I blogged last month about global trends relating to incorporation of ESG metrics into incentive plans. In another study, FW Cook examined use of ESG measures in annual and long-term incentive plans among US-listed companies with market caps greater than $25 billion – data was based on proxy statements filed as of July 2020. They found 56% of the companies used one or more ESG measures in their incentive plans, which sounds like a lot, but the study also cautions companies to be mindful of potential unintended consequences.
The last thing anyone wants is to charge forward, set ESG targets, fall short of achieving targets and then face the challenge of explaining that to investors and other stakeholders. As many comp committees continue discussions about whether to incorporate ESG measures into incentive plans, commentary to the study lists the following questions for consideration:
Is it feasible to set reasonable targets and make meaningful progress on the chosen initiatives within the time frames typically used for measuring performance in incentive programs (i.e., one year for annual incentives and three years for long-term performance awards)?
Are they prepared to communicate such targets internally to the employee population and externally to shareholders in the proxy statement? If not, are they prepared to defend their decision to reward executives for progress on ESG initiatives without providing transparency as to the specificity and robustness of the goals?
Is there a recognized standard for measurement of progress on the ESG initiatives, and if not, can the company track progress in a quantifiable manner?
Will they create outsized risk of embarrassment if they disclose underperformance, and could the risk of embarrassment lead management to make non-ideal short-term decisions that might impair the longer-term objectives?
Is it appropriate to compensate executives for achievement of ESG initiatives, particularly if financial performance and shareholder returns are below expectations?
A Corporate Board Member article also included commentary from the study’s authors saying ‘this is an area where we encourage companies to walk before they run.’ The article includes a helpful chart with possible stepping stones for incorporating ESG metrics into incentive plans.
I blogged a couple of weeks ago about one potential proxy season theme and another might be how investors and proxy advisors view 2020 Covid-related pay actions. A recent Compensation Advisory Partners’ memo provides insight into how ISS might view Covid-related pay changes. CAP reviewed select Covid-19-related pay actions from companies with fall fiscal year-ends and the corresponding ISS proxy research report. The memo highlights six companies that made various changes to their incentive plans and one high-level takeaway is that the proxy advisor’s assessment of Covid-related pay decisions appears highly correlated to the concern level on its quantitative CEO pay-for-performance screens. Here’s an excerpt:
CAP’s preliminary findings indicate that if a company made COVID-related compensation changes and received an elevated level of concern on the ISS pay for performance evaluation, the proxy advisor will likely recommend Against the Say on Pay proposal, thereby significantly impacting the Say on Pay vote. To date, we have observed three companies that experienced sharp declines in their Say on Pay results, with one failing to receive majority support.
Based on this early review, CAP encourages companies to prepare compelling proxy statement disclosures with the rationale supporting Covid-related pay decisions along with how they’re aligned with long-term shareholder value creation. Beware that ISS is highly critical of special one-time awards, upward (discretionary) adjustments to payouts, front loading annual equity awards, and reductions in performance-based long-term incentives.
It’s been a while since we’ve blogged about the potential impact of Covid-19 related complications for CEO pay ratio calculations and disclosures. A Freshfields blog provides several compensation-related considerations for the 2021 proxy season, including discussion about revisiting the CEO pay ratio calculation in light of Covid-19.
When preparing this year’s pay ratio calculation, many companies will need re-identify the median employee. The blog notes that even companies that identified a new median employee in the last two years need to evaluate whether referencing last year’s median employee is still appropriate – this is especially true for companies that faced significant workforce changes in the last year. This year, one complexity some companies will encounter is whether and how to factor furloughed employees into the pay ratio calculation, here’s an excerpt:
The rules themselves do not however address the treatment of furloughed populations. Subsequent guidance released by the SEC acknowledges that the concept of a “furlough” may have different meanings for different employers and leaves it up to companies to determine whether furloughed populations will be regarded as employees depending on the facts and circumstances (CD&I 128C.04). In making these determinations, companies with furloughed populations should consider factors such as whether the furloughed individuals are still acting as employees (albeit on reduced workweek schedules) or if they have been on leave for several months with no clear prospect of return. If a furloughed individual is identified as an employee, the company must take the additional step of determining the appropriate subset of classifications and calculate total compensation accordingly.
Although the pay ratio rules do not require narrative explanations of the resulting figure, companies that experience significant change in the year-over-year ratio may nonetheless elect to offer disclosure to provide additional context around the unique circumstances brought to bear this year.
