Tune in tomorrow for the webcast – “Pay Equity: What Compensation Committees Need to Know” – to hear Anne Bruno of Mintz, Tanya Levy-Odom of BlackRock, Josh Schaeffer of Equity Methods and Heather Smith of Impax Asset Management | Pax World Funds discuss pay equity – including why it’s in the spotlight, the difference between “pay equity” & “pay gap”, shareholder expectations, disclosure trends on pay gaps & pay equity, pay ratio interplay, mechanics of board & committee oversight and preparing for shareholder engagements & proposals.
As if the folks at Eastman Kodak weren’t having a hard enough year already, the Form 10-Q that the company filed last week disclosed that five former executives made millions by exercising forfeited stock options and selling the underlying shares. The exercises occurred in July – which was right about when Kodak was in the news for its short-lived federal loan. Here’s an excerpt from the notes to financials:
The options exercised in 2020 included 0.3 million options exercised by ex-employees of Kodak that had previously been forfeited. The Company issued shares to the ex-employees in exchange for proceeds based on the exercise prices of the forfeited options. The Company is accounting for the exercise of the forfeited options as a modification of the original awards.
The Company recognized compensation expense of approximately $5.1 million in the three months ended September 30, 2020, related to the 0.3 million previously forfeited options representing the fair value of the shares issued to the ex-employees less the exercise proceeds received from the ex-employees, which is reported in Selling, general and administrative expenses in the Consolidated Statement of Operations.
The Company is seeking to recover the fair value of the shares at the time of the sale of the shares by the ex-employees less the exercise proceeds and withholding (approximately $3.9 million) and the right to retain any refund of the withholding taxes the Company is seeking to obtain on behalf of the ex-employees (approximately $3.0 million). There are no assurances the Company will be successful in its claims against the ex-employees or in its recovery of the withholding taxes.
The company’s discussion of controls & procedures sheds some light on how this occurred – and shows why it’s important to promptly reconcile internal award updates with data maintained by a third-party stock administrator. My experience is that companies do have to be really explicit with service providers on things like forfeitures and blackouts. Here’s more detail from Kodak’s 10-Q (also see this WSJ article):
During the quarter ended September 30, 2020 the Company discovered deficiencies in controls required to safeguard Company assets. The Company did not prevent the unauthorized issuance of the Company’s common stock when previously forfeited non-qualified stock options were exercised by five former officers and employees in July 2020.
Errors existed in employee equity accounts for the five former officers and employees as well as other current and former officers and employees which could have resulted in additional inappropriate exercises. Controls were inadequate with regard to the timely input and verification of master data updates for equity grants, the maintenance of audit documentation of grant activity in the repository of grants serviced by a third-party administrator, and the performance of independent reconciliations of the repository to supporting company records for the detection of errors or misstatements in employee equity account balances.
ISS has released its 2021 proxy voting guidelines – which are effective for meetings on or after February 1st. As my colleague John blogged on TheCorporateCounsel.net, the biggest changes for US companies relate to board diversity and exclusive forum bylaws. As far as things to watch out for on the compensation front, the policies now explicitly say that directors whose pay is comparable to that of the company’s NEOs will not be considered independent. Here’s ISS’s explanation of that change:
Currently ISS looks at the pay of directors, and in some cases, where the pay is considerable and on par with NEO pay for multiple years, the director has been classified as non-independent under “Other material relationships with the company”. To better ensure data capture and categorization of material relationships, this factor is being made explicit.
In addition, the policies clarify ISS’s position on shareholder proposals for pay gap disclosure – saying that they’ll consider local laws that restrict categorizing employees or impose different definitions of ethnic and/or racial minorities in making their recommendations. See Mike Melbinger’s blog for more detail. And don’t forget to tune in for our webcast this Thursday, “Pay Equity: What Compensation Committees Need to Know” – to hear from Mintz’s Anne Bruno, BlackRock’s Tanya Levy-Odom, Equity Methods’ Jash Schaeffer and Impax Asset Management’s Heather Smith.
With volatile economic conditions, some companies have been looking for ways to conserve cash and some have considered worker pay cuts and layoffs. As an alternative, a recent White & Case memo says one strategy some of these companies are considering is replacing a portion of worker pay with equity compensation. Although replacing pay with equity can help save cash and fill a gap created by pay cuts, the memo serves as a reminder of potential issues that can arise, including those relating to employee consent, exempt employment status and tax traps. Here’s an excerpt about potential 409A issues:
While a reduction in salary alone should not trigger 409A concerns, employers should be aware that any commitment to repay the amount of reduced compensation at a later date, in the form of delayed salary payments or salary payments replaced with other consideration such as equity awards, may be a deferred compensation arrangement under Section 409A.
Under 409A, deferred compensation arrangements must comply with specific timing and other rules governing when and how deferral elections can be made. Failure to comply with the Section 409A deferred compensation requirements could exact harsh penalties on affected employees, including accelerated income taxation and a 20 percent penalty tax.
