We’ve patted everyone on the back a few times about this year’s record-low failure rate for say-on-pay. We also saw much lower rates of ISS opposition. This Pay Governance memo takes a close look at factors that may have contributed to this result, including:
1. Significantly better performance on the ISS Multiple of Median (MOM) test. The MOM test evaluates the ratio of 1-year CEO pay to the median CEO pay of the ISS-selected peer group and has historically been (and continues to be) a meaningful predictor of adverse ISS SOP recommendations. The average MOM outcome was 1.7x in 2024, compared to 2.2x in 2023 and 2.4x in 2022, demonstrating a migration of CEO pay toward peer median levels and fewer outlying pay packages.
2. Improvement in Compensation Committee responsiveness to proxy advisor and shareholder concerns over executive pay. We observed fewer Compensation Committees being criticized by ISS for poor responsiveness to shareholder concerns and fewer cases of significant one-time awards that led to an against SOP recommendation. In addition, the number of companies that received ISS opposition to SOP in two consecutive years declined, demonstrating that companies are getting better at addressing investor feedback.
These findings are worth considering if your say-on-pay resolution has gotten lower support than you’d like in recent years, and the memo goes into much greater detail on both. The notion of “conformity” also appears to align with another study that I blogged about last month.
Calendar year-end companies are gearing up to provide new disclosures under Item 402(x) of Regulation S-K in 2025 proxy statements. The new subsection of Item 402 requires:
– Disclosure of policies and practices related to the timing of awards of options, SARs and/or similar option-like instruments in relation to the disclosure of MNPI, and
– New tabular disclosure to the extent that, during the fiscal year, any stock options, SARs or similar instruments were granted to NEOs during the period beginning four business days before and ending one business day after the filing of a 10-Q, 10-K, or 8-K that discloses MNPI.
Over on the Q&A Forum (Topic # 12418) on TheCorporateCounsel.net, a member recently asked, “Have you seen any examples of disclosures containing insider trading and/or equity award disclosures that will be required for the first time in 2025 for calendar year filers?” I suspect many folks are — or will soon be — on the lookout for sample or precedent disclosures under Item 402(x), so here is my response:
Also take a look at this DLA Piper alert that gives an illustrative example of the tabular disclosure. And keep in mind that, like other sections of Item 402 that require tabular disclosure, Item 402(x)(2)(i) includes a blank table.
Late last week, shortly after releasing the results from its second annual global policy survey, Glass Lewis announced the publication of its 2025 Voting Policy Guidelines (U.S.) and the Shareholder Proposals & ESG-Related Issues Guidelines (global) that apply to shareholder meetings held after January 1. Two updates relate to executive compensation matters. Here is the description from the Summary of Changes for 2025:
Change-In-Control Provisions. We have updated our discussion of change-in-control provisions in the section “The Link Between Compensation and Performance” to define our benchmark policy view that companies that allow for committee discretion over the treatment of unvested awards should commit to providing clear rationale for how such awards are treated in the event a change in control occurs.
Approach to Executive Pay Program. We have provided some clarifying statements to the discussion in the section titled “The Link Between Compensation and Performance” to emphasize Glass Lewis’ holistic approach to analyzing executive compensation programs. There are few program features that, on their own, lead to an unfavorable recommendation from Glass Lewis for a say-on-pay proposal. Our analysis reviews pay programs on a case-by-case basis. We do not utilize a pre-determined scorecard approach when considering individual features such as the allocation of the long-term incentive between performance-based awards and time-based awards. Unfavorable factors in a pay program are reviewed in the context of rationale, overall structure, overall disclosure quality, the program’s ability to align executive pay with performance and the shareholder experience and the trajectory of the pay program resulting from changes introduced by the compensation committee.
Yesterday on TheCorporateCounsel.net, I blogged about the other (non-compensation-related) proposed changes. For more commentary and insight, we’ll be posting memos in our “Proxy Advisors” Practice Area, and Glass Lewis is planning a webinar on December 11 to share additional context.
Yesterday, ISS announced the launch of its open comment period on proposed changes to its benchmark voting policies. During this open comment period, ISS gathers views from stakeholders on its proposed voting policy changes for 2025 (and beyond). The comment period closes at 5:00 p.m. Eastern time on December 2.