Yesterday, the SEC announced it had settled charges against a gas exploration & production company and its former CEO for failing to disclose $650,000 worth of perks. Here’s an excerpt from the press release:
The SEC’s separate orders against Gulfport and Moore find that, from 2014 to 2018, Gulfport failed to disclose approximately $650,000 in executive compensation in the form of perquisites received by Moore, and also failed to disclose certain related person transactions involving Moore. According to the orders, the undisclosed perquisites included the cost of Moore’s use of Gulfport’s chartered aircraft for certain travel.
The undisclosed perquisites also included costs associated with Moore’s use of a Gulfport corporate credit card for personal expenses that he did not repay on a timely basis, which resulted in Gulfport extending Moore interest-free credit and carrying a related person account receivable. The orders also find that Gulfport failed to disclose that it paid Moore’s son’s landscaping company approximately $152,000 in 2015 for its services. The order against Moore further finds that Moore caused Gulfport’s violations by failing to supply required information that would have allowed Gulfport to identify and disclose the perquisites and related person transactions.
Similar to the perks enforcement action last fall, the Commission highlighted that it considered the company’s cooperation and prompt remedial acts when determining whether to accept the settlement offer – and this time, there was no penalty at all imposed against the company. Here’s what those efforts included:
– Replacing key personnel
– Developing an internal internal audit function
– Enhancing existing policies & procedures
– Instituting new review & tracking processes
This is the third perks settlement that the SEC has announced since last June – we list all the cases in our “Perks” Practice Area. To make sure that your company is disclosing everything it needs to, make sure to check out our 102-page chapter on Perks & Other Personal Benefits as part of Lynn & Borges’ “Executive Compensation Disclosure Treatise” posted on this site. If you attended our “17th Annual Executive Compensation Conference” last fall, you can also use the video archives to refresh your memory on the two-step analysis.
This one-page checklist from Semler Brossy is great because it acknowledges that your peer group can’t please everyone – but there are still ways to identify one that will accomplish your defined objectives. Here are the steps it recommends:
1. Engage the Committee and management to define how the “peer group” will be used (e.g., pay levels, pay practices, or both)
2. Outline a set of objective characteristics for which to evaluate potential peer companies (e.g., size, growth, valuation, industry)
3. Determine whether additional secondary criteria should be used to narrow the universe of potential peers (e.g., geographic footprint, ownership structure)
4. Acknowledge that no peer group will be perfect and that not all companies in the resulting peer group will necessarily be direct competitors for business or executive talent
5. Ensure that peer companies are within a reasonable range of the client’s revenue if using for pay levels comparisons
6. Engage Compensation Committee Chair and management early to ensure buy-in and thorough understanding of the purpose of the peer group and rationale for peer constituents
7. Confirm disclosure requirements with company’s internal and external counsel
The International Corporate Governance Network recently issued this 10-page memo on integrating ESG into executive compensation plans. Consistent with what we’ve been hearing from investors, ICGN notes that the COVID-19 pandemic has the potential to re-invigorate the debate about high levels of executive pay and income inequality.
ICGN proposes key characteristics of short- and long-term pay programs that can advance sustainability initiatives, regardless of location-specific market practices or regulations. It recommends using the SASB materiality map and guidelines from the European Commission as a starting point – and suggests that LTIPs be extended to cover 5-year periods.
What may be especially helpful to companies as they prepare for proxy season disclosures and engagements is this list of sample questions that investors can ask:
1. What are the top three environmental, social or governance considerations of your company?
2. (How) have you engaged with key stakeholders to determine these? Who are the key stakeholders? Where is the process documented? How often is this consultation repeated?
3. How many of these ESG considerations are part of the strategic outlook of the company for the next 5 years? For the next 10 years?
4. Can you define opportunities for balancing long-term value creation, short-term strategic agility, and the building of stakeholder ecosystems all at the same time?
5. How does the company’s mission and its board-level narrative on sustainability issues get translated into robust governance of these issues, a clear strategy, risk (and opportunity) management as well as metrics and KPIs?
6. What are the company-wide KPIs related to these issues?
7. Do you have along-term incentive plan in place? What are the relevant ESG-related performance metrics and gateways for these? What is the evaluation and vesting period for it?
8. How you approach setting well-fitting multiyear performance targets in long-term incentives plans, in a changing – and sometimes unpredictable – world?
9. Do executives have a share-ownership requirement? What multiple of their annual fixed salary is this? What’s the time-frame after their appointment that they need to reach this level? What is the holding period requirement after cessation of their executive role?
10. How do you entice ownership of environmental, social and governance issues in company governance and among directors, executives and employees?
11. What makes your disclosure on these issues credible and reliable?
12. How are these issues integrated in the compensation packages of executives and others?
13. What are your three-and five-year targets regarding integrating sustainability in the remuneration and what is the roadmap to get there?