Strategies for avoiding 409A penalties include paying the deferred amount no later than the end of the short-term deferral period (for calendar year 2020 compensation, by March 15, 2021), or structuring the program without an explicit commitment to repay lost wages. In this instance, the employer could unilaterally choose to repay the forgone salary amounts at any time, even beyond March 15.
The latter strategy is risky, requiring great care in both the structure of the program and all related communications with employees. These should be crafted to avoid statements that could create an expectation of deferred payment that might rise to the level of a “reliance” claim resulting in a “legal obligation” of payment which would implicate the deferred compensation rules of Section 409A.
Even with the risks, the memo notes that for companies experiencing dips in their share price but that expect growth to return in the future, offering equity awards can be an efficient and cost-effective way of delivering a meaningful share in this growth to their employees in the long term. The memo provides suggestions for companies that want to pursue such a strategy that can help get them started on the right foot, here are a few:
Transparency is key. A strong, open dialog must evolve among management, workers and unions. Communications must clearly explain to whom the plan applies, how long it will last, why any alternative approaches were rejected, what the benefits are to employees, and most importantly why management believes the plan is essential to the company’s success and the workers’ continued employment.
Communicate how the plan affects other employee programs (if at all), such as 401(k) plans, pensions, healthcare benefits and so on. Engage human resources at every stage of the plan to evaluate the HR effects of the plan and to help with communications.
Be mindful of time limits. In many jurisdictions, there are specific regulations related to how quickly a pay modification can begin after its announcement.
As an alternative, some companies may also want to consider using equity awards not to replace pay, but to make up for benefits reductions or to replace back pay already lost during furloughs.
We’ve blogged about trends in director pay – both for mid-cap and large-cap companies. This Compensia memo reviews trends in technology sector director pay. The memo examines the design and structure of director compensation programs over the last 10 years by comparing data from a 2010 study to more recent data collected earlier this year. The memo notes that although basic pay elements have remained the same over the last 10 years, there have been changes in how the pay is structured and delivered. Here are high-lights relating to director equity compensation:
– Over the last decade, companies have moved from using solely stock options and RSUs to almost exclusively using RSUs when granting equity awards to directors
– 95% of equity grants made today are fixed value-based grants whereas in 2010, only 30% of the companies studied used a fixed value approach
– The practice of granting new director “premium” equity awards, often with a value approximately 1.5x to 2.5x the size of an annual equity award, has continued declining in recent years as the size of annual equity grants has slowly increased
Due to increased scrutiny of director pay, 68% of companies included in the 2020 data include a limit in their stock plan capping the amount of equity (and often, cash) compensation that can be paid to directors annually – it’s noteworthy that these director pay limits were virtually non-existent in 2010
With respect to director “premium” equity awards, the memo discusses how increased investor and proxy advisor focus on ESG issues, along with increased attention on board composition, could lead to the return of “premium” equity awards. Increased focus on ESG matters and certain skills and experiences of directors may well lead to increased competition for certain director candidates – if so, time will tell if this revitalizes the practice of granting “premium” equity awards, in which case eyes will be on the details about award size and related-vesting provisions.
Last week, Liz blogged about FW Cook’s analysis of compensation decisions from S&P 1500 companies with early fiscal year ends (April – June of this year). This Compensation Advisory Partners’ memo provides another in-depth look at pay actions from companies with early fiscal year ends and in addition to the memo, the firm has a searchable Covid-related pay action tracker available on its website. The memo cautions that it’s too early to say whether the actions by the early filers are indicative of trends we’ll see when most companies file their proxy statements in the spring, but it’s helpful to see generally what some companies have done. Here’s some of the memo’s high-lights:
– From an industry-sector standpoint, the early filers show significant representation from Information Technology (28%), Industrials (15%) and Consumer Staples (15%).
– Of the 65 early filers, 43% announced changes to their outstanding and go-forward incentive plans because of Covid-19.
– Modifying the performance period was the most prevalent change for both annual and long-term incentive plans. CAP predicts goal-setting will remain as a key challenge for incentive plan design for 2021 and beyond. The COVID-19 pandemic hurt many companies and helped others (e.g., consumer staples), resulting in highly unusual results for 2020. To address future uncertainty during goal-setting, breaking performance periods into smaller periods may become more common until economic conditions stabilize.
– Although only 4 of the 65 early filers provided special awards to executives, CAP expects to see more special awards in the future – examples of special awards include awards to replace annual and long-term incentives that weren’t paid because of Covid-19 and special grants to incentivize executive performance.
In August, I blogged about the San Francisco ballot initiative – Proposition L – that would impose a tax on companies doing business in the city if a company’s highest paid employee earns 100x more than the company’s average San Francisco worker. The city’s vote totals show that the law has passed – here’s the full text of the measure. Under the law, the tax increases as the pay ratio increases. Here’s an excerpt from ABC News on the new law:
Under the new law, any company that pays its top executive 100 times more than their average worker will pay an extra 0.1% surcharge on its annual business tax payment. If a CEO makes 200 times more than the average employee, the surcharge increases to 0.2%; 300 times gets a 0.3% surcharge and so on.
