culture)
– There is a willingness to maintain a DEI component in pay for an extended period of time
– There is a willingness to set real, stretch goals that are durable and can withstand shifts in strategy
– If goals are missed, boards are willing to disclose externally how or why goals were not achieved
Last week, I blogged on TheCorporateCounsel.net about BlackRock’s 2021 engagement priorities. Along with BlackRock’s engagement priorities, the asset manager issued a memo about its engagement approach relating to executive compensation. In the memo, BlackRock explains situations where it finds engagement productive and states it doesn’t think it’s useful for companies to engage with shareholders primarily to gauge support in advance of shareholder meetings.
The memo also emphasizes BlackRock’s focus on long-term sustainable growth for companies and says it expects a meaningful portion of executive pay to be tied to the long-term, sustained performance of the company, as opposed to short-term increases in the stock price. BlackRock acknowledges increased use of sustainability-related metrics in incentive plans and this excerpt explains what BlackRock is looking for when companies do so:
As companies increasingly incorporate sustainability measures in their incentive plans, they should also be material and aligned with a company’s long-term strategy. It is important that companies using sustainability performance metrics explain carefully the connection between what is being measured and rewarded alongside business goals and long-term performance. Failure to do so may leave companies vulnerable to reputational risks and undermine their sustainability efforts.
When it comes to disclosure, BlackRock expects clear disclosure about how incentive plans reflect strategy and incorporate performance metrics, including sustainability-related goals, that are aligned with long-term shareholder value.
Companies should also disclose the timeframe for performance evaluation, i.e. the specific period over which shareholders should assess performance.
Where discretion is utilized, compensation committees should clearly explain how these decisions are either driving or creating long-term sustained performance aligned with shareholder interests. We expect especially rigorous disclosure and justification when mid-cycle adjustments are made. When evaluating potential windfall scenarios derived from market dislocations or company-specific events, compensation committees should disclose how they determined whether executives benefited from a windfall, or may do so in the immediate future. Disclosures should address whether and why the committee used its discretion, as well as factors taken into consideration in determining the appropriate compensation outcome. BIS is keen to understand how the compensation committee balanced the contractual obligations and rewards for their workforce and executives, while preserving the link with pay and performance, and preventing outsized awards relative to originally established goals.
This memo from Compensation Advisory Partners looks at a sample of 20 high-profile tech IPOs from recent years to understand equity practices leading up to going public. Here are a few key findings:
1. Options are still the favorite form of equity awards – but there’s been a shift to granting more RSUs, typically with double-trigger vesting based on both years of service and going public
2. Companies have been successful in getting private investor approval for equity grant pools. At median, pre-IPO equity overhang was 21.5%. At the time of the IPO, 95% of companies asked for additional equity authorization, leading to overhang of 27.7% – plus evergreen provisions and liberal share recycling.
3. Many companies implemented ESPPs in conjunction with their IPOs – which has been non-controversial from the standpoint of proxy advisors.
4. Some founders have received significant performance-based equity grants at IPO
This Gunster blog reports that about half of S&P 500 companies used ESG metrics in their annual cash incentive plans last year. Based on the number of company announcements I’ve seen lately, that number is going to be a lot higher in 2021. In Europe, investors and law-makers are starting to pressure companies to add sustainability metrics to pay plans that will be submitted to votes next year.
To help you evaluate whether adding ESG metrics is the right thing to do at your company – and how to go about doing it – we just compiled this 8-page checklist. Here’s an excerpt about linking plan payouts to reliable data:
– Involve internal audit and, if necessary, external subject experts to test the data quality and controls.
– Test your compensation model rigorously – understand payouts and disclosures at various levels of achievement (or non-achievement). This includes understanding the impact of ESG metric achievements on financial and stock-based metrics and incentives.
– Don’t rely too heavily on certifications such as ISO14001. Companies expend much time and effort into obtaining certificates like these to hang on the wall. However, the value of the efforts may not be long-lasting as operational dynamics and external pressures change. ISO certifications may be better viewed as a snapshot in time, similar to other audits. “Trust but verify” is an appropriate philosophy.