We continue hearing more about how companies are incorporating ESG metrics into incentive programs – earlier this week, I blogged about Marathon Oil’s changes to its incentive programs and here’s an entry about how Apple is incorporating an ESG measure in its annual incentive program. A recent Farient Advisors’ report analyzes global data on stakeholder measures incorporated in incentives. The report includes comparative data across global regions and industries, along with high-level data about common issues, such as how much weight to assign to the measures. Here’s an excerpt with a few takeaways:
In terms of mechanisms for incorporating stakeholder measures in incentive plans, the report shows that they’re typically incorporated as weighted measures or within a weighted scorecard. Fewer companies use measures as a modifier or a basis for general discretion.
One challenge for companies incorporating stakeholder measures in incentives is how much weight to assign to the measures. Globally, stakeholder measures are weighted at approximately 20% in incentive plans – the median weighting across regions is also 20%, with Australia being the only outlier at 30%. Even in industries in which stakeholder measures are more prevalent, companies commonly weight the measures at about 20% of total incentive mix.
When it comes to measuring progress on stakeholder interests, most companies use internally-derived goals. The report notes that there are reasons supporting use of internal goals – they can be tailored to a company’s specific strategy and corporate purpose. The report also notes that there are reasons supporting use of external benchmarks – they can provide objectivity and help promote better engagement with investors and third-party rating agencies. For companies using external benchmarks, the Dow Jones Sustainability Index and Carbon Disclosure Project are the most frequent benchmarks.
The different industry mix in each region is one reason why the incidence of stakeholder measures in incentives differs by region – Australia has the highest prevalence of stakeholder measures in incentives and has a heavy mix of materials and financial services companies in its economy whereas the U.S. has the lowest prevalence of stakeholder measures in incentives and has a more diversified economy with a heavy mix of technology companies. Information technology and consumer discretionary industries use stakeholder measures in incentives less frequently and as a result, the U.S. and Continental Europe exhibit the lowest prevalence of stakeholder measures in incentives.
One aspect of CEO succession that you don’t read a lot about is the effectiveness of steps taken to help ensure retention of other senior leaders. To help limit post-CEO succession turnover, companies sometimes make special retention grants to other senior leaders. A helpful FW Cook memo examines the effectiveness of this strategy and found retention grants can help minimize departures within one or two years of a CEO succession, but they’re not a permanent solution.
In analyzing the effectiveness of retention grants, FW Cook looked at large-cap companies with CEO turnover from 2010 – 2016. The study sample included 65 companies and of those, approximately 40% made succession-related retention grants to non-CEO NEOs. It found NEOs receiving retention grants were most likely to stay with the organization for the first two years following a CEO transition compared to those who don’t receive them. Here’s some of the study’s other findings:
– Among grant receivers, the most common departure point was in the third year after the succession (33% of those who left within the first five years, and 29% of all who eventually departed) suggesting that NEOs will often leave a company after receiving the entirety of an award with a three-year vest or majority of an award with a five-year pro-rated vest.
– In contrast, among grant non-receivers, the most common departure point was within one year of CEO succession (28% of those who left within the first five years, and 16% of all who eventually departed). Our research found that departure rates for non-receivers show a steady downward trend through five years, suggesting that stability of the leadership team is most tenuous in the initial year of a transition, and special one-time awards may provide an effective retention tool during that time.
– When it comes to the value of the grant, the study found the more valuable the grant, the stronger its ability to retain – but the ability to do so levels off once the grants pass the $2 million mark.
Although retention grants don’t keep some leaders around forever, they do promote organizational stability and allow time to develop leaders within an organization. The memo notes several other factors that of course play into whether an executive decides to stay following a CEO succession – and suggests as fodder for a future study possibly exploring the correlation between outstanding equity value and retention results.
A few things come to mind when thinking about possible themes for the 2021 proxy season and one could involve companies linking executive pay to progress on sustainability initiatives. And, last week, Marathon Oil took action by modifying its incentive programs to better align with the company’s ESG framework. The company issued a press release about the changes, which also includes new targets for greenhouse gas emissions reductions. SEC filings show the company usually files its proxy statement in the spring but this excerpt from the press release helps explain changes made to the company’s executive incentive programs:
Marathon Oil’s short-term incentive (STI) annual cash bonus scorecard has been restructured to better reflect the Company’s financial and ESG framework. The scorecard has been simplified to prioritize performance in 5 areas deemed critical for long-term shareholder value creation:
safety (total recordable incident rate);
environmental (GHG emissions intensity);
capital efficiency (corporate free cash flow breakeven);
capital discipline/free cash flow (reinvestment rate); and
financial/balance sheet strength (cash flow per debt adjusted share).
All production and growth metrics have been eliminated from the Company’s annual bonus scorecard.