It looks like 2025 will be another light year for benchmark policy changes. The main substantive policy updates address poison pills and SPAC extension requests. However, ISS also provided a summary of ongoing considerations related to U.S. executive compensation policy on the use of performance- vs. time-based equity awards, including a planned change in policy application for 2025 (under the current policy). Here’s more:
The current pay-for-performance assessment for executive compensation under ISS U.S. benchmark policy considers a predominance of time-vesting (as opposed to performance-vesting) equity awards to be a significant concern at a company that exhibits a quantitative pay-for-performance misalignment. However, a growing number of investors have expressed changing viewpoints regarding U.S. equity award practices. Some investors highlight concerns with performance equity programs that may be poorly designed and/or disclosed, including concerns about highly complex programs and non-rigorous performance measures, and some consider that well-designed timevesting awards are preferable to performance-vesting awards.
These changing viewpoints were demonstrated by the results of a question in the 2024 Global Benchmark Policy Survey. … Considering the various feedback and arguments put forward, a potential policy update remains under consideration for 2026 (or later) regarding the evaluation of the equity pay mix for regular-cycle equity awards whereby a preponderance of time-vesting equity awards generally would not in itself raise significant concerns in the qualitative review of pay programs.
For 2025 and in advance of any potential wider policy changes for 2026, we intend to implement certain pay-for-performance policy application changes that do not require formal policy changes at this time but are adaptations within the current U.S benchmark policy framework. …
Effective for 2025 (for meetings on or after Feb. 1, 2025), we will introduce adaptations to the qualitative review of performance-vesting equity awards carried out under the current U.S. benchmark policy. Specifically, any design or disclosure concerns regarding performance equity will carry greater weight in the qualitative analysis, and significant concerns in these areas will be more likely to drive an adverse say-on-pay recommendation for a company that exhibits a quantitative pay-for-performance misalignment. Further details on the changes will be provided in an update to ISS’ U.S. Executive Compensation Policies FAQ, expected to be published in mid-December 2024.
They invite additional feedback on the following questions:
– If, in the future, U.S benchmark policy were to no longer view a predominance of time-vesting equity awards as concerning in itself, what criteria would you consider most important for analyzing time-vesting equity awards? (for example, vesting periods, award magnitude, holding period requirements, or any other significant factors)
– If U.S. benchmark policy were to no longer view a predominance of regular-cycle time-vesting equity awards as concerning, do you believe the same standard should be applied to any off-cycle/one-time equity awards?
Over on TheCorporateCounsel.net in late August, I blogged about some things companies need to do — or consider — if they want to be ready to capitalize on any potential IPO window that may open in 2025. This Morgan Lewis blog is focused on the same topic — but specifically with executive compensation considerations in mind. Here are a few tips from the blog:
Cheap Stock: During the period prior to an IPO, private companies often seek to incentivize employees through the grant of stock and stock-based equity awards. While this practice is frequently a successful means of incentivizing key employees and service providers, without sufficient preparation and consideration, the practice can raise the issue of whether pre-IPO awards represent “cheap stock.” …
With equity being a popular form of compensation for many pre-IPO companies, the following are key considerations companies should take prior to the IPO:
– Work with outside advisors well in advance of the IPO process (especially in the 12-month period prior to the IPO) to understand the potential accounting, tax, and disclosure implications of cheap stock grants.
– Obtain frequent independent valuations with respect to the value of shares underlying all equity awards made during the pre-IPO period (with the valuations made contemporaneous to, or close in time to, the grant date of the equity awards).
– Ensure that there is a good corporate record of all grants of equity awards, including formal approvals by the company’s board and its consideration of outside independent valuation.
Triggering Events in Existing Arrangements: In the lead-up to an IPO, a company should consider the impacts that the IPO will have on existing executive arrangements generally and equity compensation considerations specifically. For example, it is common for an IPO not to be treated as a “change in control,” “change of control,” or “liquidity event” under its equity plan and the individual award agreements that govern private company equity awards. Many companies do not have other bonuses or arrangements with key executives that will become automatically payable in connection with an IPO.
It is advisable to review all outstanding equity awards and other executive compensation arrangements to ensure that executives have sufficient incentives to get to the IPO. If no arrangements will be automatically triggered, consider structuring bonuses or other arrangements to reward the executive team for getting the company through a successful IPO. It is not uncommon for members of the executive team to retain their own legal advisors to negotiate these arrangements and advise on market practices from the executives’ perspective. This review tends to be coupled with the proposals and considerations below to ensure that key employees and service providers will be incentivized for post-IPO success.
“Cheap stock” and other IPO-readiness issues will be addressed during an upcoming webcast on TheCorporateCounsel.net. Tune in at 2 pm ET on Thursday, December 12, 2024 to hear White & Case’s Maia Gez, Mayer Brown’s Anna Pinedo, Cooley’s Richard Segal and Gunderson Dettmer’s Andy Thorpe discuss “Capital Markets: The Latest Developments.”