Some fear the new tax will drive some businesses out of the city but San Francisco City Supervisor, Matt Haney, said the tax is modest compared to the cost for a company to move. He hopes the tax will lead companies to re-examine their compensation structures.
Questions remain about the new law though as it doesn’t define how compensation will be determined – so there’s more to understand before businesses can understand how this will impact them. The text of the law says it becomes operative on January 1, 2022 and ABC News says that the law is expected to generate between $60 million to $140 million per year.
As we brace for a possible surge in Chapter 11 filings due to the pandemic, this memo from Compensation Advisory Partners suggests that some shareholders might be more understanding of executive awards intended to retain executives who can guide the company through these challenging times – if the rationale is adequately explained. Here’s an excerpt:
While situations vary by industry, most agree that this flurry of bankruptcy filings is not the result of poor management but rather the inevitable impact of unprecedented and unforeseeable broad shutdowns across the country to contain the pandemic. The companies entering bankruptcy need continuity, stability, and motivated leadership. Carefully designed and communicated retention and performance awards can play an important role in keeping leadership in place and focused on moving the company through the restructuring process.
The memo sorts through recent Form 8-K announcements to summarize common parameters for these types of awards. It notes that a few companies have included a performance-based clawback to improve optics. It also touches on the rare arrangement of executive severance programs in bankruptcy.
Many comp committees still use some form of “tally sheet” to understand total compensation payable to NEOs under various scenarios – some also use it to track accumulated wealth. A new “CEO Wealth Tracker” from Farient Advisors makes those wealth numbers more easily accessible to anyone who’s interested – and the data can be filtered by stock index, time frame, founder status and sector. Here’s more info:
For many top executives, personal wealth is far more impacted by the value of their company shares than by their disclosed total pay. Farient Advisors is pleased to release our CEO Wealth Tracker™—a new tool that highlights the change in the value of CEO shares in the companies they lead. For companies in the Russell 3000, this interactive resource shows a CEO’s current wealth, wealth change over time, and the portion of wealth change due to stock price changes versus net new shares, all in a sortable table.
This FW Cook blog analyzes FYE compensation decisions that have been recently disclosed by S&P 1500 companies whose fiscal years ended in April – June of this year. Here are some takeaways:
– For annual bonus plans, 13 companies (22%) exercised positive discretion to increase the formulaic bonus outcome – the average payout increased from 16% of target to 80% of target and the most common approach was to pro-rate performance based on outcomes up to the onset of the pandemic
– For annual bonus plans, 12 companies (20%) delivered zero payout and didn’t exercise positive discretion – that included 2 companies that exercised negative discretion to decrease the formulaic bonus outcome to zero
– For annual bonus plans, about half of the companies that didn’t exercise discretion had a non-financial component or some other means by which to award a payout even when the financial component didn’t fund
– For long-term incentive plans, 6 companies exercised positive discretion to measure performance up to the onset of the pandemic (e.g. calculate performance using 11 of 12 quarters)
– For long-term incentive plans, only 2 companies disclosed modifications to in-cycle performance awards
– Approximately 25% of companies prospectively disclosed they were making changes to fiscal 2021 annual bonus and/or long-term incentive plans in light of pandemic challenges
The blog notes that calendar year companies may not gain much ground by pro-rating annual incentives as some of these “early filers” have done – but it may be reasonable to explore that approach for long-term incentive plans (i.e., use data for 8 or 9 of 12 total quarters). Here’s an excerpt:
We believe this approach to pro-rate the payout is an important signal to investors of the trade-offs that are necessary to deliver fair incentive plan outcomes to management participants who have faced huge challenges outside of their control, while recognizing that many shareholders are facing negative returns and rank-and-file employees have also made sacrifices (e.g., furloughs and layoffs).
Calendar year companies that decide to exercise positive discretion to increase the formulaic bonus outcome will need to articulate a more holistic rationale for the higher payout that is tailored to their individual facts and circumstances. Common themes we have observed in working with our clients include post-pandemic absolute financial performance, relative performance versus key industry peers, the shareholder experience, and the execution on the operational and supply chain challenges that arose from the pandemic, including safeguarding the health and safety of employees, suppliers and customers.
Due to accounting and disclosure consequences, the blog cautions compensation committees to consider a broad range of options before proceeding with any changes to in-cycle awards, such as changes to metrics, goals, the measurement period, or revisions to adjustments. Check out our “Covid-19″ Practice Area for lots of memos on pandemic-related pay adjustments. And mark your calendars now for our February 25th webcast, “Your CD&A: A Deep Dive on Pandemic Disclosures,” for tips on how to tell your pay story in your proxy statement.