Additionally, the Company has revised its LTI compensation framework, now focused on three vehicles, all of which are denominated in shares: restricted stock units (RSUs), relative total shareholder returns performance stock units (TSR PSUs), and free cash flow performance stock units (FCF PSUs). The revised framework is intended to mitigate an overreliance on relative TSR against direct E&P peers by introducing the S&P 500 and S&P Energy indices as peer comparators within the relative TSR calculation to promote improved performance vs. the broader market. Additionally, the introduction of FCF PSUs further diversifies the LTI performance metrics and underscores the Company’s priority to generate sustainable free cash flow.
Yesterday, Glass Lewis issued new details on its approach to executive pay in the context of COVID-19. The proxy advisor hasn’t changed its executive pay framework – but the guidance explains in more detail how those existing policies will apply to pay programs and the pay-for-performance analysis in light of the pandemic, as well as proposals for additional equity plan reserves and other compensation-related topics.
This is going to be important guidance to consider as you draft your CD&A, so that you can provide disclosure that’s responsive to what the investor community is expecting. Read the whole thing for details. Here are some high points that could affect say-on-pay recommendations:
1. Increases to Quantum. Unless companies have performed very well on a relative and absolute basis, we will view increases to short-term pay levels or above-target payouts with great scrutiny. Moreover, companies that have adjusted their programs to provide enhanced outcomes will have a high bar to prove the appropriateness of their actions.
2. Forwards vs Backwards. We generally view year-over-year increases to target incentive payout opportunities more tolerably than high payouts for backward-looking performance, as we recognize the need to incentivize executives going forward. However, this allowance is contingent on the incentive plan incorporating robust performance requirements that are reflective of executive efforts.
3. One-Off Awards. Glass Lewis continues to be wary regarding one-off awards granted outside a company’s regular incentive schemes, as such awards have the potential to undermine the integrity of a company’s regular incentive plans, the link between pay and performance, or both.
4. Major Structural Changes. We will view any major structural program changes with caution. Glass Lewis believes that boards should be thoughtfully restrained regarding sweeping, long-term changes, which may appear preemptive given ongoing market uncertainties and may only serve to heighten shareholder concerns.
5. Potential Windfalls. We will evaluate the potential for any program changes, particularly to equity-based grants, to result in windfall benefits to executives, should the company’s prospects improve over time as a result of improving conditions that lie outside of executive control.
6. No Penalty For Late Bloomers. We will not penalize firms which did not provide extensive discussion of their broad response to the pandemic in their 2020 proxy season filings — but we will credit companies that did provide some insight into the board’s approach for their willingness to address the proverbial elephant in the room. In particular, for firms which made significant adjustments to the pay program in the first months of 2020, we will review the overall framework of the program in the context of boom and bust times. We view short-sighted concessions negatively, particularly if the company has recovered meaningfully and no counterbalance to windfalls or compromises can be identified.
7. We Will Take Past History Into Account. Companies that have exhibited a healthy track record of good governance, pay-for-performance alignment and appropriate use of board discretion prior to the COVID-19 pandemic will likely be viewed through a more accommodating lens than companies that have not.
As we’ve talked about on this blog before, express board oversight of “human capital” is becoming more common – and it frequently falls to compensation committees. This Willis Towers Watson memo confirms that directors are now viewing employees not just as a cost – but as a fundamental asset to business success, which needs board-level attention. If anything, the pandemic has accelerated “human capital” as a priority. Here’s an excerpt:
Directors we spoke with in the U.S. shared how COVID-19 highlighted cultural issues in the context of HCG that could harm their company’s reputation. Better governance on human capital and understanding the drivers of a suboptimal culture have become priorities to turn the business around.
One challenging aspect of this oversight role is getting a sense for corporate culture and how it impacts employees. I blogged yesterday on our “Proxy Season Blog” on TheCorporateCounsel.net about a new report from CII that looked at disclosure about director interactions with employees as a way to gauge corporate culture oversight. The report is also posted in our “Human Capital Management” Practice Area on this site.
Another challenge for boards is collecting and interpreting appropriate data about the workforce and management’s day-to-day actions to support workers. This KPMG memo offers sample questions for the board or comp committees to consider, particularly as companies are navigating “return-to-work” plans and potential business disruptions:
1. Is management’s return-to-work strategy agile enough to withstand the constantly changing conditions? What risks does this plan present to employee health and safety and to the company’s reputation and long-term strategy, and how are these risks being mitigated?
2. What metrics does the board receive on employee health and safety (e.g., whistle-blower complaints about working conditions, employee absences related to COVID-19, unplanned turnover due to caretaking responsibilities)? How frequently is management providing the board with these metrics (e.g., a weekly email from the CEO, a COVID-19 dashboard on the board portal)?
3. What long-term changes is management considering implementing permanently after COVID-19 subsides (e.g., talent development strategy, digital strategy, flexible work strategy)?
4. Where does management feel pressure in balancing the short-term versus long-term interests of the corporation? How is management considering stakeholder priorities and social issues in light of the company’s financial condition?
5. Which roles are crucial to the company’s strategy and would present significant risk if vacant or filled by unqualified employees?