Members of TheCorporateCounsel.net are able to attend this critical webcast at no charge. If you’re not yet a member, subscribe now. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
I blogged earlier this week about share usage trends, which can be a useful data point if you’re submitting an equity plan proposal at your next meeting. As you craft your proposal, an important part of the process involves considering how your practices stack up against those of other companies. This LinkedIn post from Aon’s Laura Wanlass articulates why you might want to use that process, along with consideration of your future needs, to “look inward” – before thinking about proxy advisor policies and parameters:
Before jumping straight to the proxy advisory firm models, it is helpful to understand if you are an outlier regarding your equity usage profile (i.e., dilution and run rate across the numerous methodologies used externally in the market) and whether there are good reasons for why you might be one (i.e., lower total common shares outstanding due to share repurchases, a lot of underwater overhang, broader equity distribution throughout the organization, shares issued in lieu of earned annual cash, etc.). This context becomes incredibly important if you need to engage with shareholders. Also, have you assessed the market competitiveness of your equity granting practices, and determined what you really need to grant a competitive level of equity for the next one to three years?
Laura also points out that a negative proxy advisor recommendation isn’t necessarily the end of the line. If you can see it coming, you can take a few protective steps ahead of time:
However, if you find yourself failing one or more of these proxy advisory firm models, than you likely need to take proactive mitigating actions—such as enhancing the proxy proposal language and potentially engaging with investors. Furthermore, evaluate the policies of your top investors—do they use industry benchmarks, do they have certain dealbreaker thresholds? A holistic review can be crucial for share request proposals depending on which investors own your company.
As Laura notes, it’s helpful to start the process early, and of course consider prior investor feedback as well. Check out our treatise chapter on “Plan Disclosure When Seeking Shareholder Action” for more info about requirements and strategies when you’re submitting an equity plan proposal.
In the latest 13-minute episode of The Pay & Proxy Podcast, Meredith was joined by Ani Huang, CEO of the Center On Executive Compensation (a division of HR Policy Association), which recently released a “CHRO’s guide to governance of environmental and social matters.” Meredith and Ani discussed:
– The impetus for the CHRO guide to governance of E&S
– The guide’s five-step playbook
– How companies approach board oversight of E&S issues, and the pros and cons of the approaches
– How companies approach leadership of E&S issues at the management level, and the pros and cons of the approaches
– Investor perspectives on governance of E&S issues
– Identifying and supplementing experience gaps and resource needs at the board, management and employee levels
Now is a good time to consider whether you’ll need to update your equity plan reserve at your next annual meeting – and if so, how many additional shares to propose. Often, this exercise also leads to questions about how your company’s share usage compares to practices at other companies. To help answer some of those queries, FW Cook recently issued its 2024 aggregate share-based compensation report.
The report reviews share usage trend data covering the three-year period 2021 – 2023 from 300 companies spread across five industry groups. Data analyzed includes:
– Company-wide annual grant rates, measured based on annual share usage as a percentage of weighted average basic common shares outstanding and fair value transfer (FVT) – which is the aggregate grant date fair value of all long-term incentive awards granted during a given year as a percentage of company market cap value at grant and as a percent of revenue
– Potential share dilution,
– Frequency and prevalence of long-term incentive plan share requests
– Allocation of long-term incentive pools to the “top 5” proxy officers.
Here are a few highlights:
– Annual FVT rates as a percentage of market capitalization were slightly lower compared to our prior 2020 study, with the median 3-year average annual rate decreasing from 0.92% in the prior study to 0.87% in the current study.
– Median FVT rates increased slightly for 2022 and 2023 compared to 2021. For 2023, FVT grant value and market capitalization declined slightly compared to 2022, resulting in FVT as a % of market capitalization remaining relatively consistent.
– Potential dilution from outstanding equity awards has trended downward over the last three years, falling from 3.0% at the median in the prior study to 2.7% in the current study. Driven by companies granting a greater proportion of equity awards in the form of restricted and performance shares, which generally use fewer shares than stock options for equivalent grant value and remain outstanding for far shorter periods of time.
– Allocation of long-term incentive pools to the Top 5 proxy-reported officers (including CEO) is closely linked to company size, as small-cap companies grant a significantly higher percentage of the overall pool to their top officers compared to largecap companies, who generally have more long-term incentive participants.