14. What help would you welcome from the investment community on this?
15. Do you benchmark your current remuneration practices against peers (also in the context of the pandemic)? How do you know which peers to look at for best practice?
Tune in tomorrow for our webcast – “Your CD&A: A Deep Dive on Pandemic Disclosures” – to hear Mike Kesner of Pay Governance, Hugo Dubovoy of W.W. Grainger and Cam Hoang of Dorsey discuss how to use your CD&A to tell your story and maintain high say-on-pay support, trends and investor expectations for COVID-related pay decisions, addressing “red flags” through storytelling, linking your CD&A to your broader ESG and human capital initiatives and ensuring consistency between your CD&A and minutes.
This recent memo from Compensation Advisory Partners also discusses what actions companies are taking – 42% of companies are making changes, mostly to annual incentive plans.
If you attend the live version of this 60-minute program, CLE credit will be available! You just need to submit your state and license number and complete the prompts during the program.
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We’ve blogged before about studies showing executive pay actions in response to the pandemic. Recently, CG Lytics, the data service provider to Glass Lewis for the proxy advisor’s say-on-pay recommendations, issued a report summarizing Covid-related pay actions by Russell 3000 companies. For companies in hard-hit sectors that are interested in conserving cash, the report offered this bold, albeit potentially unrealistic, suggestion:
If CEOs in hard-hit businesses would like to help their companies save cash and support employees, bigger sacrifices, such as returning part of their compensation packages or taking bonus cuts and reductions in other short-term cash incentives, may be impactful.
The report presents high-level data about pay cuts and adjustments to incentive plans by sector. The data is generally consistent with prior reports and shows most actions have been by companies in the consumer discretionary and industrials sectors. For companies that made base salary cuts in response to challenges from the pandemic, CG Lytics characterizes these actions as “window dressing” as it notes that base salary is commonly only a small fraction of compensation packages.
In a recent Directors & Boards article, Blair Jones and Greg Arnold of Semler Brossy discuss incentive goal setting amid the pandemic. Uncertainty about the pandemic’s duration and its effect on company performance has made 2021 goal setting all the more challenging. To help compensation committees set 2021 incentive plan goals, the article provides several considerations for companies whether they’re in hard-hit or well-performing sectors. For companies that had a banner year in 2020, the article suggests the following as possible considerations to help reduce risk of a disconnect between incentive payouts and shareholder expectations:
– Change the leverage curve: while targets may be lower than 2020 performance, if these are missed, the payouts decline quickly and for maximum payout levels, those should be much harder to reach
– Use a multi-year lens: consider what is fair progress from 2019, or for 2020 and 2021 combined
– Set different performance curves based on macro environment: boards could establish one set of performance goals if the broader economy declines by 5% and a lower range of goals if it goes down by 10%, and the payout opportunity could be adjusted as well
Throughout the year, and particularly this time of year when many companies dole out bonuses, many keep a watchful eye on CEO pay. A recent Pay Governance memo takes a look at S&P 500 CEO compensation increase trends. The memo analyzes S&P 500 CEO pay trends by focusing on CEO median total direct compensation (base salary, actual bonus paid and grant date value of long-term incentives) and finds that historical CEO pay increases have been supported by historical TSR, with annualized pay increases trailing TSR performance by 9 percentage points. Here’s an excerpt with some projections about what might be in store:
– We expect that 2020 overall CEO actual TDC will decrease, potentially by 3-4%, due to the pandemic and weaker financial results that impacted bonus payout decisions, although this will vary based on industry performance
– We expect median CEO target pay increases in early 2021 to be in the low single digits due to some companies providing “supplemental LTI grants” for lost value for performance equity that was lost during COVID-19 – again, we’ll likely see variation with executives in industries with favorable economic conditions and higher growth seeing more significant pay increases, while those in hard-hit industries seeing flat or continued pay declines
– Individual CEO pay increases will continue to be closely tied to overall company performance and peer group compensation increases; it is notable that S&P 500 TSR was +18% in 2020, primarily driven by large-cap technology companies
– Although the study found a positive correlation between CEO annual pay increases and TSR performance, it says they’re confident the correlation isn’t as significant as that between realizable pay and TSR increases
Disney is one company that’s been hard-hit by the pandemic. During the last year, it’s been in the news as, among other things, it imposed executive pay cuts and made plans to furlough employees. A couple of weeks ago, the company filed its 2021 proxy statement and disclosed the compensation committee made “a determination to pay no executive bonuses despite achievement of certain performance metrics.” As we start seeing more 2021 proxy statements, for companies in hard-hit industries, we’ll see whether Disney’s decision on executive bonuses turns into a trend.