6. What skills are necessary to perform these roles? Do the individuals currently holding these roles possess the required skills?
7. Are there succession plans to fill these positions should they become vacant unexpectedly? Are employees cross-trained on these mission-critical roles so they can immediately step in?
8. In light of COVID-19 and business model disruption, have there been changes in the company’s strategy that make some positions more critical or others less so? Should any mission-critical roles be redesigned or automated?
This Orrick memo is a reminder that companies need to furnish – by next Monday, February 1st – annual information statements to people who exercised ISOs or transferred ESPP shares during 2020. Companies also need to file an information return with the IRS in March.
The memo explains what IRS forms to use, how to contact participants and make the IRS filings, and also links to a sample statement that could be provided to participants.
Willis Towers Watson recently published its annual analysis of director pay levels and practices among S&P 500 companies. As I’ve previously blogged, arrangements have been pretty consistent year-over-year – but the memo gives a detailed breakdown of the value of different pay components on an average and median basis – as well as at the 25th and 75th percentiles, and as compared to 2018 and 2019. The info on stock ownership guidelines is also useful, as investors continue to want companies to demonstrate a focus on long-term value creation.
The memo also notes that 68% of S&P 500 companies have now set annual compensation limits for directors – a 4% increase since last year (and a practice that will likely persist in light of Delaware case law). Here’s more detail:
– Of the companies that have newly adopted limits, 91% of the limits cover both cash and equity and 9% cover equity only
– 19 companies updated compensation limits last year – with 74% of those amended to include cash compensation for a combined compensation limit
– Of all the companies with limits, 31% combine fixed-value cash and equity limits, 26% use fixed-value equity limits, and 11% are based on a fixed number of shares
– The median fixed-value limit for cash & equity is $750,000 (unchanged from 2018 and 2019)
We’ve blogged before about CII urging companies to reduce complexity of their incentive plans. One positive outcome from simplifying incentive programs is that it also simplifies drafting the CD&A disclosure and helps increase investor’s understanding of the program. A recent Meridian memo says that due to uncertainty resulting from Covid-19, for companies making changes to 2021 long-term incentive awards, one common adjustment is to simplify things by granting more time-vested restricted stock. Using time-vested restricted stock may not be the right move for everyone but the memo discusses some of the benefits and considerations, here’s an excerpt:
The rationale for this predicted shift to increased use of time-vested restricted stock is not hard to understand. In this environment, restricted stock provides two key advantages over performance-based LTI:
– More certain retention value for executives in an uncertain environment; and
– No requirement to set realistic multi-year performance goals, a well-nigh impossible task for some companies right now.
Every company should carefully evaluate the design of their own program and its alignment with their unique business and talent strategies. Executive teams may reasonably question whether complex long-term incentive programs actually drive any meaningful change in behavior or performance.
However, no change to the executive compensation happens in a vacuum. As discussed in the memo, CII calls for more time-vested restricted stock. CII also calls for longer vesting periods – which can help further align executives with shareholders on a truly long-term basis and can potentially help better bridge periods of temporary uncertainty. Another crucial piece of the equation is the size of the opportunity. If companies reduce the inherent “risk” of CEO compensation by reducing or eliminating performance-based awards, they should also consider whether the size of the current pay opportunity should be adjusted accordingly.
Tune in tomorrow for our webcast – “The Latest: Your Upcoming Proxy Disclosures” – to hear Mark Borges of Compensia, Alan Dye of Hogan Lovells and Section16.net, Dave Lynn of TheCorporateCounsel.net and Morrison & Foerster and Ron Mueller of Gibson Dunn discuss all the latest guidance – including the latest SEC positions – about how to use your executive & director pay disclosure to improve voting outcomes and protect your board, as well as how to handle the most difficult issues on oversight, engagement and disclosure of executive & director pay.
Looking back at 2020, compensation committees ended up addressing a lot of issues resulting from Covid-19. As the economic effects continue, a recent Ogletree Deakins memo lists 5 key executive compensation trends and issues for 2021. The list can serve as a reminder about issues to consider when making decisions about executive compensation and 2021 changes and covers clawbacks and “cause” definitions, temporary salary reductions, 2020 performance awards, 2021 incentive compensation and change in control and severance agreements.
With respect to change in control and severance arrangements, the memo suggests this could be particularly important for companies that may be dealing with financial challenges:
Due to financial challenges, a number of companies are facing difficult restructuring decisions. In addition, many financial buyers and competitors have not abandoned their strategic business plans and may initiate acquisitions of companies that are temporarily undervalued in the COVID-19-disrupted economic environment. Accordingly, companies may want to review existing change in control or severance arrangements or implement new arrangements. With respect to severance arrangements, it is important to consider whether they are subject to the ERISA and Internal Revenue Code Section 409A, and, depending on how post-termination health benefits are provided, determine any continuing health benefits compliance issues under the COBRA. Companies should consider reviewing change in control arrangements to ensure leadership continues to be focused on the company’s business and is protected in the event of an unexpected or unwanted transaction.