– Over the last three years, 53% of our sample companies sought shareholder approval of a new share authorization under employee stock plans.
– The median size of the requests ranged from 3% to 4% of common shares outstanding, with slight variation based on company size and year of request.
I recently blogged about ESG “overperformance” — specifically, a research paper alleging that ESG targets are set at low enough levels that executives “reap their rewards even if ESG performance is not particularly strong.” The paper seemed to justify investor concerns about the lack of rigor and transparency surrounding these goals.
At the end of last month, a group of professors released a new research paper. Even though this paper was focused on companies in Europe — where ESG incentives seem to be farther along — it similarly concluded that they are often “largely discretionary, carry immaterial weights in payout calculations, and contribute little to executive pay risk” and focused on the companies’ “most visible executives.” They allege that this isn’t just a pay issue — and that it could be greenwashing — or at least evidence of greenwashing. They suggest that “[f]irms might engage in such “greenwashing” of executive pay if meaningful (that is effective) ESG incentives would conflict with shareholder value maximization but, at the same time, firms face public pressure by third parties (governments, customers, some investor groups, proxy advisors, etc.) to become more ESG-friendly.”
This approach to ESG metrics isn’t across the board for the European companies in this dataset, however. They found that this was common in financial firms and large companies, while companies in sectors with a large environmental footprint are more likely to employ “binding ESG metrics with significant weights, which have potential to influence incentives.”
Here in the US, it seems that companies are beginning to shift in this direction. The latest Semler Brossy report on ESG incentives has this to say:
Companies appear to be shifting their focus from adoption to refinement of ESG metrics, with prevalence in annual incentive plans (AIPs) and long-term incentive plans (LTIPs) remaining relatively consistent since FY2021 as companies continue to prioritize the use of short-term ESG goals. However, companies continue to adjust existing plans away from discretionary incentives and towards weighted metrics. In FY2023, 87% of companies with ESG metrics in incentives reported using weighted metrics, up from 72% in FY2021.
Most prominent shifts in metric structure were i) discretionary to scorecard (+6 companies year over year) and ii) scorecard to discrete weighted (+17 companies year-over-year), which is the typical path companies take as ESG metrics become more prominent in their programs.
We’ve speculated with some podcast participants about the insurance market that might develop in the wake of the Dodd-Frank clawback listing standards. As this Latham alert reminds us, “companies are not permitted to indemnify or insure any person against losses under the SEC Clawback Rules, nor are they permitted to directly or indirectly pay or reimburse any person for any premiums for third-party insurance policies that such person may elect to purchase to fund such person’s potential obligations under the SEC Clawback Rules.” However, insurance coverage may be purchased and funded by an individual executive, who must pay their own premiums out of pocket.
This Woodruff Sawyer blog discusses the key features of those policies in their current form:
Limits: As of this writing, primary insurers are offering relatively low limits, ranging from $500,000 to $1 million for each individual executive at a company. Higher limits will require additional carriers to participate on an excess basis. The amount of excess limit available will depend, in part, on interest in this type of insurance over time. We should also expect carriers to impose a per-company cap, at least in the near or medium term, depending on how many executives at any one company decide to purchase this insurance.
Simplified Application Process: The application process for this insurance should generally be streamlined. Insurers will review the company’s public filings and disclosures. This will often include evaluating the company’s compensation clawback policy, governance practices, any recent material weaknesses in internal controls over financial reporting, and any existing legal or regulatory disputes that might impact the company’s risk profile. Because the underwriting process relies heavily on publicly available information, there should be minimal administrative burden placed on the executive during the application phase.
Coverage for Compensation Repayment and Defense Costs: This insurance can cover both the compensation amounts an executive must repay and the defense costs associated with compensation clawback claims. As previously mentioned, compensation repayment can range from cash bonuses to equity awards based on the company hitting several metrics. This makes the insurance attractive not just for executives whose compensation is performance-based, but for all executives.
No Duty to Defend: One distinct feature of current forms of this insurance is they are not “duty-to-defend” policies. This means the policyholder (i.e., the executive) retains the right to select their own counsel rather than being constrained to the insurer’s panel of attorneys. This is important for executives who value autonomy and wish to retain counsel familiar with their individual circumstances in addition to having deep industry expertise.
The blog also notes that coverage is not limited to financial restatements and may also apply to non-financial triggers that companies may include in voluntary clawback policies. But it also notes that coverage won’t cover every scenario — for example, coverage won’t be available if an executive is found guilty of fraud or if reimbursement is prohibited by law.